Q3 2022 Timken Co Earnings Call
Good morning, My name is Emily and I'll be your conference right to today at this time I would like to welcome everyone to Timken Stead 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. If you'd like to ask a question Joe you must time simply press.
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Thanks, Emily and welcome everyone to our third quarter 2022 earnings conference call. This.
This is Neil prone Apple 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 for Casa 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 express written consent.
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.
<unk> of 160 basis points.
We continue to demonstrate <unk> 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 eight revenue was 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 in the operating environment remains dynamic.
We continue to face persistent inflation pressures cost increased in the quarter 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 and 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're 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 <unk> 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 DGB bearings DGB as a global supplier of highly engineered plane and metal polymer bearings.
The plain bearing category is highly complementary to timken roller in 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 Arrow drive systems.
As a supplier of flight critical components for rotorcraft applications.
We're always reviewing our portfolio for strategic and financial fit and we determined that <unk> will be better positioned to succeed in the market under other ownership.
It presents just over 1% of Timken revenue and we expect to close in the fourth quarter.
We do not expect any other sizeable divestitures near term, we have an attractive and diverse portfolio and we are 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.
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 <unk> divestiture.
Through late October our revenue and order run rates support our fourth quarter outlook.
On the bottom line, we're expecting input cost 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.
$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 <unk> 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 a 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 carryover to start 2023.
We have a high backlog and orders continue to come in at a healthy pace.
Typically see a seasonal step up in demand and margins from the fourth quarter to the first.
Our orders and backlog support a strong start to 2003.
We would also expect price to be up sequentially again from the fourth quarter to the first.
We are 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 'twenty, three including improving our operational performance and supply chain stabilize deliver.
Delivering on our Capex and margin enhancement initiatives.
Outgrowth, the GGP and <unk> acquisitions.
In the full year impact of share buyback.
We will provide our full year outlook for 'twenty three early next year, but we have a lot of positive momentum as we enter 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 at 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 'twenty three a stronger company than we were entering 2018 and we are in excellent position to continue to properly 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 4 billion in the quarter up nine 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 of 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 topline in the quarter.
The U S dollar continued to strengthen against the euro and other key currencies.
And the net impact of acquisitions, including spinel contributed modestly to the topline in the quarter.
And while you don't see it on the slide sequentially, our sales were down about one 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.
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 a $179 million or 17, 2% of sales last year.
Adjusted EBITDA was up $35 million or 20% from the year ago period as.
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.
<unk> our actions over the past 12 months.
Mix was also a significant contributor driven by our revenue growth in attractive sectors like industrial distribution.
Moving to material and logistics, we continued to experience higher cost compared to the year ago period.
The increase was driven mainly by materials 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.
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 34 <unk> of net expense from special items, which was driven mainly by a $29 million pre.
Pre tax impairment charge related to the planned divestiture of our aerospace drive systems business or <unk> for short.
On an adjusted basis, we earned $1 52 per share in the quarter up 29% from last year.
With respect to <unk>. 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 industry 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.
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 industry sales were $527 million up eight 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.
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 one eight times.
Which is an improvement from the end of June and well within our targeted range.
After the planned closures of the GGP bearings acquisition and the Aes divestiture in the fourth quarter, we would expect to finish the year with pro forma net leverage of around two times.
With our strong balance sheet, we remain in 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 750000 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 $5 80 to $5 95 per share.
Up from our prior guide of $5 50 to $5 80.
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.
Your 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 three 5% headwind to the top line 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 GGP bearings acquisition, and the avs divestiture and our sales outlook, assuming a mid quarter close for both transactions.
Yes.
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 guidance.
So to summarize the timken team delivered strong results in the third quarter and raised our full year outlook yet again.
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 operator.
Thank you we will now begin the question and answer session if you'd like to ask a question. Please do so now by pressing star followed by the number one on your telephone keypad. If you change your mind I would like to withdraw yourself from the queue. Please press star followed by Chase.
Also that when preparing to ask your question. Please ensure that your advice and your microphone is on mute locally.
Our first question today comes from the line of Stephens Volkman with Jefferies. Steven. 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 processes kind of crushing it but as you know we own wall Street are always going to look at the other one so mobile is.
A little bit below I guess, what we would've expected and I think at the low end of your sort of long term ranges.
Is it 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 if theres just seems like theres more to that story.
Yeah. Thanks, Steve.
Yes, so definitely mobile margins are lower than we'd like them to be we need to get them up.
To the point you just made mobile does get hit disproportionately with steel gets hit.
Disproportionately with inflation and probably a little bit with currency.
As well and then price recovery is slower.
So on the positive side I think it will also benefit more from steel prices easing, which as Phil said in his comments, we did start to see in the third quarter and we expect more of that in the fourth quarter. So we have some natural help there. We also have the opportunity.
To another opportunity in January 1st to reset many of the annual pricing agreements there.
And we'll take advantage of that and then all said I would say this year.
From a self help standpoint, two of our bigger projects.
That will be a positive next year that were a negative this year, but the two that I referenced the new plant in Mexico, which started the year at a very low level will finish the year and start next year at a much healthier level.
And then closing the chain plant both of those are.
In mobile and we will see the benefit there. So I think we have a probably a disproportionate amount of self help coming in mobile we have been getting mobile pricing.
<unk> been improving sequentially.
Just not.
Not caught up probably at what the cost but.
But we will we are focused on getting mobile margins up I think we have a good line of sight to do so.
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 EBIT.
It's nice to see price mix and material logistics kind of continues to get better, but manufacturing and SG&A actually continue 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 'twenty three.
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 although I would tell you what we've seen in the last two quarters is that number has gone up in.
Material logistics gone down that were seeing a pretty broad based inflation across the manufacturing space of everything else that we all of our other input costs beyond steel and logistics, whether it's a lubricant or a grinding wheel or a pallet.
We're seeing pretty broad based inflation.
Across that including labor so.
Spect, 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 into next year that we think we need to look at that as largely a structural cost and offset that with pricing.
Yes.
And the SG&A, Steve I mean.
Good.
No sorry, I felt place.
Yes, I was just going to say on the on the SG&A were up in dollars as we pointed out that was higher compensation some of that being incentive compensation as well as higher spending given the sales are so much higher year on year, but when you look sequentially from the second quarter. When we exclude the special items, we were roughly flat on a dollar basis.
We're running in that close to 14% of revenue that's kind of what we ran last year I think we will run in that range for the full year. This year, which sort of says hey, 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 it was more or less in line with our expectations.
<unk>.
Super is there any way to ballpark, what the productivity headwind has been kind of through all of this which may be unwind at some point in the future.
Well, it's been getting I'll say slightly better sequentially and I would certainly say of that.
Sure.
Of the bar on on the EBIT 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.
Terrific. Thank you guys I'll pass it on.
Thanks, Steve Thanks, Steve.
Yeah.
Our next question comes from David Raso with Evercore ISI. Please go ahead David.
Hi, Thank you your guidance implies organic sales growth in the fourth quarter at 10%.
Down from the third quarter, but still at a pretty healthy level.
I guess I'm, just trying to calibrate how much of that is working off an old backlog versus new orders that youre seeing I know youre 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 is that somewhat indicative of continued order strength.
Our working off the old backlog and then I have a follow up.
I'd say, David our backlog peaked in the May June timeframe and did start to come down by the end of the second quarter. However, as we sit here today in October it's quite high.
And orders are still coming in at a very healthy clip. So I'll give you. One example that I just looked at the data the other day through October .
Distribution orders are up in October over last year.
But they are up less than shipments. So we are still taking in orders at a faster clip than we were last year with price in there.
But we aren't doing a little bit into the backlog. So it is.
Some of both.
But but still positive.
And would you mind.
Give us a sense of 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 a backlog. It obviously suggests.
As of now unless we get cancellations. The first part of 'twenty. Three also starts are pretty healthy organic. So however, you want to address that.
Central that's the question.
Some sense of how large is the backlog or maybe an overall book to bill on the quarter. Whatever you can help us with to get a sense of the pace of organic to start next year. Thank you.
Thank you.
Do you have a lot of details on the backlog because it's a lot of apples and oranges and other things added up in there where we've got some businesses that run and product lines that run over a year of backlog and we've got some things that run a week of backlog.
So.
But I would tell you we.
Whenever we grow in the fourth quarter organically, we generally grow in the first quarter organically in a normal and a good market a sequential Q4 to Q1 is five plus percent up organically. So.
We sit here today, we think the orders are coming in at a pace and again the backlog is high enough that you could chew up quite a bit of it and it's still it's still going to end the year higher than it started the year. So I think.
It's setting up to finish the year strong, which almost always means you start the year strong.
And after that we'll talk more about that as we get to the January February call, Yes, and the other comment I might make David too is on the fourth quarter as we did the guidance does imply a pretty normal sequential step down in revenue call. It towards that mid single digit range, which is pretty normal which says some of that.
Healthy growth, obviously, you had to do with the comp from last year as well, but to Richard's point.
The backlog, we publish it annually in the K, it's up significantly from the end of last year and as Rich said, our expectation is we will end the year.
Up versus last year as well.
And one last little incremental if you could and I'll hop off.
The organic so you you can hit.
Hit your guidance, 10% for the quarter.
Between the two segments right, obviously mobile slowed a little bit we had an acceleration in process this quarter.
For that step down from 13 six for this quarter down to 10 do you have mobile slowing notably in process kind of holding I'm, just getting a sense of the momentum interest starting 'twenty three and as we all know the margins are a lot higher in process I'm, just trying to get a sense of.
Where is.
The growth heading into mobile typically slows a little bit more in the fourth quarter from the third then then process more OEM in the holidays and shutdowns that sort of thing.
<unk>, a little bit more as well as larger Oems managing inventory a little bit at the end of the year.
So more sequentially from Q3 to Q4 is the number that still just referenced steel I would expect it to be probably a little bit heavier in mobile.
Okay, which is not very much.
So our mix on the flip side.
Thanks, David.
Right. Thank you.
Our next question comes from Tim Thein with Citigroup. Please go ahead, Tim Your line is open.
Great. Thanks, good morning.
First one is just on distribution and rich you may have covered a little bit on this earlier, but.
You noted strength I think in pretty much every geography in the quarter.
It's certainly consistent with.
Some of the growth reported by at least one of your larger public customers anyway in North America, but.
We just think about.
The outlook.
Where that net growth trends in 'twenty, three but just how does timken performed relative to that I E.
Is there any element of a restocking.
Helping this year that maybe those again next year or I don't know just generically how do you think about that.
Your performance relative to that.
Kind of a sell in versus sell through question.
Yes good.
Good question and certainly very strong around the world I would say Europe has slowed so I would say that it was the exception the rest of the world know everywhere, except Europe , very strong and for where we have visibility to inventory levels and sales.
<unk> really being 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.
October but again, both growing from from prior year. So I think certainly for the fourth quarter I would see it as a <unk>.
<unk> is a tailwind and certainly don't see.
Any headwind heading into next year, and then I think from there probably depends on how the year plays out but inventory levels.
As you look even back to.
2019 or.
<unk> 18 would be probably on the low side, particularly given the magnitude of growth that we've experienced with turns through the channel are higher today.
Okay.
Okay got it and then.
Maybe just one of the end markets being renewables.
The one in <unk> and <unk>.
For the year and.
Certainly.
Judging by some of the larger.
Layers in that market recently.
I think a huge surprise at least on the wind side.
But there is a notion that maybe some of that is on account of just customers waiting for a little bit more clarity regarding kind of the political environment.
Subsidies et cetera, how do you think about that or.
The prospect for that maybe.
And growing in 2003.
Presumably you've got a longer lead time there Amit.
Longer sales.
Sales cycles.
Yes.
How are you thinking about that.
Vic piece of the portfolio and 23.
Yeah to the earlier question about backlog. It is an area, where we would tend to have a higher visibility to the longer higher longer visibility in the backlog than other parts of the business.
Start with I mean, we remain very bullish on this space over the long term and certainly continue to invest in it for growth and believe over the long term. It is it is going to be a high growth market for us.
And mix our growth rate up.
Any other reminder, we're heavily weighted to Asia, and then Europe and under weighted to the Americas.
So for us the business slowed at the end of 'twenty, one so we started.
Down a little bit to start 'twenty two.
Thought it would come back later in the year.
Probably would have with the exception of <unk>.
The business in China has certainly been impacted.
By Covid issues and government.
Lockdowns in various issues there probably more than it has been in the market.
But even that we're looking at down mid.
Mid single digits off a what was it.
A really strong year in 'twenty, one so it's still it's still a strong year I would tell you the for China and for Asia.
Optimism is building for 'twenty three that it will be a good year and we are getting the order flow for that Europe I think is much more uncertain.
And probably it comes back to some of the issues that you just mentioned there in terms of.
Stability of.
The economic situation, there et cetera, but coming back to my opening comment Europe U S et cetera, and there is no doubt that the momentum for renewable energies investment in growth around the world is continuing to pick up momentum and is going to be a really good place to be for the next five plus years.
Got it understood. Thanks for the time.
Thanks, Tim Thanks, Tim.
Our next question today comes from Steve Barger with Keybanc capital markets. Please go ahead Steve.
Hey, Thanks, just to clarify the inventory comments you are 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.
It's a unit reduction than we are.
Planning to produce less than we sell in the fourth quarter as well, we have built quite a bit of inventory in the last year and a half two years.
Quite a bit of it is.
There has not been as effective and as efficient as what it normally would be due to the supply chain issues and again, while those issues arent are far from smooth and eliminated we have seen things like transit times improve and become more reliable let's say.
They doubled at one point maybe there.
Now 50% longer versus twice what they were in more consistent so we're bringing our I'd say our inventory.
More in line of focus more on the productivity of the inventory. So we're not looking at a big reduction in the fourth quarter, but we are looking at.
Some correction there and that will help our cash flow in the fourth quarter as well.
Understood.
This next one is going to be tough to predict but obviously there was a lot of news as it relates to China and semiconductor manufacturing restrictions.
Obviously impossible to say if or how they will retaliate, but does tension there make you rethink your manufacturing footprint strategy at all or and can you remind us how much product you actually export from China.
Yes, we have a pretty balanced footprint, we are a small net exporter out of China, although not a lot of it comes back to the U S. More of it would go into Europe , Australia other other geographies.
So I would say we have had.
A balanced investment approach largely probably between.
Europe , and India, China, Eastern Europe , India, and China have been the bulk of our investment and then more recently Mexico.
And I think Youll see us continue to take a pretty balanced approach to that we don't we're not over weighted or have too many eggs in one basket.
I would highlight there.
As I mentioned some of the economic volatility we dealt with in that five year period on that chart. If tariffs were a really big deal to a lot of our.
Industry, if you will from steel customers and steel providers back three four years ago.
And again that was we took some short term.
Pain with that but with the.
The diversity of our footprint, we're able to navigate those things and deal with it and I think we're in a good position to handle whatever comes next.
Got it thank you.
Thanks, Steve Thanks, Steve.
Our next question comes from Bryan Blair with Oppenheimer. Please go ahead, Brian Your line is open.
Okay.
Thank you good morning, guys.
Good morning.
Yes.
Hi.
<unk> solid backlog and order trends are supportive of your implied Q4 guide.
Through October just curious if across your major end markets. There are there any you'd call out in order patterns diverging in any way from 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.
<unk> et cetera.
As I said process, probably a little bit more than mobile I think as you look to next year. It should see some change there again I think.
Renewables will get off to a better start in 'twenty three than they did in 2002, but I wouldn't say, there's any 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 aes.
I'm asking simply because I would assume that there is.
<unk> cycled runway and with growth over the coming years that the margin profile.
We would also benefit.
And then.
Another question. If you are willing to answer looking at that divestiture.
And your <unk>.
2022 acquisitions, what kind of net accretion carryover should we think about for 2023.
Yes.
Aero drive systems I would say it is slightly below the company average for margins this year, probably a little more.
Lumpy margins, if you look your year over year than the business in total so probably help our predictability cyclicality a little bit from from that regard.
The divestiture required that business over a decade ago.
And.
Warfare has changed from.
Helicopters to a lot more drones and.
The growth of that market is still a good market, it's still a good business good cash generator.
But it really needs some it needed to reposition itself on the next generation of equipment et cetera in and we chose to.
Not be the one to make that investment and consolidation and allow somebody else do that so that was really what led to.
The divestiture, but I think it'll it will have an immaterial impact on comp.
Company margins company cash flow and as I said, it's a little over 1% of revenue.
Yeah, and I would say net net accretion Brian I mean, obviously, we got this year with <unk> in the middle of the year with <unk> at the end of the year offset by the avs it'll still be net accretion flowing into a positive accretion EPS flow into <unk>.
2023 from the carryover of spin and capturing synergies driving growth as well as well as GGP.
Understood.
Thanks, guys.
Thanks, Bryan Bryan.
Our next question comes from Brian <unk>.
With Melius research. Please go ahead Rob.
Okay.
Hi, Thanks, and good morning.
Good morning, My question is basically on Europe .
Yeah, I think so.
It's no surprise that Europe is slower being flat there is no surprise, but there's some cross currents with some some industrial end market is still growing in some not I wonder. If you can just provide any clarity of what you sell into what's strong in what's weak and if theres any theme there.
Yes, I mean, I would say Rob is as we've talked about in the quarter. The flat was really a combination of the industrial markets in particular distribution and general industrial was was modestly up and then it was really offset by lower renewable energy.
Which obviously has big projects spanned 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 it's kind of a short story industrial still modestly.
Up and then offset by the lower renewable and rail revenue and then as you as we look ahead to the.
The fourth quarter, we talked about expectations for being up organically and we are expecting Europe to continue to soften in the fourth quarter slightly after a third so we should post positive growth across most of the world, but Europe will be the one spot which could tip to slightly negative in Q4.
Okay. Thank you sorry, if I missed something earlier.
And then just one other one you've touched on supply chain.
Few different ways, but just general Big picture.
Are things easing up or are they getting better or are they getting better into <unk> or is it still back and forth.
I think youre getting better they're getting better gradually more incrementally.
We don't buy a lot of chips and aren't directly impacted by that but we are indirectly impacted by that's where our customers that seems on their end too.
Have gotten better.
The labor situation.
Most of the World is significantly better from an absenteeism in coronavirus cases et cetera than it was.
It's still in third quarter, a fair amount of of China.
Issues with.
Regional lockdowns that that impacted some things there.
As I mentioned earlier transit times are still longer.
Significantly longer than they were pre pandemic.
And then labor markets and much of the World, obviously still remain tight and in challenging more challenging than normal to add some people. So.
So I think it's still it's still choppy or bumpier more surprises than.
What you would expect.
But I do think it's getting better and we're expecting slightly better again in the in the fourth quarter.
Got it thank you.
Thanks, Rob.
Our next question comes from Joe Ritchie with Goldman Sachs. Please go ahead.
Thanks, Good morning, everyone.
Good morning, Joe Hey, Joe.
Gary.
I'm curious on just the inventory commentary.
<unk> as you guys start to sell out of your inventory, obviously recognize like that positive cash flow it back, but that's going to have.
Really in 2023, I'm curious how does that impact your P&L.
Particularly given that there might be some under absorption the manufacturing facility that you are selling out I just wanted to just wanted to try to understand the margin impact.
It is a it's a slight headwind and it's one of the reasons why we normally it's one of those.
Reasons, why our margins are usually lower in the fourth quarter than the rest of the year, we usually build some inventory in the first quarter second quarter year, and lowered a little bit in the third and fourth.
Wouldn't say, it's anything abnormal but when you look at it year over year basis, we built inventory last year in the fourth quarter and we'd be looking to take a little bit out. So there would certainly be an impact from <unk>.
Lower production in the absorption factor.
But obviously as we're guiding we're guiding to more than offset that.
With margins up year over year in the fourth quarter from <unk>.
Price mix and other factors.
Yes, I guess.
Real question.
If you continue to sell out of inventory, let's say the first half of next year.
Has that been like retailer like a tougher comp.
I want to make sure that I get it or are you guys going to be taking pricing action.
Offsets on the wall.
Yes, I mean, I think I think as you look at this year, Joe We certainly had as rich said the inventory build which helped from that standpoint, we also had the <unk>.
Higher costs in a lot of inefficiencies and we're expecting the higher cost to persist into next year, but as the if we build less inventory next year that'll be a <unk>.
Negative as rich Guy, but I think the inefficiencies our expectation would be the inefficiencies would sort of come down with it because a lot of the inefficiencies caused by the significant ramp that we saw this year.
Significant ramp up in production et cetera, so as that as production moderates. If you will I think we will get a little bit of offset there coupled with a lot of the self help we talked about around new plants continuing to ramp consolidating some of the facilities.
We're working on as we speak and so I think there'll be there'll be puts and takes as we as we look ahead to next year.
Yes.
Got it that makes a lot of things and maybe one last one just on price.
Yes.
We're not going to talk about anything like from a quantification perspective.
Again kind of thinking through 'twenty three as you reprice. Some contracts you think we're still in an environment, where you can get pricing.
Or have you started to see commodities and components come down enough, where it might be a little bit more of a difficult conversation.
As we head into client.
We would expect.
Pricing to improve sequentially this quarter and again in the first quarter.
I think there is enough momentum there and theres enough need.
Due to the tough conversation the the drivers of the need for the price of moved from steel and logistics to other factors like labor and energy.
But we will we will get positive price to start 'twenty three.
Okay. Thanks, Scott.
Thanks, Joe.
Our.
Question comes from Dillon Cumming with Morgan Stanley . Please go ahead.
Great. Good morning, guys. Thanks for the question.
Just wonder if I can kind of build on Joes last question there just on pricing in the quarter.
Was it 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 consider to be normal annual price increases.
Or kind of automatic indexing put through the end of the year versus any kind of more AD hoc pricing actions that you went out with during the quarter.
Yes.
Within that price mix as we said mix is certainly a favorable year on year. So an element of that is mix. So it's not all price and then there is a percentage of the price that is.
Raw material indexed in some cases currency index for selling things.
Outside of her in another currency.
But a couple of things on that it's well under half of the pricing.
And it wont retreat and less but the cost does and generally there's a lag on that so like there was a lag in us recovering at last year there was a.
Which is negative for us there was actually a positive lag.
But with that and what we've seen with steel prices.
We'll expect pricing to be up to start 23 net of.
Any indexed.
Factors that would play into it.
Okay. That's clear. Thank you and then I realize this is kind of an unfair question that consensus number and not yours, but you obviously had.
Had a pretty good quarter relative.
The consensus number in <unk>, but the guidance raise didn't necessarily imply any upside to <unk> at the midpoint I'm. 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 full year guide that might imply a bit of upside to kind of the implied 14 number for the fourth quarter.
Well I think it would start with volume and.
Been one 2% over the.
Revenue number would obviously drop through pretty well I think on the.
The second side.
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 is also as I 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 prices 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.
Great. Thanks for the time.
Thanks, Don.
Our next question comes from Chris <unk> with <unk>.
Capital. Please go ahead Chris.
Hey, good morning, guys. Thanks for taking the question.
I guess starting off just.
Thinking about the Mexico facility can you just kind of update us on what factory loading and utilization looks like they are today. I mean are we kind of is it 2050% just a general ballpark of kind of how thats progressing would be great.
Yes, I, probably wouldn't do a percent because there is machine capacity manned capacity floor space in.
Planned to be ramping the facility up for a couple of years, but.
It's gone from.
A year ago to at close to zero two if you went in it today it would feel like a vibrant fab.
Factory with well over 100.
People working on and what's a fairly automated facility as well.
Year ago, you would've went in and saw a lot of construction equipment and idle machines being installed and running samples et cetera. So it's come a long way in the last year.
And it will be it'll be a nice.
Year on year pickup for us on the on the cost side.
Got it thanks, so much for the color there rich I guess, maybe just zoom out beyond just Mexico Timken has done a really excellent job of kind of matching labor cost the value of the product and getting out into the market. There I guess from a more holistic perspective, how are we thinking about footprint evaluation here today.
Are we talking about shortening supply chains, we're talking about shifting facilities similar to <unk> are there other opportunities like chain Theres any comments more holistically it would be great as well.
And I don't think Theres any major shift in our footprint strategy that we've been working on for better part of a decade.
We invest our capital into overweight into specific facilities in specific regions.
And then flex other facilities with with demand.
And over time take out some higher cost last smaller facilities.
Some of our acquisitions done over the last few years has given us.
So more opportunity to probably do some of that in.
In the coming years.
We had two plant closures announced.
Prior to.
The supply chain issues et cetera, those got drug out a little bit, but one of them in Italy, we completed.
Earlier this year.
And the other one I mentioned.
In Indianapolis is.
Is wrapping up kind of at the end of this year. So we don't have anything other anything else underway right now, but we do have a.
I'd say, a five year plan that we that we March to an alternative timing of that plan based on market dynamics.
And the speed of it but so we've got pretty good balanced footprint and and I think youll continue to see as March down at a no big.
Eminent moves do we have in our plan for our footprint.
Got you. Thanks, so much for the color there and congrats to the entire team on a really nice quarter.
Thanks, Thank you.
Our next question comes from Michael Feniger with Bank of America. Please go ahead.
Hey, thanks, everyone.
What you mean.
Hi, everyone. If we look at your EBITDA margin, which is up nicely. This year, it's still below the pre COVID-19 level and 19, yet your sales are above pre COVID-19 EPS above pre COVID-19. So just broadly anything structural preventing your margins from returning back to that pre COVID-19 peak and exceeding it as we look.
At $23 24.
No I think as we just outlined at the Investor day, we're targeting 20% and.
And we're committed to trying to do that and obviously the timing of.
Acquisitions and.
Various things play into the cycle industrial cycle itself play into that but.
We're we're marching towards that 20% I think we can get there.
Perfect and just on as you said time will to M&A.
Your leverage is reasonable I think you said youre going to end the year around two times you expect a bigger free cash flow next year. So just thinking about 2023 in 2020 hearing more about integrating.
And the <unk> acquisition is supposed to close in Q4.
And it's more about integration and maybe shifting more to buybacks or could we see more acquisitions are outside year of M&A in 2023.
Well I think it will be a year of good cash flow in a year that we will allocate more capital to one of those two.
The M&A side remains opportunistic I think.
The <unk> acquisition is.
It's certainly going to be is it being integrated to some degree with cone, but they're more complementary than they are overlapping so I would say, it's a fairly light integration.
GGP has a couple of hundred million dollars business being integrated into.
$3 billion bearing business. So I think we could handle we have the management bandwidth to handle more bearings should that present itself, although as we've talked before that's probably less likely because theres less.
Targets that we're working on in that space and then within the industrial motion product line I think there is ample opportunities and again, we have the management bandwidth and the organizational changes that we announced.
A few months ago, we're done specifically with the intention of making sure. We did have the bandwidth to continue that so.
Bias to M&A next year as we've had.
And I believe we'll be active in and generating good cash and redeploying that cash.
Perfect. Thanks, everyone.
Thanks, Michael.
There are no remaining questions at this time do you have any final comments or remarks.
Thanks, Emily and thank you everyone for joining us today, if you have any further questions. After today's call. Please contact me. Thank you and this concludes our call.
Thank you for participating in today's Timken Stat quarter earnings release Conference call you may now disconnect.