TKR - NYSE

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. [Operator Instructions] Thank you. Mr. Frohnapple, you may begin your conference.

Thanks Emily and welcome everyone to our third quarter 2024 earnings conference call. This is Neil Frohnapple, Vice President 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, Tarak Mehta; and Phil Fracassa, our Chief Financial Officer. We will have opening comments this morning from both Tarak 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 Tarak.

Thanks Neil and good morning everyone. Today is my first earnings call as a member of The Timken Company and I thank you for joining us. I will begin by discussing our results and then we'll share some personal observations from my first 60 days at Timken. Let's start with a look at the quarter and the outlook. Industrial markets remained soft during third quarter and we saw mixed performance across different sectors and geographies. Organically, revenue was down 3% from last year and geographically, in Europe, we saw a soft demand for most of the portfolio. And in China, revenue was down mainly due to wind. On the positive side, we were up slightly in the Americas and saw continued strength in India. Our order backlog was stable with the second quarter. At 16.9%, the adjusted EBITDA margin was down 200 basis points, and our earnings per share came in at $1.23 compared to $1.55 last year. Both earnings per share and margins fell short of our expectations. Lower volumes, combined with the higher logistics costs and other headwinds in the quarter were the main reason for the shortfall. Phil will go through these items in more detail a little bit later on. Pricing remained slightly higher in the quarter. On a positive note, we saw continued strong and margin accretive performance from our acquisitions that we have made recently, Des-Case, Lagersmit, and CGI. During the third quarter, we also closed on CGI, which will add presence in high-growth medical robotics and automation space. CGI also gives us a good position in precision drive systems and will be accretive to the Industrial Motion business going forward. This quarter, India as a market and aero, defense and marine as sectors also showed both good growth and good performance. Second half of this year is proving to be more challenging than expected across several sectors and geographies. Our updated 2024 outlook reflects the third quarter performance as well as a softer-than-normal fourth quarter. We want to align cost and capacity with the market demand, both to improve margins and also respond to our customers. We will provide more details in early February on early -- on specific actions and their impact on 2025. On a personal note, it's an order to lead Timken at this exciting time in its history. I have long admired Timken for its strong brands, its reputation for quality, innovation, and excellence. During my first 60 days, in order to get an external perspective on Timken, I met with analysts, some of our key investors, and spent time with greater than 60 channel partners and customers. I also visited colleagues in 18 production facilities in United States, Europe, and China, all of which gives me a good start in understanding the business, our team's strength in the market segments that we operate in. During the visits, I also saw how we are developing innovative products to address some of the most challenging applications for our customers. I was impressed with the talent and the organization as well as the critical role our products play in improving reliability and efficiency of our customers' applications. It's still early, but here are a few high-level examples of what we are doing to strengthen the company for 2025 and beyond. First, we're aligning our capacity and cost to the market demand by implementing cost reductions at a product line level, which will improve margins. Second, we will take a look at our entire portfolio of product lines with an eye towards allocating capital and resources for higher organic growth and better returns. We already see some good examples to build on. Third, we will maintain our disciplined and deliberate approach to capital allocation. We expect M&A to help us further diversify the portfolio and increase of our presence in attractive growth markets. An example of that is the CGI acquisition we made this quarter. In addition, we will work to reduce our net working capital, which will improve our free cash flow and returns on invested capital. This will require changes in the process and will take a bit of time to implement, but we expect our cash performance to improve over time. Again, it's early, and today, we only share some initial reflections, but we will have more to say at a later date. Today, I also want to highlight that 2024 is the 125th anniversary of Timken. It has really been the team's commitment to customers, innovation, and excellence, that is both reflected in the product quality and the service level over the last 125 years, that has resulted in the strong brand of Timken in the industry. Timken has built a strong foundation and achieved significant improvements in performance over the last several years. As a team, we will build on this foundation, a profitable growth future that delivers better cash flow, higher earnings per share, and better returns for the invested capital. With that, let me turn the call over to Phil for a more detailed review of the numbers and outlook. Phil?

Okay. Thanks Tarek and good morning everyone. For the financial review, I'm going to start on Slide 12 of the presentation materials with a summary of our third quarter results. Revenue for the quarter came in at $1.13 billion, down 1.4% from last year. Adjusted EBITDA margins were 16.9%, and adjusted earnings per share came in at $1.23. Turning to Slide 13. Let's take a closer look at our third quarter sales performance. Organically, sales were down 2.9% as volume was lower, while pricing remained positive. Looking at the rest of the revenue walk, you can see that recent acquisitions, net of one divestiture, a contributed 1.8% of growth in the quarter, while foreign currency translation was a slight headwind to the top line. On the right hand side of the slide, you can see organic growth by region. This excludes both currency and net acquisition impact. Let me comment briefly on each region. In the Americas, our largest region, we were up about 2% from last year. We saw solid growth across several sectors, including marine, distribution, and aerospace, while the off-highway and general and heavy industrial sectors were lower as we expected. In Asia-Pacific, we were down 3% as China was down, while India and the rest of the region were up. In China, the sales decline was driven mainly by lower wind energy demand. And in India, we saw double-digit growth in the quarter, driven primarily by higher revenue in the rail and distribution sectors. And finally, we were down 13% in EMEA, as we saw continued broad industrial weakness in Western Europe. Most sectors were lower, including renewable energy, automation, general and heavy industrial and off-highway. Turning to Slide 14. Adjusted EBITDA in the third quarter was $190 million or 16.9% of sales compared to $216 million or 18.9% of sales last year. Our adjusted EBITDA margin of 16.9% was below company expectations, but the vast majority of the shortfall was due to some unanticipated cost headwinds in the quarter, including logistics, currency, and a discrete customer accrual. Collectively, these headwinds negatively impacted margins by around 100 basis points. I'll talk about these items and the actions we are taking to improve margins moving forward a little later in the call. Looking more closely at the change in adjusted EBITDA dollars. You can see that the decrease was driven mainly by the impact of lower sales volume with relatively neutral price/cost in the quarter. Let me comment a little further on the individual items in the walk. With respect to price/mix, net pricing was positive once again this quarter in both segments, as pricing continues to hold up well as we expected. Mix was also a slight positive, driven largely by industrial distribution, which generally outperformed OE sectors again in the third quarter. On the material and logistics line, we saw a significant spike in logistics costs in the quarter, reflecting higher international freight costs, including some lag effect from the second quarter. This was partially offset by modestly lower material costs. On the manufacturing line, performance was slightly negative in the quarter as cost reduction initiatives and efficiency gains in our plants was slightly more than offset by the continued year-over-year impact of inflation and costs associated with new footprint investments. Looking at the SG&A other line. Costs were up slightly from last year. But in the quarter, we had an unfavorable SG&A expense impact from a discrete customer accrual. Excluding this impact, structural SG&A would have been down slightly from last year, as cost control measures and lower incentive compensation expense more than offset the impact of continued wage inflation. Currency was a sizable negative in the quarter compared to last year and compared to the revenue impact. This was driven mainly by the revaluation of cash and other balances outside the United States. As these balances get revalued into the local currency, it produces a P&L impact. We posted a large negative impact in the quarter of just over $5 million related to this revaluation. This is included in unallocated corporate, not in the segments. And finally, acquisitions net of divestitures contributed $6 million of adjusted EBITDA in the quarter, which was accretive to overall company margins. Our recent acquisitions continue to perform well, and CGI is off to a strong start. On Slide 15, you can see that we posted net income of $82 million or $1.16 per diluted share for the third quarter on a GAAP basis. The current period includes $0.07 of net expense from special items, including acquisition, amortization and other special charges, offset partially by a gain on the sale of our recently closed GAAP new bearing complex in South Carolina. On an adjusted basis, we earned $1.23 per share, down 21% from last year and below our expectations because of the margin shortfall. With respect to some below the line items, interest expense in the third quarter was about $2 million higher year-over-year, while diluted shares were down slightly. Our adjusted tax rate for the quarter came in at 27%, in line with our expectations, but up from last year due mainly to our geographic mix of earnings. And finally, non-controlling interest was up around $3 million from last year, while depreciation expense was up slightly in the quarter. Now, let's move to our business segment results, starting with Engineered Bearings on Slide 16. In the third quarter, Engineered Bearing sales were $741 million, down 4.5% from last year. Organically, sales were down 3.6%, driven by lower end market demand in Europe and China. Among market sectors, renewable energy saw the most significant decline in the quarter, driven by continued weakness in China. In addition, the off-highway, auto/truck, and general and heavy industrial sectors were down from last year. On the positive side, revenue in the distribution, aerospace and rail sectors were all up versus the year ago period. Currency was a headwind to revenue of less than 1% and while the net impact of acquisition and divestitures was slightly unfavorable. Engineered Bearings adjusted EBITDA in the quarter was $138 million or 18.7% of sales compared to $157 million or 20.2% of sales last year. Our margins in the quarter reflect the impact of lower volume, along with higher logistics and manufacturing costs, partially offset by favorable price/mix. Now, let's turn to Industrial Motion on Slide 17. In the third quarter, Industrial Motion sales were $386 million, up 5.2% from last year. Acquisitions contributed just over 6% to the top line, while currency was slightly positive as well. Organically, sales declined 1.4%, as lower demand was partially offset by higher pricing. With respect to performance by platform, Automatic Lubrication Systems posted the largest decline, while Drive Systems was notably up in the quarter. Automatic Lubrication was impacted by broad weakness in Western Europe and the off-highway sector, while Drive Systems benefited from significantly higher military marine revenue. Belts and chain was also down modestly on lower ag demand, while other platforms were relatively flat compared to last year. Industrial Motion adjusted EBITDA for the quarter was $74 million, or 19.2% of sales compared to $75 million or 20.5% of sales last year. Our margins in the quarter were impacted by lower organic volume and higher operating costs. including the customer accrual I mentioned earlier, partially offset by strong contribution from our recent acquisitions. Manufacturing performance was relatively flat in the quarter with favorable cost performance offsetting ramp costs related to our new capacity investment for Belts in Mexico. Turning to Slide 18. You can see that we generated operating cash flow of $123 million in the third quarter. And after CapEx of $35 million, free cash flow was $88 million. We expect stronger cash flow in the fourth quarter, driven by improved working capital performance. From a capital allocation standpoint, we deployed nearly $200 million in total during the quarter for the CGI acquisition and the payment of our 409th consecutive quarterly dividend. And looking at the balance sheet, we ended the third quarter with net debt to adjusted EBITDA at 2.1 times, right near the middle of our targeted range, and we have no significant debt maturities until 2027. Now, let's turn to our updated outlook for full year 2024 with a summary on Slide 19. Overall, we reduced our outlook to reflect our third quarter performance and a more cautious view on the rest of the year. So, let's go through it, starting with the sales outlook. We're now planning for full year revenue to be down around 4% in total versus 2023. Organically, we now expect sales to be down around 6% at the midpoint, 1 percentage point lower than our prior guidance. Note that the outlook for renewable energy is relatively unchanged. This sector alone accounts for more than half of our expected organic sales decline for the full year. And to reiterate, our updated sales outlook assumes a slightly greater than normal seasonal decline in the fourth quarter as we're planning for more pronounced customer slowdowns in December. With respect to currency, we're now expecting a headwind of around 25 basis points for the full year based on quarter end exchange rates. And finally, we expect M&A to contribute 225 basis points to the top line for the year. This excludes the recent CGI acquisition. On the bottom-line, we now expect adjusted earnings per share in the range of $5.55 to $5.65. This reflects our third quarter performance and a more cautious outlook for the fourth quarter, offset partially by modest accretion from CGI. Our revised outlook implies that our full year 2024 consolidated adjusted EBITDA margin will be in the low 18% range at the midpoint. And for the fourth quarter, our guidance implies that adjusted EBITDA margins and earnings per share will be down sequentially and year-over-year on lower production volume and expectations for higher costs heading into the end of the year. As Tarak highlighted, we are not satisfied with our second half margins, and we are stepping up our efforts around cost actions to improve margins for 2025 and beyond. As we have talked about on prior calls, we've been working to reduce costs all year, including facility rationalizations like the closure and sale of our Gaffney plant, reducing operative head count by over 12% since the beginning of 2023, and controlling salary hiring and nonessential spending. While this has had a positive effect, it has not been enough to fully protect margins at current demand levels. So, we intend to get more aggressive. Our objective is to bring costs more in line with demand levels and to improve margins and profitability in line with our long-term targets. We will not get into specific details today. We will outline the actions on expected savings in early February as we finalize our business plan and provide initial guidance for 2025. Moving to free cash flow. We've updated our 2024 outlook to approximately $300 million, which is down from our prior guide, mostly to reflect the impact of lower expected earnings. We expect to generate over $100 million of free cash flow in the fourth quarter, which is a step-up both sequentially and year-over-year. To summarize, our third quarter performance was below expectations, especially on the bottom-line, and we are moving aggressively to reduce costs while advancing our strategic initiatives to strengthen the company for 2025 and beyond. This concludes our formal remarks, and we'll now open the line for questions. Operator?

Thank you. [Operator Instructions] Our first question today comes from the line of Stephen Volkmann with Jefferies. Stephen, please go ahead.

Great. Good morning. Thank you guys and welcome, Tarak.

Good morning Steve.

Maybe just start with renewables, that seems like a business where you should have maybe a little bit better visibility. I'm curious if you think you're -- if there's any share shifts happening in that business and if you think there's any chance that, that actually starts to recover in 2025?

So, let me take that. And of course, Phil feel free to add commentary. So, as you have seen, wind has come down quite a bit from a renewables perspective. Solar remains quite strong overall for us, and we don't see a big change in the solar market, but rather we see from a renewal segment more wind being impacted. The volumes have come down in line with the orders that we saw from 2023 up to 2024. Over the last few months, we've seen a stabilization of our order intake rate at a low level compared to the past, quite a bit lower than we've seen in the past. So, we expect, and based on the discussions we've had with our customers and partners, we expect that low level to continue for quite some time. And there have been pockets in the wind business where the pricing has not been what we consider to be an acceptable level. And as we discussed in the past, we have decided not to participate in the very, very low price levels. But overall, our wind business from the order intake rate has been stable, and we are -- it's not the great profit levels of the past, but we are still happy with where we see our wind business from a returns perspective. But we, at this point, don't see a pickup of the wind business as I can see it from the different visits and the inputs that we've gotten.

Yes, nothing to add, Steve. I think the key here is the market has stabilized. So while we were certainly down again sizably in the quarter, the rate of decline has gone down as we -- if the comps have gotten easier. Demand has sort of stabilized. As Tarak mentioned, the order intake rates are sort of in line. So we feel like at this point, it's not getting worse. And then it's just a question of at what point does it inflect the growth. And at this point, I would not expect that in 2025.

Great. And then, Tarak, since you've been doing sort of your initial assessment and tour here, I'm curious if there's a chance that we may see any type of a shift. And I'm thinking maybe there's some businesses that kind of appear noncore to you that might not be -- or that could be divested, I guess? Or maybe on capital allocation, one of the questions I always get is why you guys don't buy back more stock relative to your M&A. And I'm just curious if any of that has bubbled up as potentially something you might want to shift a little bit.

Thanks Steve. Look, as I said, we are looking at the entire portfolio very much with the perspective that you just described. It's too early to come back with any conclusions or any even first indications. 60 days in, learning about the business and looking at the portfolio is kind of where we are. At the appropriate time, we'll come back with what we think the evolution of Timken might look like, but that would be at a later date. When it comes to share buybacks, I mean, look, as we have said, our bias remains a disciplined allocation, with a bias towards M&A. And we've done quite a few deals in the last, let's say, 18 months. We are actively executing and integrating those deals. If something comes along, that looks very interesting. On the smaller side, yes, on the medium side, we'll take a hard look. But that's our frame of mind right now when it comes to both the M&A, but also if nothing comes along, we will continue, as we've always said, with the share buyback. That's how we're biased.

Yes. And if I could just add, Stephen. Obviously, we bought a lot of shares back over the last 10 years, but we have also done quite a bit of M&A. And we do -- we've become pretty firm believers in what the M&A can do for us in terms of diversifying the portfolio, making Timken better, being accretive to growth, being accretive to margins, improving the overall package, et cetera. So, I think you'll continue to see a mix of both. Obviously, this year with EBITDA, with this year being flat or actually down from an EBITDA standpoint, we're managing the balance sheet carefully as well. But I think you'll continue to see both, but with a continued bias for the M&A.

Thank you.

Thanks Steve.

Your next question comes from Bryan Blair with Oppenheimer. Bryan, please go ahead.

Thank you.

Hey Bryan.

We know the organic revenue trends for the quarter, and you just spoke to order rates in terms of wins. Maybe touch on other large end markets how orders stayed through Q3 into Q4. And you mentioned the anticipation of production rates being pulled back a bit further late in the quarter, that being factored into your guide. Any additional detail or color you can offer on that front would be helpful.

Thanks Bryan. I mean, as we've said, we've seen a bit more softness in the general industrial area than we had indicated earlier. So, that's the more lighter side of the portfolio from products and solutions that we offer to the market. So, that's where we've seen a bit of a softness. And I mean the comment on net working capital and inventory is precisely the area where we are going to focus. So, we are running a bit ahead with our production compared to the demand, and we are now tracking down the capacity, as you mentioned, based on what we see as incoming order intake rates, plus being a bit more cautious when it comes to the fourth quarter. As you know, sequentially, we're always down in the fourth quarter compared to third quarter, and that's the same piece that we see every year. From the inorganic side, I would say, our acquisitions have performed quite well and have been supporting us this quarter. I'm not sure I'm answering your question precisely, but that's what I assume you were asking. So, we're quite happy with both the growth and the performance and the profit contributions, including the accretion that our recent acquisitions, specifically Des-Case, Lagersmit, and CGI already in the month of September. Since we closed CGI, we almost had the whole month. Those have contributed quite positively to our performance. And we expect them to continue based on what we see in their end markets.

Yes. Maybe if I could just add, Bryan. So, certainly, when we look at revenue trends through the quarter, it did get a little bit better in September off of July and August. But as Tarak mentioned, just given what we're seeing, hearing from our customers are planning for that more pronounced slowdown in December, which was primarily the basis for the lower top line guide certainly for the rest of the year. And then relative to the quarter, I would tell you some of the kind of the one-off costs I talked about really kind of popped up late in the quarter when you think about the currency and in the customer accrual, certainly were things that popped late in the quarter. But overall, that was sort of the sales trend. And then from an order book standpoint, I'd say, broadly, the backlog is -- our order book is sort of in line, kind of flattish sequentially, from the second quarter, still down a little bit year-over-year, kind of call it, mid-single-digits, which was kind of what we were last quarter as well. So, the order book, stable and I would say certainly supportive of the rest of the year guidance.

Understood. Appreciate the detail. And specific to Industrial Motion, we know Belts and Chain been facing headwinds for the year, are you willing to speak to on a year-on-year basis, how much the EBITDA compression in that platform will impact the segment? And then as we look to 2025 with Mexico capacity being fully ramped at that point, how much is a reset or a good guy that might be in the outlook?

Yes. Certainly. I mean, when you think about Industrial Motion for the full year, margins will be primarily impacted by certainly, the lower organic volume and Belts and Chains certainly be a part of that, as well as the expectation for higher cost, higher manufacturing costs year-over-year. The new plant ramp is part of that as well, and then we would have some positive pricing offsetting that. So, as you fast forward to next year, that new plant ramp, as we've talked about before, it could be a headwind of a couple of million dollars of quarters. You have two plants operating and trying to shift production from one to the other. But we get to the end of the year into the early part of next year, the U.S. plant should come down. Production will shift fully to Mexico, it will continue to ramp. And from a productivity standpoint as you move through, call it, the first half of next year. And then that should be a nice improvement for us from a margin standpoint as the cost of operating that Mexico facility will be significantly lower than operating similar capacity.

Right now, we have the kind of the trifecta. Unfortunately, we have lower volumes in the market. And we have three plants running at their full overheads versus the two that we expect in the future. So, when you combine that and a slightly lower ramp up on the Mexico, as we've said before, that facility is not ramping up as fast as we'd like. And all of those combined result in the headwinds for the Industrial Motion business when it comes to Belts specifically, the Chain part has been doing a bit better, is what I can add. Thanks.

Okay, understood. Appreciate the detail.

Thanks Bryan.

Thanks Bryan.

The next question comes from David Raso with Evercore ISI. David, please go ahead.

Hi, thank you for the time. Look, I know around the election and so forth, hopefully, some of the customers' softness for year-end is hopefully more of a pause and they're waiting for a little more clarity. But seeing the organic growth in the fourth quarter implied down a little bit more than we saw in the third quarter, even though some of the wind business stabilizing is a little surprising. You made a comment about the orders, I think more broadly, if I heard correctly about the company. When we think of organic growth, trying to swing back positive, can you give us any sense of what you're hearing from your customers to start 2025? Some of their commentary around December slowdown, but what it can mean for next year? I think right now, it seems like there's a lot of work you're going to do on getting cost and really rethinking the company to some degree on the portfolio, whatever it may be. But obviously, it's a lot easier when you get the top line working back in your favor. Not looking for exact guidance here, but is there anything you're hearing from your customers that we could see positive organic at some point in the first half of next year? Or should we assume it's down and it's more of a cost story for right now? And then I have a quick follow-up on--.

I think, I mean, as you know, David, from quarter four to quarter one, we always see an increase in business because of the nature of Timken's portfolio and our customers' ordering patterns and revenue patterns at PC. So, we expect that to also be the case this year, meaning it depends how low we get in the fourth quarter. That's one of the starting points, but we expect fourth quarter to Q1 to be a healthy increase as always, every year, the last very many years. So, that is expected to continue. When it comes to forecasting 2025, one of the reasons we have -- the outlook we have is because we are, at this point, focused primarily on 2024. And we get quite a bit of mixed signals in 2025 at this point. As we said, some of our businesses have been doing quite well, I take that all business that looks strong, expect it to be strong. But places where we are weak, we haven't seen the signs that provide us with any degree of confidence on 2025 at this point. So, I would say from our team's point of view, it's difficult to call 2025 even if you love to call it, but even the Q1 looks a bit something that we are not going to do at this point, and we're going to wait until a bit later, and then when we are back with the numbers on 2025.

Yes, David, if I could just add. I mean, certainly, I think Tarak said it well, we're not going to comment on 2025 today. I will tell you one thing from an OEM customer standpoint, I mean, our assumptions for the fourth quarter would be that they -- our inventory destock should be largely complete with OEMs by that time. So, that would be certainly one positive factor, but too early to talk about 2025 from a growth standpoint. And then to your question about the fourth quarter implied organic, you're exactly right. It does imply that it would be slightly worse year-over-year. than the third quarter. And you're right, renewable, as we said, was stable. We do have a couple of other markets that we're planning for lower year-over-year -- worsening year-over-year performance in the third quarter. One would be aerospace, would be one after several quarters of running really strong rail again after several quarters of running really strong, and then our services business are hitting some tougher comps. So, that would be -- those would be the main drivers for the delta, if you will, between the third quarter year-over-year organic in the implied fourth quarter.

One thing I can add to what Phil just said is we do see many of our customers have probably adjusted their inventories down to the level they feel comfortable. So, with rare exception, we don't see a further destocking on part of the customer that are, of course, some segments like ag, where it continues to be a bit of a challenge even for our customers. But for the most part, we see that reduced. Plus we have also reduced our lead-times quite a bit in the course of this year given the shortfalls that we see and the process improvement. So, we are sitting there with short lead-times, and we believe the customers are, for the most part, at the levels of inventory if you're comfortable with their demand. That would be a conclusion or let's say, an observation, if that helps.

That's very helpful. And just so I understand on the margins, the follow-up is -- the quarter, did I hear correctly that there was about 100 basis points of sort of onetime costs. I noted the discrete costs you mentioned. But in total, did you feel there was almost 100 basis points of onetime. Because I'm just trying to figure out if that is the case, 17.9% in the quarter, but then the fourth quarter is implying like 15.4% to 15.9%, like somewhere in that range. And I'm just trying to make sure I know the step down and maybe price/cost is negative again in the fourth quarter. There's a lot in there, but just trying to figure out that delta sequentially.

Yes. No, it's a great question, David. So, I would tell you -- we would say it was about 100 bps of negative margin relative to our expectations. And I wouldn't call them one to the other. It was sort of a little bit of one-offs in the quarter, in particular, we had the big spike in logistics costs. Now, I will tell you, we're not expecting that to receive in the fourth quarter. So, we did kind of play that one a little bit conservatively into the fourth quarter, not assuming that's going to come down. But the other two, the currency was really -- it was a reval of cash outside the U.S. and other balances would not expect that to recur. And then the customer accrual was typically an unusual thing, an allowance we took against one of our customer accounts, that would not be expected to recur. So yes, relative to expectations, it was 100 bps. And you fast forward to the fourth quarter, what's behind the margins there. It really is a combination of the lower organic revenue relative to the prior guide and the step down both sequentially and year-on-year, and then the other half would be just our continued expectations for a higher cost heading into the end of the year just because when customers slow down and we're trying to take inventory out, we do find ourselves often in the past, we find ourselves with higher costs coming through as a result. So, we decided to be a little cautious on the fourth quarter cost outlook heading into the end of the year.

Very helpful. Thanks so much.

And maybe in addition to what Phil just said, as you know, we have some structural cost adjustments and investments in Mexico and in India. So, those would start to kind of kick in more into 2025 and later into 2025. So we are carrying a significant amount of cost in terms of duplication and factory ramp-ups in the fourth quarter, where the volumes will not be there, but the investments in getting those facilities are quite significant. And those are expected to come online in terms of volume contributions and profitability contributions only into some part in 2025. So, the Belts investment probably early 2025 investments -- sizable investments we made in India for the structural cost adjustments more, like second half of next year. So, that's also, in addition, the reason why we are a bit cautious on fourth quarter.

Helpful.

Thanks David.

Your next question comes from Mike Shlisky with D.A. Davidson. Please go ahead Mike.

Yes, hi good morning. Thanks for taking my questions. Maybe to follow-up on your last answer there. If we can maybe strip out a lot of those onetime discrete costs still in the quarter, I'm just trying to get a feel -- I know you aren't going to give details about the cost reductions you've got specifically until February, but perhaps maybe a two-part question. I know we won't get the actual update until February, but you plan to start making those cost reductions this month or within next few months. And maybe are you targeting any kind of specific incremental or decremental margin range that's been different than the past? Just some broad shows as to what you're looking to do with these cost reductions.

Yes. Thanks Mike. Maybe I'll start and then ask Tarak to chime in as well. So, relative to the cost, we've been working on taking costs out all year, as I mentioned. I mean, that will continue. We will target the incremental actions at areas within the business that have seen the kind of the most pronounced declines, if you will, from a demand standpoint and then, obviously, functions supporting those areas. Though the objective would be to get the cost down more in line with current demand levels. And then obviously, if we inflect, we'll benefit from that. And then obviously, also bring our margins in line with our long-range targets, which we put out a couple of years ago at our Investor Day, and we're still working towards hitting those. So, from the cost standpoint, I wouldn't expect the incremental stuff, maybe get a little bit of a benefit in the fourth quarter. It's probably more targeted towards 2025.

I mean I would add that in certain product lines, we are a bit too big in terms of our jacket size or shoe size, you would call it. And there, we are trimming. But it's a more very specific to product lines where we see the gap between demand and our own capacity. And please remember, in the fourth quarter, we are also slowing down our operations. I mentioned we have too much inventory. So, obviously, when we slow down the operations in order to drive cash flow that will have a bit of a negative impact because of the under absorption in those facilities we are idling. So, we got a bit ahead on our production this year, and now we are stepping back, and that is also a contributing factor in the fourth quarter performance that you see from us in terms of the outlook. And as Phil said, we are being a bit cautious given the market environment that we see in terms of the forecast for 2024. We hope that after six quarters or more, now almost seven quarters of a decline in the market demand, we do see some upside going into 2025, but it's difficult at this point for us to see that and we'll call it.

And then maybe one more comment, Mike, on decrementals because I know you referenced decremental. Certainly, the implied guide would have decrementals at higher than what we would typically run, I think the implied guide would be somewhere in the mid-40s organic for the year. But keep in mind, price/cost is -- can be lumpy as you move through periods like this. And -- in 2023, we ran very strong decrementals in 2023, incrementals and decrementals as we move through the year. And if you kind of stack the two years together, the net organic decremental over that two-year period is sub-20. So, I think we have been pulling the levers and executing well across that time frame. It's just -- as we said, we sort of got stuck this quarter with lower volume kind of neutral price/cost and some of these one-offs that I talked about earlier, which combined really put us in a difficult spot from a margin standpoint for the quarter.

Okay. Okay, great. And just to follow up on the margin story going forward. So, you guys have mentioned you're looking to maybe pursue growth more aggressively, certainly makes a lot of sense. I'm just wondering if you've got cost reductions taking place in 2025 targeted or kind of broader, but you've also got maybe some investments to make in your R&D or engineering. I just want to make sure that you're expecting 2025 to be a year of net reductions in the cost structure and not mostly offset by increased investments elsewhere. I'm just trying to make sure that the cost structure is kind of permanently staying lower than it was in 2025 than it was in 2024. Any comments there would be appreciated.

I think maybe I'll take this and then, Phil, you can please add. A lot of what we're doing is to adjust to capacity and demand. And within your question, the assumption is there is a demand that's equal to this year, then probably, yes, we will quite look at costs that are lower than this year, given both the investments that we have made in the new batteries as well as what we see in terms of the demand pattern. However, there's a big gift and a big gift is the demand continues to be around the same level in 2025 as 2024. So, what we're trying to do now is to ensure that we adjust our costs in line with demand, and that's going to be the main driver. And yes, we are going to take a look and see which product lines and portfolio where we see profitable growth opportunities, and we're going to invest in them. But, in order to do that, we would have to make some investments in that portfolio. So, net-net, it's difficult for us to talk about 2025 because we don't have a view on what the top line looks like. But our going in thinking as a team is we need to address costs where we see the challenges and we need to think about growth where we see the opportunities. And right now, that's not where we'd like it to be in terms of the bottom-line performance, but this is something we are working on collectively and specifically, on the product lines where we see challenges in terms of performance.

Right. And if I could just add, Mike, as we invest, obviously, we've got targets out there for growth, margins, et cetera. As we invest, we always look for those investments to be funded within the confines of the commitments we make around margins, the commitments we make around cash flow, et cetera. So, I think over the years, we've done a very good job of making investments in the business to grow and improve margins and improve competitiveness, M&A, et cetera, all within the confines of the targets we've set and the commitments we made around margins, et cetera, and I think that would continue.

Fair enough. Thanks for the time.

Thanks Mike

Thank you, Mike.

The next question comes from Steve Barger with KeyBanc Capital Markets. Steve, please go ahead.

Thanks. Good morning. Tarak, you said there were some wind business where pricing is so bad, you don't want to participate. Is there 1 main competitor or multiple competitors out there willing to take business at margins do you consider unacceptable? And are you seeing competitive pressures like that in any of your other end markets?

Thanks Steve. Having been to China and spend time with -- this is exactly where we see the biggest price pressure is in China. It's a few competitors, not many, but it's a few competitors where we don't see those price levels as long-term sustainable. They're more capacity-based concepts rather than a more sustained profitability-based thinking. So there, we do see and we have walked away from business. But, in the meantime, Andreas and the team are working on ensuring that our cost structure is in line with both expectations from a performance point of view and also from a customer point of view. So, everybody is looking to reduce. And we're developing new products and new processes to meet the specific requirements of wind in order to make sure we can still participate in the market. But it is a difficult market in a very low volume scenario compared to where it was a couple of years ago. So, we do see competitive pressures. But I will not say in the segment that we participate in, we see many, but we do see a few local competitors who are a bit more aggressive and willing to take business at the levels that we don't find, particularly interesting or acceptable at this point. Until our own product costs are a bit more in line with our own gross margin requirement. So, that is a kind of a continuous process where Andreas and the team are working to make sure we stay both competitive and participate in the market.

Yes. And I would say, Steve, that's really isolated to wind from -- in China, in particular, I mean, we don't see -- if anything, we feel like we're gaining share, where we're targeting versus the opposite. And in China, I mean, Tarak summarized it extremely well. But I would tell you, it's not unlike what you would see in any market that's down as significantly as China wind is down where customers are looking for price concessions and willing to move business to get it, at least in the near term. So, it's not totally unique. Obviously, the China dynamic adds a little bit to it. But overall, Tarak summarized it well. I mean, that would be the only spot. And again, it was by choice as much as anything else.

And to continue on your question, I mean, do we see it in other segments, we're down quite a bit in many other segments, but we don't see the same kind of, let's say, both behavior plus also we don't see the same need for us to "walk away" from some business. So, I mean, we've seen that from Phil and we've talked about it over the course of last year. We don't see the same behavior in other segments.

Yes. That's good to hear. And I don't want to--

That's why prices--

Sorry. Go ahead.

Go ahead, please.

Go ahead, Steve.

Sure. Sure. Yes, I understand that you don't want to take a view to 2025. But we are ultimately, at the end of this year, we'll be six quarters into negative growth. EPS will be down around 20% year-over-year per your guidance. My question is when you think about destocking and inventory trends, the cost actions that you expect to take and your capital deployment options, do you have enough in your control to drive double-digit EPS growth next year? Or is it even too early to say that based on how you're thinking about the broader environment?

I would say it's a bit too early based on how we see the broader environment. Certainly, our balance sheet says we could do it, but we want to -- as we said, we want to make sure from a share purchase perspective, we want to make sure that we have adequate funds available for investing in the business. So, at this point, we are at least being more cautious about 2025, and that's what I would say. Just being a bit more cautious about 2025 for this one.

Yes, I agree. I mean I think we really need to see how the market situation develops as we move into 2025. We'll have a better view of that in February because that will really drive, that you really answered your question. But, to your point, we're taking actions on the cost side, including the incremental actions we talked about today. Customer inventories should -- are at a good level, should remain at a good level heading through the end of the year. So, as we get through the end of the year, I think we'll be in a good position. But until we really see how the markets develop too soon to say.

Understood. Thank you.

Thanks Steve.

Your next question comes from Joe Ritchie with Goldman Sachs. Joe, please go ahead.

Thank you, and welcome, Tarak. Maybe my first question is just on that discrete customer accrual that you mentioned. Yes, you're welcome. Was that sensibly, like bad debt expense? Just wanted to get some clarification around that item.

Yes, that's exactly. It was a collectibility accruals reserve that we set up for one specific customer in the quarter in the renewable energy sector. If you look at our history around collectibility, it's quite strong. I mean I would stack it up against anybody. But occasionally, we will have a situation like where we got to set up a reserve, it's typically very few and far between and we're watching it closely, obviously, but collections have generally been stable and consistent with prior years, this was sort of an outlier that we had to set up a reserve for.

Okay. Yes. I get it. It happens. I guess the -- on the logistics side of things, you guys are referencing that as a -- it seemed like that was a pretty big impact this quarter to margins. It seems like it's going to impact the fourth quarter. I guess, Tarak, as you're thinking about improving structural costs. Is there anything that you guys can do with the way you're set up on the logistics side to maybe kind of offset times when like you see like a big spike in logistics cost?

Yes, I mean, one of the -- I mean logistics is something that you know has been quite volatile in the last four years. It has not necessarily followed the normal economic pattern. So, I would say, the Red Sea challenges are perhaps the main reason why we see the bigger logistics costs. And you combine that with the structural changes we are making in terms of our supply locations to our demand locations. It's an area that we will take a look at as we look at the evolution of Timken in terms of how we serve the different markets and from our geographies. So, I wouldn't say at this point, I have an answer or we have an answer, but it's an area where we will examine how we meet the different geographies, whether it's Americas, Europe, Middle East, Africa, and Asia. How do we design our supply chains, so we are not as dependent on the logistics, at least at an interregional level. But at this point, it's a long-term discussion and decision. And at this point, we're not ready to say we're going to change the way we operate based on logistics. But it's something to consider as we look into the future, as far as supply/demand alignment.

Yes. Certainly, Joe, we've lengthened our supply chains over the last 10 years, and some of that's been trying to get to lower-cost suppliers, very competitive suppliers across the globe, frankly, and that always comes with lower costs. You got the extra logistics. But net-net, it's been a benefit to the company. And logistics has always been very manageable. We've had the last few years where it's been a little bit choppy and spiking including this quarter, it sort of spiked on us. And we didn't expect it. We didn't see it come. And we did expect it to be a little bit higher, but not as much as it came through. So, it will normalize as we move forward. We're not planning on it for the fourth quarter. It will normalize. But net-net, the logistics has kind of come with lower cost on the material side and those two kind of go hand-in-hand.

Got it. Okay, great. Thanks guys. Appreciate it.

Thank you, Joe.

The next question comes from Michael Feniger with Bank of America. Michael, please go ahead.

Great. Thank you guys. Thanks for squeezing me in. Just Phil, just on the -- I was surprised a little bit on the inventory build in the quarter relative to your sales, just it seems like that's -- you guys are going to be working that down. It should be good for free cash flow in the fourth quarter. Do you feel like with where you think demand finishes the year -- like do you feel like your inventories are going to be in line with that demand? Or if demand stays where it is at the end of Q4 into 2025, is there still some work to do there?

I would say, in general, our net working capital is -- I mean, if you look at our historical net working capital volumes, we are on the high side compared to the past. So, we have a homework to do in terms of reducing our net working capital as a percentage of revenue in general. It's high today, and we will have to make process changes and Mike, in terms of how we run our supply chains to serve the customers to drop it down, and we will work on that together over the course of the next quarters to redesign and ensure that our net working capital for a certain level of inventory and a certain level of fill rates and performance for our distribution and our customers is lower going into the future than it has been in the past. So, that's something we're working on.

Yes. Mike, just for clarification, I think in the quarter, we had acquisitions and currency. And when you look at the balance sheet. Organically, we would say inventory came down right close to $10 million. You see that if you look at the cash flow statement, we'd expect more to come out in the fourth quarter. And as Tarak mentioned, even after that, I think there's still opportunity moving ahead for Timken to get more efficient in managing both inventory and working capital more broadly.

Okay, that's helpful. I didn't think about the acquisition. And guys, just curious, just thinking about some of the moving pieces, talking about price versus cost. Timken has done a great job getting pricing even this year. It's been positive. We're starting to see in the industrial channel, pricing really starting to flatten out. When we look at some of the OEMs are thinking for Q4 and going forward. I'm curious, just big picture, how you're kind of thinking 2025. Is it price/cost neutral? Could it be positive price versus cost? And if that is positive price, is that you guys leaning more on the cost measures on that cost bucket to drive that? Just any big picture thoughts on that would be helpful. Thanks everyone.

Yes, I think on a big picture level, we don't expect pricing to be anything other than flattish in 2025. So, as you can imagine, it won't be like it was in 2023, but we expect to continue to see flattish pricing in 2025 from a big theme perspective. And then obviously, distribution will be a bit better and some areas might not be. But overall, we expect to see flat pricing based on what we see and based on what -- because costs have gone up, and not down. And usually in a downturn when prices have gone down, have been primarily driven by the input cost going down, as you can see from third quarter and also the expectations on fourth quarter plus with labor inflation. So, there isn't a natural driver for the price to go down in the overall market other than trying to fill factories and that's not what we will do. So, that isn't there, and if there is some discipline in the market like we've seen this year. I think -- at least we think pricing will hold up, and let's see what actually happens in 2025. But that's how we see it. We don't see any intrinsic driver of low -- significant lower input costs to really drive the price down overall.

Thanks everyone.

Thanks Mike.

We have time for one further question. And our next question comes from Tim Thein with Raymond James. Tim, please go ahead.

All right. Thank you. Just a quick one -- just a lot of discussion here in terms of matching the supply and demand. I saw one of your peers in Europe announced it pretty sizable restructuring plan this morning. And maybe it is more Europe specific, but you can broaden it just in terms of -- given the challenges in the auto industry, combined with industrial production in Germany that's been down, like probably three years in a row. How do you think about just the overall kind of supply/demand balance? And historically, I think there's some fluctuation when the auto industry softens up, you see some of that capacity kind of move around. Maybe just can you speak to that kind of what you're seeing just in terms of Europe more generally? Thank you.

Thanks Tim. Yes, it's been soft, as Phil mentioned, and we did discuss for quite some time, and I think you have said almost a year -- it almost looks like year three in Europe in terms of the soft demand. Overall, we are making capacity adjustments based on the portfolio, based on what we see mid to long-term as the needs of the business. And those are being managed by Chris when we're talking about industrial automation promotion. And then we see the same thing being addressed by Andreas. So, those are not necessarily short-term discussion or decisions. They are more mid to long-term. So, that actions are -- those actions are being taken. And short-term actions to adjust capacity, whether it's furloughs or small adjustments in individual factories, those are also being managed at the individual plant level. And not everything is down. As we said, we have quite a few of our product lines doing well and that's why we need to make it more targeted, more specific, and more product line rather than even a location-specific discussions and decisions. But this is something we've been doing for quite some time, and we will continue to do it. If there's something sizable, we'll announce it as we are expected to. But that's a homework that the team is engaged on pretty regularly and now a bit more given the softness that we see.

Okay. Got what we needed there. Thank you.

Thanks Time.

There are no remaining questions at this time. Sir, do you have any final comments or remarks?

Yes. 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.