Timken Company (The)

Good morning. My name is Anna, and I will be your conference operator today. As a reminder, this call is being recorded. 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 speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the number one, I'm sorry, press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star then the number two on your telephone keypad. Thank you. Mr. Frohnapel, you may begin your conference.

Thanks, Anna, and welcome everyone to our third quarter 2021 earnings conference call. This is Neil Frohnapel, 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 Fricasa, 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, 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, everyone, and thank you for joining Timken's third quarter earnings call. Our third quarter results reflect what is a very strong but also unpredictable industrial market. Results also demonstrate the resiliency of our business to respond to a wide variety of market conditions, as well as the strength of our team and their ability to successfully navigate through the issues as they arise. Our revenue of $1,037,000,000 was up 16% from last year. The revenue set a new third quarter record and was 13% higher than the previous record set in the third quarter of 2019. Additionally, order input continued at a strong pace and we ended the quarter with a very healthy backlog. Our demand continued to be more erratic than normal due to customers battling through multiple supply chain issues such as the global chip shortage and international freight delays, but demand remains a very positive situation and one that we expect to continue through next year. Given our own supply chain challenges, we're pleased with the 16% revenue gain, but it did come at a significant cost premium. Earnings per share of $1.18 was also a record for the third quarter. It was 4 cents over the prior record. EBITDA margins declined 220 basis points from last year to a still very respectable 17.2%. I want to remind everyone that our year-over-year comps for the quarter and year-to-date include the temporary cost actions we took last year at the height of the pandemic. 2020 temporary cost comps normalized in the fourth quarter of this year. From a cost perspective, steel, freight, and other purchased material were all up significantly from prior year and up sequentially from the second quarter. Labor efficiency in our plants also continued to suffer from a variety of issues that included volatile plant schedules due to demand and supply changes, pandemic-related absenteeism, and the onboarding of new hires to meet the increased demand. Pricing was up over 100 basis points year-on-year, but continues to lag cost increases by a significant margin. Sequentially, price realization increased from Q2 to Q3 and has increased sequentially each month from June through September. Our cash flow performance reflects continued inventory build to serve increased customer demand and to account for the extended lead times within the supply chains. We are not providing specific revenue or earnings guidance due to the supply chain uncertainties, but I will provide additional color on what we are seeing. Demand remains strong in total across markets and geographies. Channel inventories are also favorable to provide support for the demand strength to continue well into next year. Timken has steadily ramped up our ability to supply the market through the course of the year, but the uncertainty around supply and cost remains elevated. Some of the issues that impacted us in the third quarter have improved, some have gotten worse, and some new ones have arisen. The chip shortage is not forecasted to stabilize any time in the near future. Logistics delays are not expected to improve until after the holiday shipping season at the soonest, and logistics costs continue to rise. Steel costs appear to have leveled off, but remain much higher than they were a year ago and are not moving down. We're doing very well addressing our internal labor inefficiencies, but new issues continue to surface, such as the intermittent power outages at our plants in China and a recent resurgence of the virus in Romania. We expect pricing to increase sequentially from Q3 to Q4, but we still expect price costs to be negative in Q4. Our revenue typically declines modestly from the third quarter to the fourth, call it low to mid-single digits, and we expect the sequential decline this year to be slightly greater than recent history. This would still result in solid year-on-year revenue growth in the mid to high single-digit range. We expect EBITDA margins to decline sequentially in the fourth quarter as they normally do. And I again caution that the supply chain situation remains very dynamic, so the range of possible outcomes is wider than normal. As we look out to 22, we are planning for the demand situation to remain strong. Preparing the start of 22 to the start of 21, we will enter next year with a much higher backlog, higher order input levels, and higher production levels. We also expect more self-help in 22, both from pricing as well as operational initiatives. We predominantly price at the time of shipment, and we expect a step up in price at the start of the year from the fourth quarter. Keep in mind, many annual price agreements will open for repricing at year-end, and we will benefit from other pricing actions which continue to gain traction, including our material recovery mechanisms. We also expect to operate more efficiently in 22 as we get deeper into our production ramp and the labor issues specific to the pandemic ease. We no longer expect near-term cost relief in material, logistics, or labor. but we do expect price to be a much larger contributor to margins and we also expect to improve our internal labor efficiencies. We're planning for a very strong start to 22 with a step up in sequential revenue and margins in the first quarter from the fourth. We also expect contribution to our full year 22 results from capital allocation. We continue to have a bias to M&A with share buyback as an attractive option. I want to take a moment to highlight two of our acquisitions, Roland and IMS. Roland was our first step into linear motion. Roland is a leader in the engineered linear space, developing unique customer applications for a wide range of markets and applications. The business has a strong management team, a strong technical value proposition, and has been an excellent addition to the Timken portfolio. Roland has a small but growing position in linear systems for factory automation, To expand their product offering, last quarter we acquired Intelligent Machine Solutions, or IMS. This bolt-on acquisition gives us a full size range of linear systems for the factory robotics space and gives us greater scale in the U.S. market. We will continue to drive financial and strategic value for the corporation through the acquisition of businesses like Roland and IMS. I also want to highlight that we recently released our 2020 Corporate Social Responsibility Report. Sustainability has been core to our products for more than 120 years, and being an excellent corporate citizen is a priority for all of us at Timken. We're proud of our work in developing renewable energy sources and the actions we are taking to reduce our own environmental impact. We're also committed to being a top global employer with a diverse workforce, giving back to our communities in leading the corporation ethically and with strong governance practices. Before I turn it over to Phil, let me close with saying that while the last couple of years have been filled with unplanned events, our response to those events has really demonstrated the strength and resiliency of the company for all stakeholders. After delivering record revenue and record earnings per share in 2019, our world was turned upside down in early 20 with the onset of the pandemic. As the year progressed, we managed the downturn well with strong cash flow and earnings, excellent decremental margins, and an increase in the dividend. And while we delivered good financial results, we also continued to advance the company's strategy, including delivering a breakout year for our renewables business and completing the acquisition of Aurora Bearings. In 2021, we've been dealt with a surge in inflation across many of our key input costs, as well as unexpected supply chain and labor market challenges. Despite these challenges, we are once again on track to deliver another year of record revenue and earnings per share as we continue to advance the company's strategy with our outgrowth, operational excellence, and capital allocation initiatives. Looking at 22, we are confident that the company can and will perform well if the inflationary environment persists. We are in great position to deliver new record levels of revenue and earnings again in 2022, all while continuing to advance the company's long-term strategy to grow as a diversified industrial leader. Phil?