RBC Bearings INC: Form 10-Q for the period ended Dec 31, 2022

Cautionary Statement as to Forward-Looking Information

The objective of the discussion and analysis is to provide material information relevant to an assessment of the financial condition and results of operations of the Company including an evaluation of the amounts and certainty of cash flows from operations and from outside sources.

The information in this discussion contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are subject to the “safe harbor” created by those sections. All statements, other than statements of historical facts, included in this quarterly report on Form 10-Q regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management are “forward-looking statements” as the term is defined in the Private Securities Litigation Reform Act of 1995.

The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation: (a) the bearing and engineered products industries are highly competitive, and this competition could reduce our profitability or limit our ability to grow; (b) the loss of a major customer, or a material adverse change in a major customer’s business, could result in a material reduction in our revenues, cash flows and profitability; (c) our results have been and are likely to continue to be impacted by the COVID-19 pandemic; (d) weakness in any of the industries in which our customers operate, as well as the cyclical nature of our customers’ businesses generally, could materially reduce our revenues, cash flows and profitability; (e) future reductions or changes in U.S. government spending could negatively affect our business; (f) fluctuating supply and costs of subcomponents, raw materials and energy resources, or the imposition of import tariffs, could materially reduce our revenues, cash flows and profitability; (g) our results could be impacted by governmental trade policies and tariffs relating to our supplies imported from foreign vendors or our finished goods exported to other countries; (h) some of our products are subject to certain approvals and government regulations and the loss of such approvals, or our failure to comply with such regulations, could materially reduce our revenues, cash flows and profitability; (i) the retirement of commercial aircraft could reduce our revenues, cash flows and profitability; (j) work stoppages and other labor problems could materially reduce our ability to operate our business; (k) unexpected equipment failures, catastrophic events or capacity constraints could increase our costs and reduce our sales due to production curtailments or shutdowns; (l) we may not be able to continue to make the acquisitions necessary for us to realize our growth strategy; (m) businesses that we have acquired (such as Dodge) or that we may acquire in the future may have liabilities that are not known to us; (n) goodwill and indefinite-lived intangibles comprise a significant portion of our total assets, and if we determine that goodwill and indefinite-lived intangibles have become impaired in the future, our results of operations and financial condition in such years may be materially and adversely affected; (o) we depend heavily on our senior management and other key personnel, the loss of whom could materially affect our financial performance and prospects; (p) our international operations are subject to risks inherent in such activities; (q) currency translation risks may have a material impact on our results of operations; (r) we are subject to changes in legislative, regulatory and legal developments involving income and other taxes; (s) we may be required to make significant future contributions to our pension plan; (t) we may incur material losses for product liability and recall-related claims; (u) environmental and health and safety laws and regulations impose substantial costs and limitations on our operations, and environmental compliance may be more costly than we expect; (v) our intellectual property and proprietary information are valuable, and any inability to protect them could adversely affect our business and results of operations; in addition, we may be subject to infringement claims by third parties; (w) cancellation of orders in our backlog could negatively impact our revenues, cash flows and profitability; (x) if we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud; (y) litigation could adversely affect our financial condition; (z) changes in accounting standards or changes in the interpretations of existing standards could affect our financial results; (aa) risks associated with utilizing information technology systems could adversely affect our operations; (bb) our quarterly performance can be affected by the timing of government product inspections and approvals; (cc) we may not be able to efficiently integrate Dodge into our operations; (dd) we may fail to realize some or all of the anticipated benefits of the Dodge acquisition or those benefits may take longer to realize than expected; (ee) we incurred substantial debt in order to complete the Dodge acquisition, which could constrain our business and exposes us to the risk of defaults under our debt instruments; and (ff) increases in interest rates would increase the cost of servicing the Term Loan Facility and could reduce our profitability. Additional information regarding these and other risks and uncertainties is contained in our periodic filings with the SEC, including, without limitation, the risks identified under the heading “Risk Factors” set forth in our Annual Report. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make. We do not intend, and undertake no obligation, to update or alter any forward-looking statement. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, that appears elsewhere in this Quarterly Report.

Overview

We are a well-known international manufacturer and maker of highly engineered bearings and precision components. Our precision solutions are integral to the manufacture and operation of most machines and mechanical systems, reduce wear to moving parts, facilitate proper power transmission, and reduce damage and energy loss caused by friction. While we manufacture products in all major bearings categories, we focus primarily on the higher end of the bearing and engineered component markets where we believe our value-added manufacturing and engineering capabilities enable us to differentiate ourselves from our competitors and enhance profitability. We believe our expertise has enabled us to garner leading positions in many of the product markets in which we primarily compete. With 56 facilities in 10 countries, of which 37 are manufacturing facilities, we have been able to significantly broaden our end markets, products, customer base and geographic reach.

Previously we operated under four reportable business segments – Plain Bearings, Roller Bearings, Ball Bearings, and Engineered Products – but the Dodge acquisition has resulted in a change in the internal organization of the Company and how our chief operating decision maker makes operating decisions, assesses the performance of the business, and allocates resources so that we now operate under two reportable business segments – Aerospace/Defense and Industrial:

• Aerospace/Defense. This segment represents the end markets for the Company’s highly engineered bearings and precision components used in commercial aerospace, defense aerospace, and marine and ground defense applications.
• Industrial. This segment represents the end markets for the Company’s highly engineered bearings, gearings and precision components used in various industrial applications including: power transmission; construction, mining, energy and specialized equipment manufacturing; semiconductor production equipment manufacturing; agricultural machinery, commercial truck and automotive manufacturing; and tool holding.

Financial information for fiscal 2022 has been recast to conform to the new segment presentation.

The markets for our products are cyclical, and we have endeavored to mitigate this cyclicality by entering into single and sole-source relationships and long-term purchase agreements, through diversification across multiple market segments within the Aerospace/Defense and Industrial segments, by increasing sales to the aftermarket, and by focusing on developing highly customized solutions.

Currently, our strategy is built around maintaining our role as a leading manufacturer of highly engineered bearings and precision components through the following efforts:

• Developing innovative solutions. By leveraging our design and manufacturing expertise and our extensive customer relationships, we continue to develop new products for markets in which there are substantial growth opportunities.
• Expanding customer base and penetrating end markets. We continually seek opportunities to access new customers, geographic locations and bearing platforms with existing products or profitable new product opportunities.
• Increasing aftermarket sales. We believe that increasing our aftermarket sales of replacement parts will further enhance the continuity and predictability of our revenues and enhance our profitability. Such sales include sales to third party distributors and sales to OEMs for replacement products and aftermarket services. The acquisition of Dodge has had a profound impact on our sales volumes to distributors and other aftermarket customers. We expect to further increase the percentage of our revenues derived from the replacement market by continuing to implement several initiatives.
• Pursuing selective acquisitions. The acquisition of businesses that complement or expand our operations has been and continues to be an important element of our business strategy. We believe that there will continue to be consolidation within the industry that may present us with acquisition opportunities.

Outlook

Our net sales for the three-month period ended December 31, 2022 increased 31.7% compared to the same period last fiscal year, which included only two months of sales attributable to the Dodge division. The increase in net sales was a result of a 41.6% increase in our Industrial segment and 13.2% increase in our Aerospace/Defense segment. Excluding sales from Dodge, our Industrial segment increased 11.8% year over year. Our backlog, as of December 31, 2022, was $613.6 million compared to $603.1 million as of April 2, 2022.

We are continuing to see the recovery of the commercial aerospace business, which increased by 24.2% for the three-month period ended December 31, 2022 versus the same period last fiscal year. We anticipate this growth to continue throughout the rest of the fiscal year and beyond. Orders have continued to grow as evidenced by our backlog. Defense sales, which represented approximately 31.7% of segment sales during the quarter, were down 4.8% year over year. This was in part due to the timing of delivery on parts that require government approval prior to revenue being recognized.

The increase in our Industrial sales reflected a pattern of sustained growth over the last fiscal year, with strong results in several areas. Our energy business during the quarter continued a pattern of growth which is expected to continue into future periods.

The Company expects net sales to be approximately $375.0 million to $385.0 million in the fourth quarter of fiscal 2023.

We experienced strong cash flow generation during the third quarter of fiscal 2023 as discussed in the section “Liquidity and Capital Resources” below. We expect this trend to continue into the fourth quarter of the fiscal year as customer demand continues to be significant. We believe that operating cash flows and available credit under the Revolving Credit Facility will provide adequate resources to fund internal growth initiatives for the foreseeable future, including at least the next 12 months. As of December 31, 2022, we had cash and cash equivalents of $82.0 million, of which approximately $30.8 million was cash held by our foreign operations.

Results of Operations

(dollars in millions)

Our net sales for the three-month period ended December 31, 2022 increased 31.7% compared to the same period last fiscal year; on an organic basis (excluding Dodge sales for both periods), net sales were up 12.7% year over year. Net sales in our Industrial segment increased 41.6% year over year; excluding Dodge, Industrial segment sales increased 11.8% year over year. This reflected a pattern of sustained growth, with strong results in areas including the energy and general industrial markets. Net sales in our Aerospace/Defense segment increased 13.2% year over year, led by commercial OEM, which was up 22.8% compared to the same period in the prior year while sales to the defense sector were down 4.8%. The increase in commercial aerospace reflected recovery in orders from large OEMs as build rates escalate and our expansion in the aftermarket. Defense sales were negatively impacted by the timing of delivery on parts that require government approval and/or completion of certain milestone achievements prior to revenue being recognized.

Net income attributable to common stockholders for the third quarter of fiscal 2023 was $30.6 million compared to a $5.2 million net loss for the same period last fiscal year. Net income for the third quarter of fiscal 2023 was affected by approximately $1.2 million of pre-tax transition services costs associated with the Dodge acquisition. Net income for the third quarter of fiscal 2022 was affected by approximately $7.0 million of pre-tax inventory purchase accounting adjustments associated with the Dodge acquisition and $23.5 million of other costs associated with the acquisition of Dodge.

Our net sales for the nine-month period ended December 31, 2022 increased 84.0% compared to the same period last fiscal year; on an organic basis (excluding Dodge sales for both periods), net sales were up 11.9% year over year. Net sales in our Industrial segment increased 149.2% year over year; excluding Dodge, Industrial segment sales increased 12.3% year over year. This reflects a pattern of sustained growth, with strong results in areas including the semiconductor, mining, energy, and general industrial markets. Net sales in our Aerospace/Defense segment increased 11.6% year over year, led by commercial OEM, which was up 25.3% compared to the same period in the prior year while sales to the defense sector were down 7.3%. The increase in commercial aerospace reflected the recovery in build rates from large OEMs and stability in the aftermarket. Defense sales were negatively impacted by the timing of shipments associated with our marine business.

Net income attributable to common stockholders for the nine months ended December 31, 2022 was $100.3 million compared to $17.0 million for the same period last fiscal year. Net income for the nine-month period in fiscal 2023 was affected by approximately $8.9 million of pre-tax transition services costs associated with the Dodge acquisition. Net income for the nine-month period in fiscal 2022 was affected by approximately $7.0 million of pre-tax inventory purchase accounting adjustments associated with the Dodge acquisition and $24.9 million of other costs associated with the acquisition of Dodge.

Gross Margin

Gross margin was 41.5% of net sales for the third quarter of fiscal 2023 compared to 35.0% for the third quarter of fiscal 2022. The increase in gross margin as a percentage of net sales was driven by increased volumes and efficiencies achieved and approximately $7.0 million of inventory purchase accounting adjustments associated with the Dodge acquisition during the third quarter of fiscal 2022.

Gross margin was 40.8% of net sales for the first nine months of fiscal 2023 compared to 37.6% for the same period last fiscal year. Gross margin for the nine-month period of fiscal 2022 was impacted by approximately $7.0 million of inventory purchase accounting adjustments associated with the Dodge acquisition and approximately $0.9 million of restructuring costs associated with consolidation efforts at one of our domestic facilities.

Selling, General and Administrative

SG&A for the third quarter of fiscal 2023 was $56.8 million, or 16.1% of net sales, as compared to $41.7 million, or 15.6% of net sales, for the same period of fiscal 2022. The increase in SG&A was primarily driven by an additional month of costs associated with the Dodge business in the third quarter of fiscal 2023 compared to the same quarter in fiscal 2022 and increased personnel costs, freight costs, IT costs and other professional fees.

SG&A expenses increased by $57.0 million to $170.1 million for the first nine months of fiscal 2023 compared to $113.1 million for the same period last fiscal year. The increase in SG&A was primarily driven by increased personnel costs, selling costs and administrative costs associated with the Dodge acquisition. SG&A as a percentage of sales was comparatively higher for the first nine months of fiscal 2022 primarily due to $17.5 million more stock-based compensation recognized during the period.

Other, Net

Other operating expenses for the third quarter of fiscal 2023 totaled $18.9 million compared to $35.8 million for the same period last fiscal year. For the third quarter of fiscal 2023, other operating expenses included $1.2 million of Dodge TSA costs and other costs associated with the Dodge acquisition, $17.4 million of amortization of intangible assets, and $0.3 million of other items. For the third quarter of fiscal 2022, other operating expenses included $20.2 million of costs associated with the Dodge acquisition, $3.3 million of Dodge TSA costs, $12.1 million of amortization of intangible assets and $0.2 million of other costs.

Other operating expenses for the first nine months of fiscal 2023 totaled $61.3 million compared to $44.7 million for the same period last fiscal year. For the first nine months of fiscal 2023, other operating expenses were comprised mainly of $8.9 million of Dodge TSA costs and other costs associated with the Dodge acquisition, $51.5 million of amortization of intangible assets, and $0.9 million of other items. For the first nine months of fiscal 2022, other operating expenses were comprised mainly of $21.6 million of costs associated with the Dodge acquisition, $3.3 million of Dodge TSA costs, $17.5 million in amortization of intangibles, $1.7 million of restructuring and related items, and $0.6 million of other items.

Interest Expense, Net

Interest expense, net, generally consists of interest charged on the Company’s debt agreements and amortization of deferred financing fees, offset by interest income (see “Liquidity and Capital Resources” below). Interest expense, net, was $20.9 million for the third quarter of fiscal 2023 compared to $11.9 million for the same period last fiscal year. During the third quarter of fiscal 2022, the Company incurred approximately $1.1 million in costs associated with the amortization of fees for a bridge financing commitment established in connection with the Dodge acquisition during the third quarter of fiscal 2022, which was replaced with the Term Loan Facility, Revolving Credit Facility and Senior Notes in the same quarter. The increase in interest expense from fiscal 2022 to fiscal 2023 was primarily due to an additional month of interest expense associated with the Term Loan Facility and Revolving Credit Facility and the increase in LIBOR from fiscal 2022 to fiscal 2023.

Interest expense, net was $55.0 million for the first nine months of fiscal 2023 compared to $27.9 million for the first nine months of fiscal 2022. During the nine months ended January 1, 2022 the Company incurred approximately $16.6 million in costs associated with the amortization of fees for the bridge financing commitment mentioned above and $11.3 million of interest expense on outstanding financing. The increase in interest expense from fiscal 2022 to fiscal 2023 was primarily due to seven more months of interest expense associated with the Term Loan Facility and Revolving Credit Facility and the increase in LIBOR from fiscal 2022 to fiscal 2023.

Other Non-Operating Expense/(Income)

Other non-operating expenses were $1.5 million for the third quarter of fiscal 2023 compared to $1.4 million of income for the same period in the prior year and consisted primarily of post-retirement benefit costs and foreign exchange gains and losses.

Other non-operating expenses were $2.5 million for the first nine months of fiscal 2023 compared to $0.6 million of income for the same period in the prior year. For the first nine months of fiscal 2023, other non-operating expenses were comprised of $2.6 million of post-retirement benefit costs, partially offset by $0.1 million of foreign exchange gain. For the first nine months of fiscal 2022, other non-operating expenses were comprised of $0.9 million of charges associated with the elimination of a debt facility, $0.6 million of post-retirement benefit costs, $0.1 million of foreign exchange loss, and $0.2 million of other items partially offset by $1.2 million of income associated with short-term marketable securities.

Income Taxes

Income tax expense for the three-month period ended December 31, 2022 was $11.7 million compared to $2.1 million for the three-month period ended January 1, 2022. Our effective income tax rate for the three-month period ended December 31, 2022 was 24.4% compared to 79.2% for the three-month period ended January 1, 2022. The effective income tax rate for the three-month period ended December 31, 2022 of 24.4% included $0.3 million of tax benefits associated with stock-based compensation offset by $0.2 million of other items. The effective income tax rate without discrete items would have been 24.5%. The effective income tax rate for the three-month period ended January 1, 2022 of 79.2% included $0.5 million of tax benefits associated with stock-based compensation offset by $0.1 million of other items. The effective income tax rate without discrete items for the three-month period ended January 1, 2022 would have been 91.6%. The effective income tax rate differed from the statutory rate primarily due to nondeductible stock-based compensation expense recognized in the period, and state and foreign taxes that increased the rate while R&D credits and the foreign-derived intangible income provision decreased the rate. In the quarter ended, January 1, 2022, the Company’s tax rate was also increased by non-deductible transaction costs incurred in the Dodge acquisition.

Income tax expense for the nine-month period ended December 31, 2022 was $31.9 million compared to $9.9 million for the nine-month period ended January 1, 2022. Our effective income tax rate for the nine-month period ended December 31, 2022 was 21.3% compared to 30.0% for the nine-month period ended January 1, 2022. The effective income tax rate for the nine-month period ended December 31, 2022 of 21.3% included $3.2 million of tax benefits associated with stock-based compensation partially offset by $0.1 million of other items; the effective income tax rate without these benefits and other items would have been 23.5%. The effective income tax rate for the nine-month period ended January 1, 2022 of 30.0% included $2.7 million of tax benefits associated with stock-based compensation offset by the establishment of a $1.9 million valuation allowance for capital loss carryforwards we don’t expect to recognize and $0.1 million of other items. The effective income tax rate without these benefits, valuation allowance and other items for the nine-month period ended January 1, 2022 would have been 32.3%. The effective income tax rate differed from the statutory rate primarily due to nondeductible stock-based compensation expense recognized in the period, and state and foreign taxes that increased the rate while R&D credits and the foreign-derived intangible income provision decreased the rate. In the nine-month period ended, January 1, 2022, the Company’s tax rate was also increased by non-deductible transaction costs incurred in the Dodge acquisition.

Segment Information

We previously reported our financial results under four operating segments (Plain Bearings; Roller Bearings; Ball Bearings; and Engineered Products), but the Dodge acquisition has resulted in a change in the internal organization of the Company and how our chief operating decision maker makes operating decisions, assesses the performance of the business, and allocates resources. Accordingly, we now report our financial results under two operating segments: Aerospace/Defense; and Industrial. Financial information for fiscal 2022 has been recast to conform to the new segment presentation. We use segment net sales and gross margin as the primary measurements to assess the financial performance of each reportable segment.

Aerospace/Defense Segment

Net sales increased $12.3 million, or 13.2%, for the three months ended December 31, 2022 compared to the same period last fiscal year. Commercial aerospace increased during the period 24.2% year over year. The commercial OEM business was up 22.8%, demonstrating continued recovery as build rates and orders escalate in the OEM markets. Our defense markets, which represented approximately 31.7% of segment sales, decreased by approximately 4.8% during the period. These markets were impacted by the timing of deliveries to certain government customers that require sign-off or achievement of certain milestones prior to shipment. Overall distribution and aftermarket sales, which represented 17.3% of segment sales, increased 16.8% year over year.

Gross margin as a percentage of segment net sales was 39.5% for the third quarter of fiscal 2023 compared to 40.2% for the same period last fiscal year. The decrease in gross margin as a percentage of net sales was driven by product mix.

Net sales increased $32.0 million, or 11.6%, for the nine months ended December 31, 2022 compared to the same period last fiscal year. The 11.6% increase was primarily driven by a 24.1% increase in our commercial aerospace market, both OEM and aftermarket, while our defense market was down 7.3% year over year due to the timing of shipments related to our marine business. During the year, we saw improvement in the sales and orders to our commercial aerospace customers as build rates continued to grow. Our backlog and recent results reflect the early stages of this process which we expect to continue to see in upcoming quarters. Overall distribution and aftermarket sales were up 11.5% year over year.

Gross margin as a percentage of net sales decreased to 39.3% for the first nine months of fiscal 2023 compared to 40.8% for the same period last fiscal year. The decrease in gross margin percentage was due to product mix.

Industrial Segment

Net sales increased $72.3 million, or 41.6%, for the three months ended December 31, 2022 compared to the same period last fiscal year. The increase was primarily due to the inclusion of a full quarter of Dodge sales in fiscal 2023 and continued strong performance across the majority of our industrial markets. Excluding Dodge sales from both periods, organic net sales increased 11.8% period over period. This increase was driven by performance in energy and the general industrial markets. Sales to distribution and the aftermarket represented 67.7% of our quarterly industrial sales. These distribution and aftermarket sales increased 54.7% compared to the same quarter in the prior year and 7.8% organically.

Gross margin for the three months ended December 31, 2022 was 42.4% of net sales, compared to 32.2% in the comparable period in fiscal 2022. The improved gross margin was due to price and volume increases and also the unfavorable impact of $7.0 million of inventory purchase accounting adjustments associated with the Dodge acquisition during the third quarter of fiscal 2022.

Net sales increased $458.8 million, or 149.2%, for the nine months ended December 31, 2022 compared to the same period last fiscal year. The increase was primarily due to nine months of Dodge sales in fiscal 2023 compared to two months in fiscal 2022 and strong performance across our industrial markets. Excluding Dodge sales, net sales increased $24.3 million, or 12.3%, period over period. Sales to distribution and the aftermarket increased 224.1% over last fiscal year, and 6.6% on an organic basis. The overall segment increase, excluding the addition of Dodge, was driven by performance in semiconductor, energy, mining, and the general industrial markets.

Gross margin for the nine months ended December 31, 2022 was 41.4% of net sales, compared to 34.8% in the same period in fiscal 2022. The increase in gross margin is driven by price and volume increases and the fact that gross margin for the first nine months of fiscal 2022 included the unfavorable impact of $7.0 million of inventory purchase accounting adjustments associated with the Dodge acquisition.

Corporate

28

Corporate SG&A was $19.9 million, or 5.6% of sales, for the third quarter of fiscal 2023 compared to $16.4 million, or 6.2% of sales, for the same period last fiscal year. The year over year increase was primarily due to increases in personnel costs and professional fees.

Corporate SG&A decreased $3.5 million for the nine months ended December 31, 2022 compared to the same period last fiscal year due to a $17.5 million decrease in stock-based compensation expense, partially offset by increases in personnel costs and professional fees.

Liquidity and Capital Resources

(dollars in millions in tables)

Our business is capital-intensive. Our capital requirements include manufacturing equipment and materials. In addition, we have historically fueled our growth, in part, through acquisitions, including the Dodge acquisition completed on November 1, 2021. We have historically met our working capital, capital expenditure and acquisition funding needs through our net cash flows provided by operations, various debt arrangements and sales of equity to investors. We believe that operating cash flows and available credit under the Revolving Credit Facility will provide adequate resources to fund internal growth initiatives for the foreseeable future. For further discussion regarding the funding of the Dodge acquisition, refer to Part I, Item 1 – Note 13.

Our ability to meet future working capital, capital expenditure and debt service requirements will depend on our future financial performance, which will be affected by a range of economic, competitive and business factors, particularly interest rates, cyclical changes in our end markets and prices for steel and our ability to pass through price increases on a timely basis, many of which are outside of our control. In addition, future acquisitions could have a significant impact on our liquidity position and our need for additional funds.

From time to time, we evaluate our existing facilities and operations and their strategic importance to us. If we determine that a given facility or operation does not have future strategic importance, we may sell, relocate, consolidate or otherwise dispose of that facility or operations. Although we believe our operations would not be materially impaired by such dispositions, relocations or consolidations, we could incur significant cash or non-cash charges in connection with them.

Liquidity

As of December 31, 2022, we had cash and cash equivalents of $82.0 million, of which approximately $30.8 was cash held by our foreign operations. We expect that our undistributed foreign earnings will be re-invested indefinitely for working capital, internal growth and acquisitions for and by our foreign subsidiaries.

Domestic Credit Facility

On November 1, 2021 RBC Bearings Incorporated, our top holding company, and RBCA, our top operating subsidiary, entered into the New Credit Agreement with Wells Fargo, as Administrative Agent, Collateral Agent, Swingline Lender and Letter of Credit Issuer and the other lenders party thereto, and terminated the Company’s prior credit agreement, which was entered into with Wells Fargo in 2015. The New Credit Agreement provides the Company with (a) a $1,300.0 million term loan facility (the “Term Loan Facility”), which was used to fund a portion of the cash purchase price for the acquisition of Dodge and to pay related fees and expenses, and (b) a $500.0 million revolving credit facility (the “Revolving Credit Facility” and together with the Term Loan Facility, the “Facilities”). Debt issuance costs associated with the New Credit Agreement totaled $14.9 million and are being amortized over the life of the New Credit Agreement.

Prior to December 2022, amounts outstanding under the Facilities generally bore interest at either, at the Company’s option, (a) a base rate determined by reference to the higher of (i) Wells Fargo’s prime lending rate, (ii) the federal funds effective rate plus 0.50% and (iii) the one-month London interbank offered rate (LIBOR) rate plus 1.00% or (b) the LIBOR rate plus a specified margin, depending on the type of borrowing being made. The applicable margin was based on the Company’s consolidated ratio of total net debt to consolidated EBITDA from time to time. In December 2022 the New Credit Agreement was amended to replace LIBOR with the secured overnight financing rate administered by the Federal Reserve Bank of New York (“SOFR”) so that borrowings under the Facilities denominated in U.S. dollars bear interest at a rate per annum equal to Term SOFR (as defined in the New Credit Agreement) plus a credit spread adjustment of 0.10% plus a margin ranging from 0.75% to 2.00% depending on the Company’s consolidated ratio of total net debt to consolidated EBITDA. The Facilities are subject to a SOFR floor of 0.00%. As of December 31, 2022, the Company’s margin was 0.50% for base rate loans and 1.50% for SOFR loans. The Company’s commitment fee rate was 0.20% and the letter of credit fee rate was 1.50%.

The Term Loan Facility will mature on November 2, 2026 and amortizes in quarterly installments with the balance payable on the maturity date. The Company can elect to prepay some or all of the outstanding balance from time to time without penalty, which will offset future quarterly amortization installments. The required future principal payments on the Term Loan Facility are $0 for the remainder of fiscal 2023, $0 for fiscal 2024, and $0 for fiscal 2025, due to prepayments previously made, and approximately $27.5 million for fiscal 2026, and $942.5 million for fiscal 2027. The Revolving Credit Facility will mature on November 2, 2026, at which time all amounts outstanding under the Revolving Credit Facility will be payable.

The New Credit Agreement requires the Company to comply with various covenants, including the following financial covenants: (a) a maximum total net leverage ratio of 5.50:1.00, which maximum ratio will decrease during certain subsequent test periods as set forth in the New Credit Agreement (provided that, no more than once during the term of the Facilities, such maximum ratio applicable at such time may be increased by the Company by 0.50:1.00 for a period of 12 months after the consummation of a material acquisition), and (b) a minimum interest coverage ratio of 2.00:1.00. As of December 31, 2022, the Company was in compliance with all debt covenants.

The New Credit Agreement allows the Company to, among other things, make distributions to stockholders, repurchase its stock, incur other debt or liens, or acquire or dispose of assets provided that the Company complies with certain requirements and limitations of the New Credit Agreement.

The Company’s domestic subsidiaries have guaranteed the Company’s obligations under the New Credit Agreement, and the Company’s obligations and the domestic subsidiaries’ guaranty are secured by a pledge of substantially all of the domestic assets of the Company and its domestic subsidiaries.

As of December 31, 2022, $970.0 million was outstanding under the Term Loan Facility and approximately $3.7 million of the Revolving Credit Facility was being utilized to provide letters of credit to secure the Company’s obligations relating to certain insurance programs, and the Company had the ability to borrow up to an additional $496.3 million under the Revolving Credit Facility.

Senior Notes

On October 7, 2021, RBCA issued $500.0 million aggregate principal amount of the Senior Notes. The net proceeds from the issuance of the Senior Notes were approximately $492.0 million after deducting initial purchasers’ discounts and commissions and offering expenses. On November 1, 2021, the Company used the proceeds to fund a portion of the cash purchase price for the acquisition of Dodge.

The Senior Notes were issued pursuant to the Indenture, which contains covenants limiting the ability of the Company to (i) incur additional indebtedness or guarantee indebtedness, (ii) declare or pay dividends, redeem stock or make other distributions to stockholders, (iii) make investments, (iv) create liens or use assets as security in other transactions, (v) merge or consolidate, or sell, transfer, lease or dispose of substantially all of its assets, (vi) enter into transactions with affiliates, and (vii) sell or transfer certain assets. These covenants contain various exceptions, limitations and qualifications. At any time that the Senior Notes are rated investment grade, certain of these covenants will be suspended.

The Senior Notes are guaranteed jointly and severally on a senior unsecured basis by RBC Bearings and certain of RBCA’s existing and future wholly owned domestic subsidiaries that also guarantee the New Credit Agreement.

Interest on the Senior Notes accrues at a rate of 4.375% and is payable semi–annually in cash in arrears on April 15 and October 15 of each year.

The Senior Notes will mature on October 15, 2029. The Company may redeem some or all of the Senior Notes at any time on or after October 15, 2024 at the redemption prices set forth in the Indenture, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. The Company may also redeem up to 40% of the Senior Notes using the proceeds of certain equity offerings completed before October 15, 2024, at a redemption price equal to 104.375% of the principal amount thereof, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. In addition, at any time prior to October 15, 2024, the Company may redeem some or all of the Senior Notes at a price equal to 100% of the principal amount, plus a “make–whole” premium, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. If the Company sells certain of its assets or experiences specific kinds of changes in control, the Company must offer to purchase the Senior Notes.

Foreign Revolving Credit Facility

The New Foreign Revolver is a CHF 5.0 million (approximately $5.4 million USD) revolving credit facility with Credit Suisse (Switzerland) Ltd. to provide future working capital, if necessary. As of December 31, 2022, $0 had been borrowed from the New Foreign Revolver. Fees associated with the New Foreign Revolver are nominal if the facility is not utilized.

Interest Rate Swap

The Company is exposed to certain risks relating to its ongoing business operations, including market risks relating to fluctuations in interest rates.

On October 28, 2022, the Company entered into a three-year USD-denominated interest rate swap (“the Swap”) from a third-party financial counterparty under the New Credit Agreement. The Swap was executed to protect the Company from interest rate volatility on our variable-rate Term Loan Facility. The Swap has an effective date of December 30, 2022 and is comprised of a $600.0 million notional with a maturity of three years. RBC will receive a variable rate based on one-month Term SOFR and will pay a fixed rate of 4.455%. The notional on the Swap will amortize as follows:

Year 1: $600.0 million

Year 2: $400.0 million

Year 3: $100.0 million

The Swap has been designated as a cash flow hedge of the variability of the first unhedged interest payments (the hedged transactions) paid over the hedging relationship’s specified time period of three years attributable to the borrowing’s contractually specified interest index on the hedged principal of its general borrowing program or replacement or refinancing thereof.

Cash Flows

Nine-month Period Ended December 31, 2022 Compared to the Nine-month Period Ended January 1, 2022

The following table summarizes our cash flow activities:

During the first nine months of fiscal 2023, we generated cash of $149.3 million from operating activities compared to $133.4 million of cash generated during the same period of fiscal 2022. The increase of $15.9 million was mainly a result of an increase in net income of $94.3 million and a favorable change in non-cash activity of $6.2 million partially offset by the unfavorable impact of the net change in operating assets and liabilities of $84.6 million. The unfavorable change in operating assets and liabilities is detailed in the table below, while the increase in non-cash charges resulted from a $48.5 million increase in depreciation and amortization and a $0.1 million increase in the loss on disposal of assets, partially offset by unfavorable changes of $17.5 million of stock-based compensation charges, $11.4 million of amortization of deferred financing costs, $10.5 million in deferred taxes, $0.9 million related to the extinguishment of debt in the prior year and $2.1 million of consolidation, restructuring, and other noncash charges.

The following chart summarizes the unfavorable change in operating assets and liabilities of $84.6 million for fiscal 2023 versus fiscal 2022 and the favorable change of $24.4 million for fiscal 2022 versus fiscal 2021.

During the first nine months of fiscal 2023, we used $1.6 million for investing activities as compared to using $2,839.5 million during the first nine months of fiscal 2022. This decrease in cash used compared to the prior year was attributable to $2,935.7 million less cash used for acquisitions, $30.0 million less purchases of marketable securities and $0.5 million more proceeds from the sale of assets partially offset by a $7.8 million increase in capital expenditures and $120.5 million less in proceeds from the sale of marketable securities.

During the first nine months of fiscal 2023, we used $247.0 million in financing activities compared to $2,810.3 million generated during the first nine months of fiscal 2022. This decrease from cash generated to cash used was primarily attributable to proceeds received during the first nine months of fiscal 2022 related to $605.5 million from the issuance of common stock, $445.3 million from the issuance of preferred stock, $1,286.2 million from the Term Loan Facility, and $494.2 million from the Senior Notes. During fiscal 2023 there were $220.0 million more payments made on outstanding debt, $17.3 million cash dividends paid on preferred stock, $7.3 million fewer exercises of stock-based awards, and $2.5 million more in principal payments made on finance lease obligations, partially offset by $19.9 million less in finance fees paid in connection with credit facilities and term loans and $1.1 million fewer repurchases of common stock.

Capital Expenditures

Our capital expenditures were $6.5 million and $29.6 million for the three- and nine-month periods ended December 31, 2022, respectively. We expect to make additional capital expenditures of $5.0 million to $10.0 million during the remainder of fiscal 2023 in connection with our existing business. We expect to fund these capital expenditures principally through existing cash and internally generated funds. We may also make substantial additional capital expenditures in connection with acquisitions.

Obligations and Commitments

The Company’s fixed contractual obligations and commitments are primarily comprised of our debt obligations disclosed in Part I, Item 1- Note 10 of this report. We also have lease obligations which are materially consistent with what we disclosed in our Annual Report.

Other Matters

Critical Accounting Policies and Estimates

Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. We believe the most complex and sensitive judgments, because of their significance to the consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Notes to the Consolidated Financial Statements in our Annual Report describe the significant accounting estimates and policies used in preparation of our consolidated financial statements. Actual results in these areas could differ from management’s estimates. There were no significant changes in our critical accounting estimates during the first nine months of fiscal 2023.

Off-Balance Sheet Arrangements

The Company has $3.7 million of outstanding standby letters of credit, all of which are under the Revolving Credit Facility. We also have a contractual obligation for licenses related to the implementation and upgrade of an enterprise resource planning (“ERP”) system for Dodge. These license costs of $10.5 million will be incurred over a five-year period.

Other than the items noted above, we had no significant off-balance sheet arrangements as of December 31, 2022.

We are exposed to market risks, which arise during the normal course of business from changes in interest rates and foreign currency exchange rates.

Interest Rates. We currently have variable rate debt outstanding under the Term Loan Facility. We regularly evaluate the impact of interest rate changes on our net income and cash flow and take action to limit our exposure when appropriate. As discussed in Note 14 in Part I, Item I of this report, we entered into the Swap on October 28, 2022, which became effective on December 30, 2022.

Foreign Currency Exchange Rates. Our operations in the following countries utilize the following currencies as their functional currency:

As a result, we are exposed to risk associated with fluctuating currency exchange rates between the U.S. dollar and these currencies. Foreign currency transaction gains and losses are included in earnings. Approximately 11% and 12% of our net sales were impacted by foreign currency fluctuations for both the three- and nine-month periods ended December 31, 2022, respectively, compared to 12% and 11% for the three- and nine-month periods ended January 1, 2022, respectively. Foreign currency transaction exposure arises primarily from the transfer of foreign currency from one subsidiary to another within the group, and to foreign currency denominated trade receivables. Unrealized currency translation gains and losses are recognized upon translation of the foreign operations’ balance sheets to U.S. dollars. Because our financial statements are denominated in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies have had, and will continue to have, an impact on our earnings. We periodically enter into derivative financial instruments in the form of forward exchange contracts to reduce the effect of fluctuations in exchange rates on certain third-party sales transactions denominated in non-functional currencies. As of December 31, 2022, the Company had no forward exchange contracts.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of December 31, 2022. This evaluation excluded the Dodge business acquired on November 1, 2021 as we are currently in the process of integrating the internal controls and procedures of Dodge into our internal controls over financial reporting. As provided under the Sarbanes-Oxley Act of 2002 and the applicable rules and regulations of the SEC, we will include the internal controls and procedures of Dodge in our annual assessment of the effectiveness of internal control over financial reporting for our 2023 fiscal year.

Remediation of Material Weakness

To address the previously reported material weakness in internal control over financial reporting described in Part I, Item 4 of the Company’s Form 10-Q for the quarterly period ended July 2, 2022, the Company enhanced and revised the design of existing controls and procedures to properly review employment agreements involving equity awards to ensure they are accounted for in accordance with the latest accounting pronouncements. The Company’s internal audit department will test the operating effectiveness of management’s controls during the fiscal year.

Changes in Internal Control over Financial Reporting

Except for the changes related to the Company’s remediation efforts described above, no change in the Company’s internal control over financial reporting occurred during the third quarter of fiscal 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934).

As discussed in Note 13 included in Part I, Item 1 of this report, we acquired Dodge on November 1, 2021. We are currently in the process of integrating the internal controls and procedures of Dodge into our internal controls over financial reporting. As provided under the Sarbanes-Oxley Act of 2002 and the applicable rules and regulations of the SEC, we will include the internal controls and procedures of Dodge in our annual assessment of the effectiveness of our internal control over financial reporting for our 2023 fiscal year.

There have been no material changes to our risk factors and uncertainties since the filing of our Annual Report with the SEC on August 5, 2022. For a discussion of the risk factors, refer to Part I, Item 2, “Cautionary Statement as to Forward-Looking Information” contained in this quarterly report and Part I, Item 1A, “Risk Factors,” contained in our Annual Report.