Timken Co Q3 FY2022 Earnings Call

Good morning. My name is Emily, and I'll be your conference operator today. At this time, I would like to welcome everyone to Timken's Third Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Mr. Frohnapple, you may begin your conference.

Thanks, Emily, and welcome everyone to our third quarter 2022 earnings conference call. This is Neil Frohnapple, Director of Investor Relations for The Timken Company. We appreciate you joining us today. Before we begin our remarks this morning, I want to point out that we have posted presentation materials on the company's website that we will reference as part of today's review of the quarterly results. You can also access this material through the download feature on the earnings call webcast link. With me today are The Timken Company's President and CEO, Rich Kyle; and Phil Fracassa, our Chief Financial Officer. We will have opening comments this morning from both Rich and Phil before we open up the call for your questions. During the Q&A, I would ask that you please limit your questions to one question and one follow-up at a time to allow everyone a chance to participate. During today's call, you may hear forward-looking statements related to our future financial results, plans and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today's press release and in our reports filed with the SEC, which are available on the timken.com website. We have included reconciliations between non-GAAP financial information and its GAAP equivalent in the press release and presentation materials. Today's call is copyrighted by The Timken Company, and without expressed written consent, we prohibit any use, recording or transmission of any portion of the call. With that, I would like to thank you for your interest in The Timken Company, and I will now turn the call over to Rich.

Thanks, Neil. Good morning and thank you for joining our call. Timken delivered another excellent quarter with year-on-year revenue growth of 10%, earnings per share growth of 29% and margin expansion of 160 basis points. We continue to demonstrate Timken's ability to grow and deliver strong results through a variety of macroeconomic conditions. Our financial performance is driven by the successful execution of our strategy, the diversity and attractiveness of our portfolio and end-market mix and our disciplined approach to capital allocation. Demand continued to be strong across most markets and geographies, and when combined with our outgrowth initiatives and positive pricing resulted in organic growth of just under 14%. All regions except Europe were up double digits in the quarter. And as noted on Slide 8, revenue is forecast to be up for the year mid-single digits or higher for nearly all of our end markets. Supply chain issues continued to ease gradually, although they remain a challenge and the operating environment remains dynamic. We continued to face persistent inflation pressures, costs increased in the quarter and are well above prior year and pre-pandemic levels. Price realization was up significantly over prior year and up modestly sequentially. Price-cost was positive for the quarter and price realization has increased sequentially for eight consecutive quarters. Cash flow improved sequentially but conversion remains modest year-to-date due to the working capital required to support the organic growth and the supply chain challenges. From a capital allocation standpoint, we paid our 401st consecutive dividend and purchased about 1% of the outstanding shares. We're investing CapEx into the business for growth in margin, including investing in our footprint and capabilities. Examples include our state-of-the-art bearing facility in Mexico, which has ramped up through the course of the year and provides additional capacity at a very competitive cost position. We are also close to completing our plans to consolidate our chain operations into one facility in Illinois which will further improve our productivity and cost structure. We also continue to allocate capital to M&A. The first full quarter of Spinea has gone well and we remain excited about the growth potential of the business across the global automation space. We're also excited about our agreement to acquire GGB Bearings. GGB is a global supplier of highly engineered plain and metal-polymer bearings. The plain bearing category is highly complementary to Timken's roller and ball bearing offering and we expect significant synergies in the coming years as we integrate the businesses. We are on track to close the acquisition in the fourth quarter. We also recently reached an agreement to divest Aero Drive Systems. ADS is a supplier of flight critical components for rotorcraft applications. We're always reviewing our portfolio for strategic and financial fit and we determine that ADS will be better positioned to succeed in the market under other ownership. They represent just over 1% of Timken revenue and we expect to close in the fourth quarter. We do not expect any other sizable divestitures in the near term. We have an attractive and diverse portfolio and we're investing in it to win in the marketplace. I'd also like to point out that aerospace will continue to be an important end market for us. We also released our annual Corporate Social Responsibility report in the quarter. The report both highlights our accomplishments and outlines many of our forward-looking activities and goals. Overall, it was an excellent quarter in both delivering strong results in a dynamic environment, while also continuing to position the company for greater levels of performance in the years to come. Turning to the outlook, we are planning to achieve record revenue, record earnings and an improvement in year-over-year margins again in the fourth quarter. We've increased our full-year revenue outlook to 9% to reflect continued strong organic growth, acquisitions and price realization, partially offset by increased currency headwinds and the ADS divestiture. Through late October, our revenue and order run rate support our fourth quarter outlook. On the bottom line, we are expecting input costs to remain elevated and for the supply chain challenges to persist with only gradual improvements. We also expect the fourth quarter to be our ninth consecutive quarter of sequential price realization and for price-cost to be positive. We have increased our full-year earnings per share forecast to $5.80 to $5.95. At the midpoint, this would be a 25% increase over last year's performance. And finally, from a cash flow standpoint, we expect very strong cash flow in the fourth quarter from both seasonality and improving execution around inventory management. Turning to '23 in the longer term, we are always closely monitoring our global end markets and channels for signs of demand strength or softening and we are very aware of the concerns around global recession. However, as demonstrated in our recent results as well as our outlook for this quarter, demand for our products remains very strong and we expect the positive momentum to carry over to start 2023. We have a high backlog and orders continue to come in at a healthy pace. We typically see a seasonal step-up in demand end margins from the fourth quarter to the first. And our orders and backlog support a strong start to '23. We would also expect price to be up sequentially again from the fourth quarter to the first. We're not expecting any relief from inflation in the near term, but we believe we are well positioned to keep price in line with costs as we move forward. And additionally, we have a lot of self-help heading into '23, including improving our operational performance as supply chains stabilize, delivering on our CapEx and margin enhancement initiatives, outgrowth, the GGB and Spinea acquisitions, and the full-year impact of share buyback. We will provide our full-year outlook for '23 early next year, but we have a lot of positive momentum as we end 2022. And finally, longer term, I'd like to take you back to Slide 11 in the deck, which summarizes our five-year financial performance. As we discussed in our recent Investor Day, Timken has delivered consistent and top quartile financial results through what has been a particularly volatile macroeconomic period. We will enter '23 a stronger company than we were entering 2018 and we are in an excellent position to continue to profitably scale our business as a diversified industrial leader and deliver strong shareholder returns. I'll now turn it over to Phil for more color on the results and the outlook.

Okay. Thanks, Rich, and good morning, everyone. For the financial review, I'm going to start on Slide 13 of the presentation materials with a summary of our strong third-quarter results. We posted revenue of $1.14 billion in the quarter, up 9.6% from last year. We delivered an adjusted EBITDA margin of 18.8% and we achieved record third-quarter adjusted earnings per share of $1.52. We will dive deeper into each of these items as we move through the materials. Turning to Slide 14, let's take a closer look at our sales performance. Organically, third-quarter sales were up nearly 14% from last year, as we generated double-digit growth in both of our segments. Our strong revenue reflects higher demand across most end-market sectors as well as the impact of continued positive pricing. I would also point out that our year-on-year organic growth rate stepped up from the 11% organic growth we delivered in the first half this year. Our team continues to win in the marketplace and serve customers well in this dynamic environment. Looking at the rest of the revenue walk, foreign currency translation was a sizable headwind on the top line in the quarter as the U.S. dollar continued to strengthen against the euro and other key currencies. And the net impact of acquisitions, including Spinea, contributed modestly to the top line in the quarter. And while you don't see it on the slide, sequentially our sales were down about 1.5% from the second quarter driven mainly by currency. Organically, our sales were roughly flat sequentially, which is stronger than we would normally see when you consider our typical seasonality. On the right-hand side of this slide, you can see organic growth by region, which excludes both currency and acquisitions. Most regions were up double digits in the quarter versus last year, with the Americas posting the strongest growth. Let me touch briefly on each region. We were up 25% in Latin America. All sectors were up in that region with industrial distribution posting the strongest growth. In North America, our largest region, we were up 20% with most sectors up led by distribution, off-highway and automotive. In Asia Pacific, we were up 12%, as most sectors were up there as well, led by distribution, renewable energy and rail. And notably, we delivered high single-digit growth in China in the quarter. And finally, in EMEA, we were flat overall as modest gains in distribution, off-highway and general industrial were offset by lower renewable energy and Russian rail revenue. Turning to Slide 15, adjusted EBITDA in the third quarter was $214 million or 18.8% of sales compared to $179 million or 17.2% of sales last year. Adjusted EBITDA was up $35 million or 20% from the year-ago period, as we delivered an incremental margin of 35% on the higher sales, which enabled us to expand margins by 160 basis points. Looking at the change in adjusted EBITDA dollars, we benefited from strong price mix and higher volume in the quarter, which more than offset the impact of higher material and logistics costs, unfavorable net manufacturing performance and higher SG&A other expense. Let me comment a little further on a few of these items. Price/mix was a key driver once again to our strong quarterly results. Pricing was meaningfully higher in both mobile and process industries, reflecting our actions over the past 12 months. Mix was also a significant contributor, driven by our revenue growth and attractive sectors like industrial distribution. Moving to material and logistics, we continue to experience higher costs compared to the year-ago period. The increase was driven mainly by material and reflects the impact of supplier price increases across the globe. I would note that the year-on-year negative impact from material and logistics moderated compared to the second-quarter headwind and we would expect further moderation again in the fourth quarter. On the manufacturing line, we were negatively impacted by higher energy, labor and other costs as well as continued supply chain and labor-related inefficiencies. Supply chain and labor issues are easing slowly and we have several self-help initiatives underway in our plants. So we would expect some improvement in the fourth quarter and even more in 2023. And finally, on the SG&A other line, costs in the third quarter were up in dollars, driven by higher compensation expense and other spending to support the increased sales levels, but SG&A was roughly flat with the second quarter and in line with our expectations. On Slide 16, you can see that we posted net income of $87 million or $1.18 per diluted share for the third quarter on a GAAP basis. This includes $0.34 of net expense from special items, which was driven mainly by a $29 million pre-tax impairment charge related to the planned divestiture of our Aerospace Drive Systems business or ADS for short. On an adjusted basis, we earned $1.52 per share in the quarter, up 29% from last year. With respect to ADS, the business is expected to post revenue of around $50 million in 2022 with EBITDA margins below our company average. You'll note that we had 4% fewer shares outstanding in the third quarter compared to last year, reflecting our significant buyback activity over the past 12 months. Interest expense was up slightly from last year as expected, and our third-quarter adjusted tax rate of 25.5% was in line with our prior guidance. Now let's move to our business segment results, starting with Process Industries on Slide 17. For the third quarter, Process Industries' sales were $610 million, up 10.8% from last year. Organically, sales were up nearly 15% driven by growth across most sectors with distribution, general industrial and heavy industries posting the strongest gains. Marine and industrial services were also up, while renewable energy was modestly lower year-on-year. Pricing was positive, and net acquisitions contributed modestly, while currency translation was a headwind in the quarter. Process Industries' adjusted EBITDA in the third quarter was $167 million or 27.4% of sales compared to $131 million or 23.8% of sales last year. The increase in Process segment EBITDA margin reflects the benefits of positive price mix and higher volume, which more than offset the impact of higher operating costs in the quarter. Now let's turn to Mobile Industries on Slide 18. In the third quarter, Mobile Industries' sales were $527 million, up 8.1% from last year. Organically, sales increased more than 12% with off-highway and automotive posting the largest gains. We were also up in the heavy truck and aerospace sectors, while rail was relatively flat. Pricing was positive, while currency translation was a headwind in the quarter. Mobile Industries' adjusted EBITDA for the third quarter was $55 million or 10.5% of sales compared to $58 million or 11.9% of sales last year. The decrease in Mobile segment EBITDA margin was driven by the impact of higher operating costs, which more than offset the benefits of positive price mix and higher volume in the quarter. I would point out that Mobile Industries continues to be impacted by material inflation, labor inefficiencies and supply chain challenges to a greater degree than Process Industries. Turning to Slide 19, you can see that we generated operating cash flow of $145 million in the quarter. And after CapEx, free cash flow was $98 million. The higher free cash flow compared to last year was driven mainly by higher earnings. We expect working capital to come down seasonally as we approach year-end and we are taking other targeted steps to reduce inventory. So we would anticipate a further step up in free cash flow in the fourth quarter. Taking a closer look at our capital structure, we ended September with net debt to adjusted EBITDA at 1.8 times, which is an improvement from the end of June and well within our targeted range. After the planned closures of the GGB Bearings acquisition and the ADS divestiture in the fourth quarter, we would expect to finish the year with pro forma net leverage of around 2 times. With our strong balance sheet, we remain in a great position to continue to drive our strategic priorities and we expect capital allocation to be accretive to earnings again in 2023. During the third quarter, Timken returned $72 million of cash to shareholders through dividends and the repurchase of 750,000 shares of company stock. Year-to-date, we've repurchased 3 million shares or about 4% of total shares outstanding as we continue to view buybacks as an attractive use of capital. Now let's turn to the outlook, with a summary on Slide 20. We are raising our full-year outlook for both the top and bottom-line performance, based on our strong third-quarter results and our expectations for the rest of the year. We now estimate adjusted earnings per share will be in the range of $580 to $595 per share, up from our prior guide of $550 to $580. The midpoint of our new outlook would represent a 25% increase in EPS from last year and a new all-time record for Timken. The midpoint of our earnings outlook also implies that our consolidated 2022 adjusted EBITDA margin will be up about 125 basis points versus last year, which is an improvement from our prior outlook. We expect strong year-on-year margin performance in the fourth quarter, driven by continued positive price-cost dynamics, higher year-over-year volume and improving operational performance. Turning to the revenue outlook. We're now planning for revenue to be up around 9% in total at the midpoint versus 2021. Organically, we now expect sales to be up about 11.5% for the year, which is up from our prior outlook of 9%. This reflects our strong third-quarter revenue performance and implies organic revenue growth of around 10% in the fourth quarter. Our backlog supports our increased outlook. We now expect currency to be roughly a 3.5% headwind to the topline for the full year, which is about 100 basis points worse than our prior outlook. And finally, we now expect M&A to contribute around 100 basis points to our revenue for the full year, up from 50 basis points prior. Note that we are including the net impact from the GGB Bearings acquisition and the ADS divestiture in our sales outlook, assuming a mid-quarter close for both transactions. Moving to free cash flow, we now expect to generate $250 million for the full year 2022. This is lower than our prior outlook and reflects higher working capital driven by increased sales and ongoing supply chain issues. As we highlighted at our recent Investor Day, we would expect free cash flow and conversion to step up significantly in 2023 under almost any scenario. We estimate CapEx will come in around 4% of sales for the year with the spend fueling our long-term growth and operational excellence initiatives. And finally, we anticipate full-year net interest expense of roughly $70 million and we expect our adjusted tax rate will be around 25.5%, both unchanged from our prior guide. So, to summarize, the Timken team delivered strong results in the third quarter and raised our full-year outlook yet again. We're on pace to deliver all-time record earnings in 2022 and we're well positioned to continue to drive top quartile financial performance and scale our position as a diversified industrial leader going forward. This concludes our formal remarks and we'll now open the line for questions.

Thank you. We will now begin the question-and-answer session. Our first question today comes from the line of Stephen Volkmann with Jefferies. Stephen, please go ahead. Your line is open.

Thank you so much. Nice to talk to everybody today. I wanted to start off talking a little bit about sort of the margin differential between the two segments if we could, because obviously Process is kind of crushing it, but as you know we on Wall Street are always going to look at the other one. So Mobile is a little bit below, I guess what we would have expected and I think at the low end of your sort of long-term ranges. And is cost just that much different between these two segments? Is there something going on with price that's also somewhat different? Is there perhaps some inventory reduction happening in Mobile? I don't know, there just seems like there's more to that story.

Yes, thanks, Steve. Mobile margins are definitely lower than we would like, and we need to improve them. As you mentioned, Mobile is disproportionately affected by steel prices, inflation, and likely currency fluctuations as well. Additionally, price recovery has been slower. On a positive note, we expect Mobile to benefit from easing steel prices, which we've already started seeing in the third quarter and anticipate will continue into the fourth quarter. We have a chance to adjust many of the annual pricing agreements starting January 1st, and we plan to take advantage of that. Moreover, two of our major self-help initiatives that were negative this year should turn positive for us next year. One is the new plant in Mexico, which started at a low output but is set to finish the year and enter next year at much better levels. The other is the closure of the chain plant, both located in Mobile, which should yield benefits. Overall, we're seeing significant self-help opportunities in Mobile. We’re noticing improvements in Mobile pricing, although it hasn’t fully caught up with costs yet, but we are committed to increasing Mobile margins and believe we have a clear path to achieve this.

Okay, great. That's helpful. And maybe the follow-up, I don’t know, if this is related. But Phil, based on your kind of bridge that you gave us for EBITDA, it's nice to see price/mix and material logistics kind of continues to get better, but manufacturing and SG&A actually continued to get worse as we go through the year here. So what's the outlook for that as we kind of get through year-end and into '23?

On the manufacturing piece, as Phil said, there is an element of that that is still supply chain inefficiencies and we need to do some things there and then also some of our self-help to improve that. What I would tell you, what we've seen in the last two quarters, is that number has gone up and material logistics gone down and we're seeing pretty broad-based inflation across the manufacturing space of everything else that we over our other input costs beyond steel and logistics, where it's a lubricant or grinding wheel or a pallet. We're seeing pretty broad-based inflation across that including labor. So I expect some self-help and some improvement on the one side, but I'm not sure the other side has topped out. So we are looking, as we look at next year that we think we need to look at that as largely a structural cost and offset that with pricing.

Yes, and on the SG&A, Steve, please proceed.

No, sorry Phil, please.

Yes, I was just going to say on the SG&A, we were up in dollars as we pointed out with was higher compensation, some of that being incentive compensation, as well as higher spending, given the sales were so much higher year-on-year. But I mean you look sequentially from the second quarter when we exclude, you know, the special items, we were roughly flat on a dollar basis, running in that close to 14% of revenue. That's kind of what we ran last year. I think we'll run in that range for the full year this year, which sort of says, the SG&A did increase but kind of in line, in line with revenue, and coming out of COVID people traveling more and getting back to more normal activities, it was more or less in line with our expectations.

Super. Is there any way to ballpark what the productivity headwind has been kind of through all this, which may be unwind at some point in the future?

Well, I think it's been getting, I'll say, slightly better sequentially, and I would certainly say of that, of the bar on the EBITDA walk, it's well less than half of the manufacturing expense. I mean, there is certainly something there we need to get after and capture and get out of our cost structure, but I think as I said inflation is the bigger issue, right.

Hi, thank you. Your guidance implies organic sales growth in the fourth quarter at 10%, down from the third quarter, but it's still at a pretty healthy level. So, I guess, I'm just trying to calibrate how much of that is working off old backlog versus new orders that you're seeing? I know you're not a heavily backlog-oriented business, but just that kind of resiliency in the organic growth in the fourth quarter is interesting. And I'm just trying to calibrate, how much of that somewhat indicative of continued order strength or working off the old backlog? And then I have a follow-up.

I'd say our backlog peaked around May and June and began to decline by the end of the second quarter. However, as we look at the situation today in October, it's still quite high, and orders continue to come in at a very strong pace. For example, our distribution orders in October have increased compared to last year, although they are still growing at a slower rate than shipments. We are receiving orders faster than we did last year, and despite rising prices, we are making a small dent in the backlog. Overall, the situation is positive.

And would you mind giving us a sense how large the backlog is right now, like I mean essentially the genesis of the questions here, I mean if you can really do 10% in the fourth quarter, and it's not just chewing through backlog, it obviously suggests at least as of now, unless you get cancellations, the first part of '23 also starts with pretty healthy organic. So, however you want to address that, you know, essentially, that's the question. Some sense as to how large is the backlog or maybe an overall book-to-bill on the quarter, whatever you can help us to get a sense of the pace of organic to start next year? Thank you.

We don’t provide many details about the backlog because it includes various elements, with some businesses having over a year’s worth of backlog while others only have a week. However, I can say that when we see organic growth in the fourth quarter, we typically experience similar growth in the first quarter. In a normal strong market, we expect a sequential growth rate of over 5 percent from Q4 to Q1. Currently, we believe orders are coming in steadily, and the backlog is substantial enough that even with a significant amount being processed, it’s likely to end the year higher than it began. This suggests a strong year-end, which usually indicates a strong start to the new year, and we will provide further updates during our call in January or February.

Yes, I'd also like to mention that for the fourth quarter, the guidance suggests a typical sequential decline in revenue, around the mid-single digit range, which is quite normal. This indicates that some of the healthy growth we experienced was influenced by comparisons to last year. Additionally, the backlog we report annually is significantly higher than it was at the end of last year. As Rich mentioned, we expect to finish the year with numbers above last year.

Great. Thanks. Good morning. Yes, the first question is about distribution. Rich, you mentioned earlier that there has been strength in nearly every geography during the quarter, which aligns with some growth reported by at least one of your larger public customers in North America. As we consider the outlook for 2023, it’s uncertain where that growth will lead. How does Timken perform in comparison? Specifically, is there any restocking this year that might negatively impact next year? Additionally, how do you view your performance regarding sell-in versus sell-through?

Yes, good question. And certainly, it's very strong around the world. I would say, Europe has slowed. So I would say that is the exception. The rest of the world though, everywhere except Europe very strong. And for where we have visibility to inventory levels and sales which would clearly be in Europe and the United States and maybe a couple of large global distributors. I would say, inventory is still more of a tailwind for us than a headwind and distributors are looking still to build more inventory. As I just quoted the October data, we are shipping at a higher rate than the orders in October, but again both growing from prior year. So I think, certainly for the fourth quarter, I would say, it still is a tailwind and certainly don't see any headwind heading into next year. And then, I think, from there it probably depends on how the year plays out. But inventory levels, you know, really as you look even back to 2019 or/and '18 would be probably on the low side, particularly given the magnitude of growth that we've experienced, so turns through the channel are higher today.

Yes, one of the end markets is renewables, which has been a concern this year. While not a huge surprise, particularly on the wind side, it seems that some customers are waiting for more clarity regarding the political environment and subsidies. How do you view the potential for growth in this area in 2023, considering that it has a longer lead time and sales cycles? What are your thoughts on this specific part of the portfolio for next year? Yes, in response to the earlier question about backlog, we have more visibility into the backlog compared to other areas of our business. We remain very optimistic about this sector in the long term and continue to invest in it for growth, believing it will be a high-growth market for us and will enhance our growth rate. It's important to note that we are significantly focused on Asia, followed by Europe, while our presence in the Americas is less pronounced. At the end of 2021, our business experienced a slowdown, which continued slightly into 2022. We anticipated a rebound later in the year. However, the situation in China has certainly been affected by COVID and government lockdowns, impacting us more than the overall market. Nonetheless, we expect to be down mid-single digits from a robust 2021, which was a strong year overall. For China and Asia, optimism is increasing for 2023, suggesting it will be a promising year, and we are seeing a good order flow. In contrast, Europe presents a more uncertain outlook due to the economic stability issues mentioned earlier. However, I reiterate that the momentum for investment and growth in renewable energy worldwide is gaining traction and promises to be a very favorable area for the next five plus years.

Got it. Understood. Thanks for your time.

Hi, thanks. Just to clarify the inventory comments, you're expecting solid growth, you said orders are still coming in and distributors still want to increase their own inventory, but yours came down sequentially for the first time in quite a while. Is that just working through higher priced items on the balance sheet or is that an actual unit reduction? Just trying to frame that up.

We are planning to produce less than we sell in the fourth quarter. Over the past year and a half to two years, we built up a significant amount of inventory; however, much of it has not performed as effectively and efficiently as usual due to supply chain challenges. While these issues are not completely resolved, we have observed improvements in transit times, which have become more reliable, although they are still longer than before. Therefore, we are focusing on aligning our inventory and enhancing its productivity. We do not anticipate a substantial reduction in the fourth quarter, but we expect some correction that will positively impact our cash flow during that period.

Understood. The next topic will be difficult to predict, but there has been significant news regarding China and semiconductor manufacturing restrictions. It's impossible to determine if or how they might retaliate, but does the tension in that area cause you to reconsider your manufacturing strategy? Also, could you remind us of the volume of product you export from China?

We have a fairly balanced presence globally. While we are a small net exporter from China, most of that is directed towards Europe, Australia, and other regions rather than returning to the U.S. Our investment strategy has been balanced, primarily focused on Europe, India, and China, with more recent investments in Mexico. This balanced approach ensures we are not overly reliant on any single area. Reflecting on the economic fluctuations we've faced over the past five years, tariffs significantly impacted our industry, particularly in steel. Despite some short-term challenges, our diverse footprint has allowed us to manage these issues effectively, and I believe we are well-prepared for future developments.

Got it. Thank you.

Thank you. Good morning, guys.

Good morning.

Good morning, Bryan.

I noted solid backlog and that order trends are supportive of your implied Q4 guide through October. Just curious if across your major end markets, there are any you'd call out and order patterns diverging in any way from normal seasonality?

Yes, I think it's consistent with what Phil commented on, where the strength of the third quarter is probably still the strength of the fourth quarter, distribution looking strong and et cetera. I mean, as I said, Process is probably a little bit more than Mobile. I think as you look to next year, you'd see some change there. Again, I think renewables will get off to a better start in '23 than they did in '22, but I wouldn't say there's anything significant happening in the fourth quarter different than what we just outlined happened in the third quarter.

Okay. Understood. And any further color you can offer on the decision to divest ADS? I'm asking simply because I would assume that there's attractive cycle runway and with growth over the coming years that the margin profile would also benefit. And then another question, if you are willing to answer, looking at that divestiture and your 2022 acquisitions, what kind of net accretion carryover should we think about for 2023?

On Aero Drive Systems, I would say it is slightly below the company's average margins for this year, with more variable margins compared to the overall business year-over-year. This might enhance our predictability and somewhat reduce cyclicality. We acquired that business over a decade ago, but the market has shifted from helicopters to a greater focus on drones. Although it remains a strong market and a good cash generator, the business needed to invest in the next generation of equipment. We decided not to make that investment in consolidation and allowed someone else to take that on. This decision led to the divestiture, which I believe will have a minimal impact on the company's margins and cash flow, accounting for just over 1% of revenue.

Yes. And I would say net accretion, Bryan. I mean, obviously we got this year with Spinea in the middle of the year, we got GGB at the end of the year, offset by the areas. It will still be net accretion flowing into a positive accretion, EPS flowing into 2023 from the carryover of Spinea, capturing synergies, driving growth as well as GGB.

Hi, thanks, and good morning.

Good morning, Rob.

Good morning.

My question is basically on Europe. Yes. So it's no surprise that Europe is slower, being flat there is no surprise, but there are some cross currents where some industrial end market still growing and some not. I wonder if you just provide any clarity of what you sell into, what's strong and what's weak and if there's any theme there?

Yes, I mean, I would say, Rob, as we talked about it in the quarter, the flat was really a combination of the industrial markets, in particular distribution and general industrial was modestly up. And then it was really offset by lower renewable energy, which obviously is big project spend over in Europe. And then also lower rail revenue with most of that rail revenue loss being because we idled our operations in Russia at the beginning of the year. So, you know, it's kind of the short story. Industrial still modestly up and then offset by the lower renewable and rail revenue. And then as we look ahead to the fourth quarter, we talked about expectations for being up organically. We are expecting Europe to continue to soften in the fourth quarter, slightly off the third. So we should post positive growth across most of the world, but Europe would be the one spot, which could tip to slightly negative in Q4.

Thanks. Good morning, everyone.

Good morning, Joe.

Hi, Joe.

I'm interested in your comments about inventory. As you begin to sell through your inventory, it's clear that this will have a positive impact on cash flow. Looking ahead to 2023, how will this affect your profit and loss statement, especially considering there could be under-absorption at your manufacturing facility? I want to understand how this will influence your margins.

It's a slight challenge and one reason why our margins tend to be lower in the fourth quarter compared to the rest of the year. We typically build inventory in the first and second quarters and reduce it a bit in the third and fourth. This isn't unusual. However, when comparing year-over-year, we built inventory last year in the fourth quarter, and we plan to reduce it a bit this time. Therefore, there will definitely be an effect from lower production on the absorption factor. Nevertheless, as we are projecting, we expect to more than compensate for that with improved margins year-over-year in the fourth quarter due to price and other factors.

Yes. I guess, I think, the real question is, if you continue to sell a lot of inventories in, let's say, the first half of next year, like does that then like lead to is like a tougher comp, like I just want to make sure that I get it or are you guys going to be taking proactive cost actions to help offset some of that?

Yes, looking at this year, we definitely have the inventory build, which has been beneficial. However, we've also faced higher costs and many inefficiencies, and we expect those higher costs to continue into next year. If we reduce inventory next year, it will have a minor negative impact, but we anticipate that some inefficiencies will decrease as well, primarily because many of them were related to the significant production ramp we experienced this year. As production levels off, we expect some offset from this, along with ongoing improvements from new plants and the consolidation of facilities we are currently working on. Therefore, there will be various factors to consider as we move into next year.

Great. Good morning, guys. Thanks for the question.

Good morning.

Just wondering if I can kind of build on Joe's last question there, just on pricing in the quarter. You were obviously clear about the kind of contribution from mix on the distribution side. But just wondering if you can kind of parse out how much of the actual price contribution in the quarter was from kind of what you considered to be normal annual price increases or kind of automatic indexing put through the start of the year versus any kind of more ad hoc pricing actions that you went out with during the quarter?

Yes. In terms of pricing and mix, we have experienced a favorable mix year-over-year, so that plays a role. It's not solely about price. A portion of the price is linked to raw material costs and in some instances, currency fluctuations when we sell in different currencies. However, I want to emphasize that this indexed pricing accounts for less than half of our total pricing and won't decrease unless the costs do. There is typically a delay in this adjustment, which was evident last year when we faced challenges recovering. This time, however, we have seen some positive effects. Given the trends in steel prices, we still anticipate that pricing will increase at the start of 2023 after accounting for any indexed factors.

Okay. That's clear. Thank you. And then I realized it was kind of an unfair question since the consensus number are not yours, but you obviously had a pretty good quarter relative to the consensus number in 3Q, but the guidance raise didn't necessarily imply any upside into 4Q at the midpoint. Just curious if you can kind of talk through your assumptions in terms of what would have to go right in order for you to kind of hit the top end of your kind of full year guide that might imply a bit of upside kind of implied 4Q number for the fourth quarter?

Well, I think it would start with volume and being 1%, 2% over the revenue number would obviously drop through pretty well. I think on the second side, if we see further contraction on the material logistics sequentially, that would certainly begin to help. And then we can even just stop the increase on the manufacturing side. And then there's also, as we said earlier, we are planning to produce slightly less than we sell during the quarter, but obviously anything that sales is higher helps that situation as well. I think the price is largely set. And then, I guess, the last one I'd say is the mix, which, again, we're largely counting on that to be positive again and all indications are with two months left, it will be.

Hi, good morning, guys. Thanks for taking the question.

Good morning.

To start off, could you provide an update on the current loading and utilization rates at the Mexico facility? Are they around 20%, 50%? A general idea of how that is progressing would be appreciated.

I wouldn't want to specify a percentage because we have to consider machine capacity, workforce availability, and floor space. We plan to increase the facility's output over the next few years. However, the situation has improved significantly from a year ago. If you visited today, you would see a bustling factory with more than 100 employees in a largely automated environment. A year ago, you would have observed mostly construction equipment and machines that were either being installed or running samples. We've made significant progress over the past year, and we anticipate a substantial year-on-year improvement in our costs.

Got you. Yes, thanks so much for the insights there, Rich. To broaden the discussion beyond just Mexico, Timken has done an excellent job of aligning labor costs with product value and entering the market effectively. From a more comprehensive viewpoint, how are we approaching footprint evaluation today? Are we considering shortening supply chains? Are we looking at relocating facilities, or are there other opportunities to explore? Any broader comments would be appreciated as well.

I don't think there's any significant change in our footprint strategy that we've been developing for almost a decade. We allocate our capital to specific facilities and regions while adjusting other facilities based on demand, and over time, we phase out some higher-cost, smaller facilities. Some of our acquisitions in recent years have provided us with additional opportunities to pursue this in the future. We announced two plant closures before the supply chain issues; one in Italy was completed earlier this year, and the other in Indianapolis will conclude by the end of this year. Currently, we have no other closures in progress. However, we do have a five-year plan that we adjust based on market dynamics and their pace. Overall, we have a well-balanced footprint, and I expect us to continue our current trajectory without any major imminent changes in our footprint strategy.

Hi, thanks everyone for squeezing me in. Hi, everyone. If we look at your EBITDA margin, which is up nicely this year, it's still below the pre-COVID level in '19, yet your sales are above pre-COVID, EPS above pre-COVID. So just broadly, anything structural preventing your margins from returning back to that pre-COVID peak and exceeding it as we look at '23, '24?

No. I think as we mentioned at the Investor Day, we're aiming for 20%, and we are dedicated to achieving that. The timing of acquisitions and other factors, along with the industrial cycle, influence this. However, we are making progress towards the 20%. I believe we can reach that goal.

Perfect. And just on, as you said, timing of the M&A, I mean your leverage is reasonable. I think you said you're going to end the year around 2 times. You expect a bigger free cash flow year next year. So just thinking about 2023, is 2023 more about integrating Spinea and the GGB acquisition is supposed to close in Q4, you know, and it's more about integration and maybe shifting more to buybacks or could we see more acquisitions outside year of M&A in 2023?

I believe this will be a strong year for cash flow, and we plan to allocate more capital to one of the two areas. Our M&A strategy remains opportunistic. The Spinea acquisition will be integrated to some extent with Cone, but they are more complementary than overlapping, leading to a relatively light integration. Additionally, GGB is a couple of hundred million dollar business being brought into a $3 billion bearing business, and we have the management capacity to handle further bearing opportunities, although that is less likely due to fewer targets in that market. In the industrial motion product line, there are plenty of opportunities. We have the management capacity and the organizational changes made a few months ago were specifically intended to ensure we can continue pursuing these opportunities. We are inclined towards M&A next year as we have been, and we expect to be active in generating strong cash flow and redeploying that cash. That concludes our call. Thank you for joining us today.