The Timken Company (NYSE:TKR) Q4 2022 Earnings Call Transcript

The Timken Company (NYSE:TKR) Q4 2022 Earnings Call Transcript February 6, 2023

Operator: Good morning. My name is Glen, and I’ll be your conference operator today. At this time, I would like to welcome everyone to Timken’s Fourth 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.

Neil Frohnapple: Thanks, Glen, and welcome everyone to our fourth 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 Web site 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 Web site. 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.

Richard Kyle: Thanks, Neil. Good morning and thank you for joining our call. Timken delivered another excellent quarter which concluded an outstanding year. Organic revenue in the fourth quarter was up 10%, demand continued to be strong, with North America and Asia both up double-digits. Price contributed meaningfully to the fourth quarter revenue gain, and our outgrowth initiatives also added to the results. Fourth quarter EBITDA margins improved 380 basis points from prior year, with improved price-cost being the largest driver. Earnings per share of $1.22 was a record for the fourth quarter, and was up 56% from prior year. We also closed on the GGB Bearings acquisition and the Aero Drives Systems divestiture, and purchased 250,000 shares.

And free cash flow in the quarter was very strong at $186 million. For the full-year, we delivered 9% total growth, and around 12% organic growth, which was the second consecutive year of double-digit organic growth. Organic growth was at least 10% all four quarters of the year, and we start ’23 with very good momentum. EBITDA margins, of 19%, were up 160 basis points from ’21, and were more consistent through the course of the year. Our price realization exceeded the 4% that we guided to at the beginning of the year, and price improved sequentially each quarter for the second straight year. The rate of cost increases leveled off around mid-year, but costs were up over prior year each quarter, and we remain in an inflationary environment. There have been a lot of moving pieces on costs.

Steel and logistics were the early inflationary pressures. They have both eased off peak, but labor, energy, other material, and SG&A costs all increased. Internal inefficiencies from supply chain and labor challenges were better than ’21, and improved through the course of the year but remained elevated. Earnings per share, of $6.02, we 28% over last year’s record level. Free cash flow, of $285 million, was up from prior year. In addition to the M&A, we continue to invest about 4% of sales in CapEx for growth and cost initiatives. We advanced our products, advanced our footprint, improved our productivity, invested in our digital platform, and expanded our capacity through these investments. We also purchased about 4% of our outstanding shares during the year, and we ended the year with a strong balance sheet.

We were also named one of America’s Most Responsible Companies, by Newsweek, for the third year in a row. This recognition underscores our commitment to being an excellent corporate citizen. We’re driving sustainability through the products we make, the industries we serve, and across our global operations. We also invest in the development of our people, the diversity of our workforce and safety across the enterprise. In summary, 2022 was a very good year for industrial demand, but also had a lot of unexpected challenges. And we once again capitalized on the opportunities while navigating through and responding to the challenges to deliver outstanding results for both our customers and our shareholders. Before I turn to ’23, I want to highlight slide 12 in our quarterly deck.

This slide is from our recent Investor Day, and is updated for our ’22 results, and our new adjusted EPS definition. Through the five-year period, we delivered an 8% revenue CAGR, an 18% earnings per share CAGR, and an average EBITDA margin of 18.5% with only 180 basis points of margin variation through the five years. When you reflect back on the macroeconomic volatility through that five-year period, from tariffs, pandemics, inflation, supply chain challenges and more, these results demonstrate the resiliency of the demand for our products and technology, the diversity of our business, and our commitment and capability to drive value through economic cycles. So, while uncertainty remains elevated today, Timken is well-positioned to continue to create value in the years to come through industrial cycles, and through evolving technologies.

Timken enters ’23 a larger and better version of the company that we were in 2018, and we are confident that we will be able to continue the trajectory of this performance in the years to come. And we expect that ’23 will be a good start to the next five years. Turning to 2023, I will start with our recently announced acquisitions. First, American Roller Bearing, or ARB; ARB has been family-owned and operated in the United States for three generations, they have a long-standing position in the U.S. process industries markets; they have a large install base of products throughout the U.S. and sell primarily through bearing distributors through a fragmented base of OEMs and end users. These are markets and channels that Timken knows very well, and we are confident that we can create value for customers and shareholders through integrating ARB in the Timken’s engineered bearings portfolio.

ARB enters the portfolio at modest EBITDA margins, but we expect, over time, to get it to Process Industries’ level margins. Nadella will add a combination of new products to our portfolio, and also expand existing product lines and market positions. The largest product line is linear motion actuators. The product compliments and scales our linear motion platform, and we will deliver strong synergies with our Rollon business. Nadella also brings industrial needle roller bearings, ball screws, and rod ends to the portfolio. Timken entered the rod end market with the 2020 acquisition of Aurora, and adding Nadella will globalize our rod end market position. Nadella will further scale our position in several of our targeted markets as they serve a fragmented customer base across markets like automation, packaging, food and beverage, logistics, and medical.

Nadella will join Timken with a margin profile slightly above the company average. And with synergies, we will both expand margins and accelerate the global growth rate. We’re excited to be adding both ARB and Nadella to our portfolio. Upon completion, we will remain comfortably within our targeted leverage ratios. And with our ’23 cash flow, we can continue to be opportunistic with capital allocation opportunities through the year. Turning to our markets, in slide seven in the deck, we are guiding to a 3% organic revenue increase in total. We expect price to be over 2% for the year, so price comprises over half of the organic revenue outlook. We are confident in achieving at least the 2% price. Starting on the right, we’re expecting a strong full-year in renewals, driven by Asia wind, both from the market as well as from our outgrowth tactics.

This is a market where we have good visibility into demand for several quarters out. The order book and backlog are strong, and customers are committed to a step up in revenue for the full-year. We’re planning for the rest of our markets to range from flattish to up mid-single digits. I’ll talk more about the first quarter in a moment, but this guide assumes we will start the year well above the 3% level, and then moderate the second-half of the year partly from tougher comps, but primarily from taking a cautious view of the markets where we do not have extended visibility. We are also anticipating some channel inventory pullback in this outlook as supply chains improve and customers return managing inventory with higher precision. If our outlook for the second-half proves to be low, we will be in excellent position to capitalize on the situation.

From a margin standpoint, we are guiding to roughly flat margins for the year. As I said in my ’22 comments, there have been a lot of moving pieces on the cost and margin front and that continues into ’23. We are expecting price cost to be modestly positive for the full year. We also expect margin help from better operational execution, supply chain improvements, our ’22 CapEx and footprint investments, and lower steel and logistics cost. However, we remain in an inflationary environment. And we do anticipate further cost increases in SG&A, labor, and other purchase materials. Currency and mix are also expected to be margin headwinds for the year. We have been dealing with a rising and volatile cost situation for a couple of years. And I am confident that we will successful navigate through the price cost dynamics again in ’23.

Earnings per share would be up about 5% at the mid-point. We expect much stronger cash flow in ’23 primarily from higher earnings and lower working capital requirements due to both moderating growth rate as well as improved supply chain execution. While we are taking a cautious view on the second-half, we are starting the year strong. We have good visibility for the first quarter and well into the second quarter. And we expect organic revenue to be up high single digits in the first quarter. We have a healthy backlog, good order input, and the benefit of another sequential price improvement. We would also expect our normal sequential step-up in margins from the fourth quarter to the first. In summary, we delivered an excellent year in 2022 both strategically and financially, and we are off to an excellent start to ’23.

We are in a great position to extend our strong performance. We are excited about the opportunities in front of us, and we feel confident in our ability to continue to create shareholder value for a long-term as we continue advance Timken as a diversified industrial leader.

Philip Fracassa: Okay, thanks, Rich, and good morning, everyone. For the financial review, I am going to start on slide 14 in the presentation material with a summary of our strong fourth quarter results which capped off a record year for Timken. We posted revenue of close to $1.1 billion in the quarter, up over 7% from last year. We delivered an adjusted EBITDA margin of 17.2% with strong year-over-year margin expansion. And we achieved record fourth quarter adjusted earnings per share of $1.22, up 56% from last year and over 20% than our next best fourth quarter. Turning to slide 15, let’s take a closer look at our sales performance. Organically, fourth quarter sales were up 10.2% from last year driven by strong growth across most end markets and sectors, and with healthy contributions from both volume and pricing.

Looking at the rest of the revenue block, foreign currency translation was a sizeable headwind in the quarter driven by a stronger U.S. dollar against the euro and other key currencies. And the impact of acquisitions net of divestitures contributed modestly to the top line. On the right-hand side of the slide, you can see organic growth by region, which excludes both currency and acquisitions. Let me touch briefly on each region. In Asia-Pacific, we were up 10% driven by strong growth across the region with renewable energy and distribution posting the strongest sector gains. In North America, our largest region, we were up 13% with most sectors up led by off-highway, distribution, and general and heavy industrial. In Latin America, we were up 5% driven mainly by year-over-year growth in distribution.

And finally, in EMEA, we were down slightly as lower renewable energy revenue and lost Russia sales were mostly offset by growth in other sectors. And notably if you exclude Russia, we would have been up modestly in the region for the quarter. Turning to slide 16, adjusted EBITDA in the fourth quarter was $186 million or 17.2% of sales compared to $135 million or 13.4% of sales last year. Looking at the increase in adjusted EBITDA dollars, we benefited from strong price mix and higher volume in the quarter, which more than offset the impact of unfavorable net manufacturing performance and higher SG&A other expense. As you can see on the walk, material and logistics costs were relatively flat year-on-year, a significant improvement from the sizeable headwinds we’ve experienced over the past several quarters.

Overall, we delivered an incremental EBITDA margin of 68% on the higher sales driven by our positive price cost performance, which enabled us to expand margins by 380 basis points, versus the fourth quarter of last year. Let me comment a little further on a few of the key drivers in the quarter. With respect to price mix, pricing was meaningfully higher in both mobile and process industries reflecting our significant pricing actions over the past year. Mix was also positive, driven by our strong growth in attractive sectors like industrial distribution. Moving to material and logistics, as I mentioned, the year-over-year impact in the quarter was largely neutral as higher material costs from continued supplier price increases are mostly offset by lower logistics and transportation costs.

I would also point out that material and logistics costs were down sequentially from the third quarter. On the manufacturing line, we were negatively impacted by continued cost inflation, including energy and labor, as well as lower production volume. And we were also impacted by higher costs that had been capitalized to inventory in prior periods. This will continue to be a headwind in 2023. On the positive side, we’re seeing improved execution from our teams around the world as supply chain and other constraints continue to ease. We should also benefit more in 2023 from our manufacturing footprint actions, and other self-help initiatives. And finally, on the SG&A other line, costs were up in the fourth quarter driven by higher compensation expense, and other spending to support the increased sales levels.

But I would point out that SG&A expense was in line with our expectations, and up only slightly organically from the third quarter run rate. On slide 17, you can see that we posted net income of $97 million or $1.32 per diluted share for the quarter on a GAAP basis, which includes $0.10 of net income from special items. On an adjusted basis, we earned $1.22 per share up 56% from last year, and a record for the fourth quarter. You’ll note that we benefited from a lower share count in the quarter, reflecting the significant buyback activity we’ve completed over the past year. And lastly, the higher interest expense and 25.5% adjusted tax rate are in line with our expectations. Now let’s move to our business segment results starting with Process Industries on slide 18.

For the fourth quarter, Process Industries sales were $586 million, up 11.1% from last year. Organically, sales were up 13.5% driven by growth across all sectors, with distribution, heavy industries and general industrial, posting the strongest gains in the quarter. Pricing was positive once again and that acquisition contributed nearly three percentage points of growth to the top line. But currency translation was a sizable headwind in the quarter, reducing growth by over 5%. Process Industries adjusted EBITDA in the fourth quarter was $143 million, or 24.4% of sales compared to $105 million, or 20% of sales last year. The increase in Process segment margins reflects the benefit of positive price costs and higher volume, which more than offset the impact of higher manufacturing and SG&A costs in the quarter.

Now let’s turn to Mobile Industries on slide 19. In the fourth quarter, Mobile Industries sales were $496 million up 3.3% from last year, organically sales increased 6.4% with the off highway and rail sectors posting the largest revenue gains. We were also up in heavy truck while aerospace and automotive are relatively flat. Pricing was positive once again, our net acquisitions contributed modestly. Currency translation was a headwind in the quarter, reducing growth by nearly 4%. Mobile Industries adjusted EBITDA in the fourth quarter was $56 million or 11.3% of sales compared to $41 million or 8.6% of sales last year. The increase in Mobile segment margins was driven by the benefit of positive price costs which more than offset the impact of higher manufacturing and SG&A costs.

And notably, mobile margins were up sequentially from the third quarter, which is unusual given our seasonality and reflects a moderation of costs over the past few months. Turning to slide 20, you can see that we generated operating cash flow of $242 million in the quarter. And after CapEx, free cash flow was $186 million, or more than tripled what we delivered last year. Looking at the full-year, free cash flow was $285 million, up from $239 million in 2021. The higher free cash flow was driven mainly by earnings growth, which more than offset the impact of higher working capital to support the record sales levels, as well as higher CapEx to fund our growth and operational excellence initiatives. During the year, Timken paid $92 million in dividends, or $1.31 per share, making 2022 the ninth consecutive year of higher annual dividends per share.

In addition, we repurchased over 3 million shares of stock during the year or about 4% of total shares outstanding, and we have nearly 6 million shares remaining on our current authorization. We also completed the acquisitions of GGB and Spinea and with those acquisitions, 2022 marks the 13th straight year where Timken has made at least one acquisition. When you take into account our CapEx, dividends, net acquisitions and share buybacks, Timken deployed just over $900 million of capital in 2022. And we did it while maintaining a strong balance sheet. Turning to the balance sheet, we ended the year with net debt-to-adjusted EBITDA at 1.9 times while within our targeted range. In addition, we completed several debt financings during the year to provide us with additional financial flexibility, including the $350 million issuance of 10 year bonds back in March at an attractive fixed rate.

We also refinanced and upsized both our revolver and U.S. term loan in December, extending their maturities to 2027. With our strong capital structure and cash flow, we remain in a great position to continue to drive shareholder value creation in 2023 and we’re off to a great start with ARB and Nadella. Now let’s turn to the outlook with a summary on slide 21. As Rich highlighted, we expect strong top and bottom line performance again in 2023 with a large step up in free cash flow generation. Starting on the sales outlook, we’re planning for another year of record revenue, with sales up 4% to 8% in total or 6% at the midpoint versus 2022. Organically, we’re planning for revenue to be up above 3% at the midpoint, driven by positive pricing and modest volume growth, with our volume assumptions, reflecting some prudent cautiousness around the second-half, given our limited visibility.

We expect the acquisitions net of divestitures to contribute around 3.5% to our revenue for the full-year. This includes the recent ARB acquisition, but does not include Nadella. We will include Nadella in our outlook after the deal closes, which will be around the end of the first quarter. And finally, we expect currency translation to be a 50 basis point headwind to the top line for the full-year based on December 31st spot rates. On the bottom line, we expect record adjusted earnings per share in the range of $6.50 to $7.10 per share, which represents around 5% growth at the midpoint versus last year on a comparable basis. Note that the guidance range reflects our new definition for adjusted EPS, which excludes acquisition intangible amortization expense of roughly $0.50 per share.

I’ll come back to this later in my remarks. The midpoint of our earnings outlook implies that our 2023 consolidated adjusted EBITDA margin will be roughly in line with 2022. Note that our margin assumption reflects a sizeable headwind from currency off the positive impact we saw last year. Organically, we should see strong incrementals as favorable price costs momentum, and improved operational execution should more than offset headwinds from higher manufacturing, and SG&A costs, lower production volume and unfavorable mix. Moving to free cash flow, we expect to generate approximately $400 million for the full-year 2023 of approximately 90% conversion on net income at the midpoint. This is over $100 million higher than 2022 and reflects the impact of improved earnings and working capital performance.

We’re estimating CapEx at around 4% of sales for the year, with the spend continuing to fuel our long-term growth and operational excellence initiatives. And finally, we anticipate higher interest expense, and we expect our adjusted tax rate to remain around 25.5%. Turning to slide 22, let me comment further on the revision to our adjusted EPS calculation. As I mentioned, our new definition for adjusted earnings excludes acquisition intangible amortization expense, which has grown in recent years with the cumulative amount of acquisitions we’ve made. Overall, we believe this change will provide a better representation of our core operating earnings and improved comparability of our performance versus peers. So, to summarize, the company delivered strong results again in the fourth quarter to finish another record year.

Our team continues to win in the marketplace, and drive our profitable growth strategy. We’re off to a strong start in 2023, and we’re well-positioned to continue to scale as a diversified industrial leader through any environment. This concludes our formal remarks. And we’ll now open the line for questions. Operator?

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Q&A Session

Operator: Thank you. With our first question, comes from Steve Barger from KeyBanc CM. Steve, your line is now open.

Steve Barger: Thanks. Good morning.

Richard Kyle: Good morning.

Philip Fracassa: Morning, Steve.

Steve Barger: Rich, you said price is 2% of the 3% organic growth. If I go back to slide seven, you have the worst case for the four sectors as flat, and most of the sectors are mid single-digit or better. Can you talk about which of the end markets, if any, you think are going to have negative volume growth this year?

Richard Kyle: Yes, and we don’t specifically split out the volume versus the price. But certainly if those middle markets all have price realized over the last year on them, so if they end up at zero their volume would be down a little bit.

Steve Barger: But it sounds to me like you’re taking a pretty conservative approach just based on what this slide looks like, since you do expect positive price-cost. I guess I’m trying to get to the idea of whether you really think volume is negative or positive in 2023 for most of your end markets?

Richard Kyle: Well, it’s certainly not negative to start the year. And if you look at this, slide seven, we have four markets on this slide that we have visibility well into the second-half on, renewable energy, aerospace, heavy industries, and marine. So, the four markets where we have good visibility into the second-half volume as well as price were all looking, overall, for them projecting to be up mid single digits or more for the full-year. And as I said, we’re looking to be up high singles organically in the first quarter. So, certainly to get to these numbers for the full-year, you’d have a moderating, from high single digits down to low single digits as the year advanced, in total.

Steve Barger: So, as you look at your internal model, do you show positive growth in the back-half or in 4Q specifically or do you expect that that goes negative in the back-half?

Richard Kyle: With price, we’d be still modestly positive.

Steve Barger: Great, thanks for the time.

Richard Kyle: And — but I’d also want to emphasize again as we — as you part there, Steve, again, we don’t have visibility into that. We’re taking a cautious outlook into it. But again, we’re starting the year up. We just finished the fourth quarter up 10, and starting the year up high single.

Steve Barger: Understood. Thanks.

Operator: Thank you, Steve. With our next question, comes from David Raso from Evercore. David, your line is now open.

David Raso: Hi, thank you. I have been jumping between calls, so sort of if I missed this, but earlier, you said mix would be part of why margin is only flattish year-over-year. Did I miss some growth guide particular to Process versus Mobile, where Mobile is up more? I’m just trying to figure out why would the mix be down? And was there something unique toward the end of ’22 that really skewed the mix? I mean, obviously, process in general, right, gives you the better margins. But did I miss something about the bigger mix comment or is there already been something within Process?