Good morning. My name is Paula, 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 Fourth Quarter Earnings Release Conference Call. Thank you. Mr. Frohnapple, you may begin your conference.

Thanks, Paula, and welcome, everyone, to our fourth quarter 2021 earnings conference call. This is Neil Frohnapple, Director of Investor Relations for the Timken Company. We appreciate you joining us today. Before we begin our remarks this morning, I want to point out that we have posted presentation materials on the company's website that we will reference as part of today's review of the quarterly results. You can also access this material through the download feature on the earnings call webcast link. With me today are the Timken Company's President and CEO, Rich Kyle, and Phil Fracassa, our Chief Financial Officer. We will have opening comments this morning from both Rich and Phil before we open up the call for your questions. During 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. Without expressed written consent, any use, recording, or transmission of any portion of the call is prohibited. With that, I would like to thank you for your interest in the Timken Company, and I will now turn the call over to Rich.

Thanks, Neil. Good morning, and thank you for joining us today. The fourth quarter was consistent with the trend that we saw early in 2021 and that ran through the full year with strong revenue across most end markets and geographies, pricing costs, particularly in steel and logistics, and an abnormally high amount of inefficiencies across our operations from labor and supply chain challenges. The result was revenue of $1.01 billion and earnings per share of $0.78. Revenue was up 13% from 2020 and up 10% from the prior fourth quarter record. We delivered this revenue growth despite continued supply chain and operational challenges. The revenue strength was broad-based and orders were also strong across almost all markets. Backlog grew despite the record level of shipments and is up significantly sequentially and over prior year. Ramping up to meet the demand continued to require a significant cost premium as costs increased further in the quarter and price-cost remained negative. Price was up both year-on-year as well as sequentially in the quarter and contributed modestly to the revenue growth but lagged the cost increases. The result was a year-on-year decline in margins of 280 basis points and a decline in earnings per share of 7% for the fourth quarter. For the full year of 2021, Timken delivered record revenue of $4.1 billion, which was an 18% increase over 2020 and a 9% increase over 2019, the prior high mark for revenue. We delivered strong revenue levels despite significant challenges with supply chains, including labor shortages, transportation delays and material shortages. The growth was driven by robust industrial demand across most end markets and was boosted further by our outgrowth activities, including delivering a fourth consecutive year of double-digit growth in renewable energy and a 12th consecutive year of completing at least one acquisition. Our focus in '21 on responding to our customers' demand and increasing our market position did come with a significant cost premium. Costs increased sequentially each quarter through the year. The primary drivers were steel, logistics and supply chain inefficiencies. The challenges ranged from higher-than-normal absences and onboarding costs within our plants, transportation delays, material shortages and premium costs associated with securing supply. Price-cost went modestly negative early in the year and by the second half had a significant impact on margins. Our price realization in '21 lagged the cost increases in magnitude and timing due to a combination of factors that included contractual commitments as well as inflation exceeding our expectations. We began increasing prices in the second quarter of the year and price realization increased sequentially each month from April through December. Price for the year was up under 1%, and margins for the year declined by 140 basis points as the negative impact of cost more than offset the benefits of increased revenue and price. Despite the supply chain challenges and rapid increase in costs, Timken did deliver record earnings per share of $4.72 in 2021, and we are positioned for another record year in '22. We added 5% more employees to our global plant staffing levels through the course of the year. We also added inventory to increase customer demand and to accommodate for supply chain issues. We made progress on mitigating internal and external supply chain constraints and inefficiencies and we expect productivity gains in '22. We have negotiated or implemented price increases for much of the portfolio which will be evident in the '22 results. We entered 2022 confident that price realization will be significantly higher than it was last year. Due to strong markets, our rapid response to the increase in demand and our outgrowth initiatives, our backlog grew significantly through the course of the year, and we are well positioned to deliver another year of double-digit top line growth. During the year, we executed well against our long-term strategy. We completed the acquisition of iMS, strengthening our linear motion offering in robotics. We continued our investment in our digital platform with the elimination of two legacy ERP systems. We advanced our footprint with the closure of a facility in Italy, the opening of a facility in Mexico and the investment of $150 million in CapEx, including the advancement of our previously announced $75 million investment in renewable energy. The '21 CapEx will help us achieve new levels of revenue in '22 as well as mitigate the cost and labor issues that we faced last year. We continue to deliver financially and strategically on our acquisitions, including the 2019 acquisition of BEKA Lubrication Systems. Despite the challenges from the pandemic and the supply chain issues, which started within a few months of closing, we continue to deliver synergies and value from the BEKA acquisition. We have completed integration of Groeneveld and BEKA's management teams, product lines and sales forces. We've invested in and launched new products that are being well received by the market, and we advanced the footprint, including the closure of our manufacturing operation in the U.K. and the expansion of our operations in the U.S. and China. We continue to pursue M&A opportunities, and we expect our M&A activity to increase in the next couple of years. We ended the year with a strong balance sheet and would expect capital allocation to be a significant contributor to our results in the coming years. We also advanced our corporate social responsibility program in the year, and our Timken team continues to prioritize employee safety and employee diversity, giving back to our communities, and advancing environmental sustainability in our operations and through our products. As a result, Timken was once again recognized as one of America's most responsible companies. Turning to the '22 outlook. We are guiding to 10% revenue growth across the portfolio. Ten percent is comprised of 7% volume, 4% price and negative 1% currency. We are expecting almost all markets to be up at least to mid-single digits. As I mentioned earlier, our backlog to start the year is high, order flow is strong, customer sentiment is bullish, our growth pipeline is robust, and our production, plant staffing and inventory levels are all up. We're still dealing with various supply chain issues, but we are off to a good start to achieving the 7% volume growth and we have the backlog and momentum to support the revenue outlook for the full year. On the 4% price, the actions needed to achieve this level have already been implemented or negotiated and we are confident that we will realize at least 4% this year. The majority of the pricing is in effect today, so it will be evident in the first quarter results. We're also guiding to $5 to $5.40 of earnings per share, which would be up about 10% at the midpoint, with EBITDA margins of about 17%. In those estimates, we are assuming that the increased cost levels we experienced in the second half of '21 hold for the full year of '22. That is what we are experiencing to start the year. We believe we've been conservative in our cost assumptions. We're including market inflationary and manufacturing costs, but the supply chain situation remains very dynamic and the range of possibilities remains wider than normal. We remain very focused on both mitigating the supply chain costs and recovering costs with pricing. In summary, we expect to deliver record revenue and record earnings per share in '22 in what remains a robust but very choppy industrial market expansion. And we will do it while continuing to advance and grow our market position as a diversified industrial leader, creating long-term value for all stakeholders. Phil?

Okay. Thanks, Rich, and good morning, everyone. For the financial review, I'm going to start on Slide 12 of the presentation materials, which includes a summary of our results. Revenue in the quarter was just over $1 billion and set a Timken record for the fourth quarter. Sales were up 13% from last year and up more than 10% from the fourth quarter of 2019. We delivered an adjusted EBITDA margin of 13.4% and adjusted earnings per share of $0.78 in the quarter, both down from last year. And as Rich mentioned, Timken delivered record sales of $4.1 billion and record adjusted earnings per share of $4.72 in 2021 in a robust, yet challenging environment. Turning to Slide 13, let's take a closer look at our fourth quarter sales performance. Organically, sales were up nearly 13% from last year as both segments delivered double-digit growth in the quarter. In addition, we saw double-digit growth across both our bearings and power transmission product lines. Pricing was positive, while acquisitions and currency translation combined had a modest impact on the top line in the quarter. On the right-hand side of this slide, you can see our organic growth by region, excluding both currency and acquisitions. All regions were up in the quarter versus the year ago period. Let me make a comment or two on each region. In Latin America, we delivered strong growth in the quarter, up 21%, with most sectors up, led by industrial distribution. In Europe, we were up 17%, with off-highway, general industrial and distribution posting the strongest gains. In Asia, we were up 3%, as most sectors were up modestly, while renewable energy was roughly flat in the quarter as expected against a difficult comp last year. And finally, in North America, our largest region, we were up 14%, with solid growth across most sectors, led by industrial distribution and off-highway. Turning to Slide 14. Adjusted EBITDA was $135 million or 13.4% of sales in the fourth quarter compared to $144 million or 16.2% of sales last year. The decline in adjusted EBITDA reflects the impact of significantly higher material, logistics and other operating costs, partially offset by higher volume, positive price mix and favorable currency. EBITDA margins in the fourth quarter were down 280 basis points versus last year as price realization was more than offset by continued cost inflation, supply chain constraints and related inefficiencies. Let me comment a little further on our manufacturing and operating expense performance in the quarter. On the manufacturing line, we were impacted by higher labor costs and plant inefficiencies as we continue to navigate through the challenging supply chain environment. This was offset partially by the impact of slightly higher production volume as we continue to ramp up to serve higher demand. Moving to material and logistics. We saw significantly higher cost in the fourth quarter compared to last year and higher costs in the third quarter. Higher costs reflect continued inflationary pressures, including higher surcharges and other increases from material suppliers and freight vendors around the world. And finally, on the SG&A other line, costs were up year-on-year in the quarter as we had increased spending to support the sales levels and higher compensation expense versus the year ago period. On Slide 15, you'll see that we posted net income of $63 million or $0.82 per diluted share for the fourth quarter on a GAAP basis, which includes $0.04 of income from special items, driven by pension mark-to-market income in the period. On an adjusted basis, we earned $0.78 per share in the quarter, down 7% from last year. Our fourth quarter adjusted tax rate was 21.3%, which brought our full year adjusted rate down to 24%. This reflects our geographic mix of earnings and the impact of tax planning initiatives. Now let's move to our business segment results, starting with Process Industries on Slide 16. For the fourth quarter, Process Industries sales were $528 million, up about 15% from last year. Organically, sales were up 14.5%, driven by growth across most sectors with distribution and general industrial posting the strongest gains. Marine and Industrial Services were also up, and Heavy Industries was up slightly, while renewable energy was flat. Looking at our nonbearing product lines, linear motion generated the strongest growth year-on-year in the quarter as we continue to win new business and benefit from higher demand. Process Industries' adjusted EBITDA in the fourth quarter was $105 million or 20% of sales compared to $102 million or 22% of sales last year. The decline in Process segment EBITDA margin was due to the impact of higher operating costs, which essentially offset the benefits of improved volume and price mix in the quarter. Now let's turn to Mobile Industries on Slide 17. In the fourth quarter, Mobile Industries sales were $480 million, up 10.6% from last year. Organically, sales increased nearly 11% with off-highway posting the strongest gain. We were up in aerospace, rail and heavy truck as well, while automotive was relatively flat. We also benefited from higher pricing in the quarter. Mobile Industries' adjusted EBITDA in the fourth quarter was $41 million or 8.6% of sales compared to $54 million or 12.4% of sales last year. The decline in mobile segment EBITDA and margins was driven by the impact of higher operating costs, which more than offset the benefit of higher volume and price mix in the quarter. Note that Mobile had more significant material cost headwinds in the quarter than Process, and this impacted its margins to a greater degree. Turning to Slide 18, you'll see we generated operating cash flow of $103 million in the fourth quarter. And after CapEx, free cash flow was $58 million. Looking at the full year, free cash flow was $239 million, down from $456 million last year. The year-on-year decline reflects the impact of higher working capital to support the record sales levels and longer lead times in the supply chain and to position us for strong growth again in 2022. In addition, we had higher CapEx to fund growth and operational excellence initiatives, and we also saw a more normal level of payments for employee medical benefits this year. Looking across both 2020 and 2021, we did convert over 100% of our adjusted net income to free cash. From a capital allocation standpoint, during the fourth quarter, Timken paid its 398th consecutive quarterly dividend and repurchased 500,000 shares of company stock. In total, we bought back almost 1.3 million shares during the year and we have over 9 million shares remaining on our current authorization. Taking a closer look at our capital structure. We ended the quarter with a strong balance sheet. Our leverage, as measured by net debt to adjusted EBITDA, was 1.7x at year-end, below last year's level and near the low end of our targeted range. This puts us in a great position to continue to drive shareholder value creation through capital deployment, consistent with our strategy. Now let's turn to the outlook with a summary on Slide 19. As Rich highlighted, we expect strong revenue and earnings growth again in 2022. We're planning for another year of record revenue up around 10% in total at the midpoint of our guidance versus 2021. Net of currency impact. Our guidance implies that revenue will be up 11% organically, which would mark our second straight year of double-digit organic growth. We expect most end markets and sectors to be up year-on-year, and we will also benefit from organic outgrowth initiatives and 400 basis points of net positive pricing. Our revenue outlook is supported by our order book, which is up double digits from last year as well as customer sentiment and other external data. On the bottom line, we expect record adjusted earnings per share in the range of $5 to $5.40, which would be up 10% from last year at the midpoint. The midpoint of our outlook implies that 2022 adjusted EBITDA margin will be around 17%, down slightly from full year 2021 as higher price realization is expected to be more than offset by higher year-over-year operating costs, principally in the first half of the year. Recall that material and logistics costs and related inefficiencies accelerated in the second half of 2021. Our outlook assumes that costs will largely persist at these elevated levels through 2022. In addition, we're expecting continued inflation across other costs like wages and energy but we are planning for some improved manufacturing performance from our ongoing operational excellence initiatives. Moving to free cash flow. For 2022, we estimate conversion of around 70% of adjusted net income. We expect higher free cash flow in 2022 as compared to last year, driven by the impact of higher earnings, offset partially by higher CapEx spending. We are planning for CapEx in the range of 4% of sales, which includes several growth-related projects and higher spending on initiatives to improve operating efficiency. For the full year, we anticipate net interest expense to be in line with 2021 levels, and we estimate that our adjusted tax rate will be around 25% based on our planned geographic mix of earnings. So to summarize, Timken delivered record revenue and earnings per share in 2021 and we are well positioned to do so again in 2022. Our team is working hard to mitigate the higher costs through pricing and other tactics, and we continue to focus on driving our profitable growth strategy. This concludes our formal remarks, and we will now open the line for questions. Operator?

We'll take our first question from Rob Wertheimer with Melius Research.

Thank you, good morning everybody. So Rich, you've taken probably a very realistic but maybe more conservative look at supply chain disruption and the outlook in the comments you made. I'm just curious if you spend a lot of time with your customers and partners and what the general sentiment is out there. I think some are still hoping for a 2x improvement. I'm not sure if that's tangibly founded or just not on the generally good management that's out there. That's one question. I'll just do my second one as well. If you could just talk us through any changes in strategically how you're looking at pricing as we walk into an inflationary environment? Thank you.

Yes. Thanks, Rob. Certainly, talking a lot to customers, talking to Board members and talking to how others are dealing with this, and as releases come out, we'll digest some of those as well. I think we do have probably one bit of a uniqueness to our business model in that because over half of our business is bearings and the steel content. And bearings, we probably are a little disproportionately impacted by steel costs, which would be one of the three big buckets of costs that have hit us. If you look at our last four quarterly EBITDA walks, our material logistics costs have gone from negative 11% in the first quarter to negative 27%, to negative 53%, to negative 58%. And so from 38% in the first half to 111% in the second half on a little lower volume in the second half. So we are basically assuming that those costs continue. I think for material, there could be some relief there, but I'd be surprised if those dropped dramatically in a robust market. I think the logistics one is a little bit more of a wildcard. The price is there. The steel is maybe a little higher than what would be normal in a good industrial market for us, and happened a little faster maybe than normal. But logistics is very unique for us in that things that we were buying a year ago, in some cases, transportation routes are up 200, 300-plus percent. We've assumed, again, that continues. And right now, I would say that is the case. We don't see any relief on that in the first quarter. But certainly, if we were to see some relief on that in the second half of the year, that would be favorable for us. On the flip side, it's not taking a step up today. I don't think it will in the second quarter, but it could improve in the second half. At this point, last year, we weren't expecting what happened as well. So I think the logistics one is more likely than not to be favorable as the year progresses, but we weren't conservative enough on it last year. And I think that's a little bit of a different thing as we look at the pricing there. Certainly, we would fully expect to recover all of material. If logistics remains a structural change in the industry, we would have to recover that as well. I think we're trying to play that one down the middle a little bit and cover some of it and share some pain. I do think that's one of the challenges as we look at the price/cost dynamic is there is a significant element of our cost that I believe are clearly transitory. They've lasted longer than what we have expected. We're still dealing with elevated absenteeism in a few of our plants in the U.S. as well as in Eastern Europe from coronavirus. In the fourth quarter, we had plant shutdowns in China from power shortages. We still had premium freight where your plant shut down in China for half the month and you're paying premium freight. To go to a customer and expect them to pay you for that is a little bit unique. So certainly, we expect to cover normal inflationary costs of material costs and wages. If energy goes higher, steel goes higher, et cetera, we will recover those. On the transitory side, we have to improve them. And I think we are being conservative there, but it lasted longer than what we thought to this point, and they're still largely there today as well. I think when you look at the manufacturing bucket on those four walks that we would have had the last four quarters, we were plus $9 million in Q1, plus $5 million, plus $5 million and then minus $8 million. Typically, the fourth quarter would be wider and lower and although that was a little extreme. So only a plus $11 million for the year. That's where higher onboarding costs are hitting us, the absenteeism is hitting us, having parts that you're waiting for for production stuck in a port for a month or hitting us. And that's an area that's pretty disappointing that given the volume that we are running through these operations, we would typically do much better there. Again, I think we've been conservative there. This is an area I think we're good at, whereas Phil said, we're working relentlessly. We've seen some improvement, and then we see some new issues arise as well. Certainly, I think logistics would be one of the two upsides to the cost situation. And then the other thing I think we had, I would say, normal-ish, maybe slightly on the high end of normal wage inflation last year. We are expecting and planning for and preparing for a little higher wage inflation around the world this year, and that's baked in there. But on the flip side, we also have a very full self-help story on our cost side as well. The footprint things I talked about that we did last year and that we'll do this year will help us. So I hope it is a conservative outlook, and we're working hard. In the parts that are directly in our control, we're doing a lot, and we have made a lot of progress on it. But as everybody else has talked, these things are still all out there. On the pricing side, I think the answer is yes. If again, you've got this transitory issue versus true cost increases that we expect to stay in perpetuity. And then the steel piece, we've historically had a pretty good model there. Maybe there's a lag on the way up and a lag on the way down that we benefit from—and I think that model still works for us because there is a cyclical element to that inflation versus just being like wage inflation which typically doesn't go back. So if we're in a situation where we think our costs are going to be going up, we'd probably be looking at about 4% to 5% pricing. If we were looking at 4% to 5% a year, yes, I think our commercial model we have to change a little bit where long-term contracts have duly been a win-win for us and our customers. And they flipped last year to a win-lose for us in some cases where we are absorbing those costs. So we would definitely have to change that model going forward. And I think as the year progresses, we would share more with you on that. We certainly haven't been signing the long-term commitments without pricing, but we still have some. And I think the expectation is probably still that that model will remain, but we'll see.

Thanks so much.

Moving on, we'll go to Steve Barger with KeyBanc Capital.

Hey, good morning guys. Just, obviously, incremental margins weaker than people expected. You've been clear on the challenges stemming from the inflationary environment. Should we be thinking significantly better incrementals in the back half as you take these mitigation actions and pricing rolls through? And do you expect EPS will be up year-over-year in 1Q?

So yes. I think you go back to my material logistics comment looking at last year, roughly $40 million in the first half, $110 million in the second half. So that $110 million. We're planning on that rolling in. So the cost comps in the first half of the year are significantly higher. We expect some improvement in price through the course of the year, but most of it happening today. So yes, I would see year-over-year comp wise, a stronger second half than first half, not based really on cost improving, but more on the costs rolling over in the first half and then price extending. I'm not looking to provide quarterly guidance, certainly would expect revenue to be up, I would expect a sizable step-up in margins and earnings per share from the fourth quarter to the first quarter. We've done that the last couple of years, and that was without significant pricing from Q4 to Q1. So certainly would expect a sizable step up, but I don't want to get into the specifics of higher or lower than last year. Obviously, last year ended up being a high watermark for us for margins in the first quarter. I'll pause as a follow-up.

All right. You mentioned that both staffing and inventory are up. Just year-over-year growth in inventory outpaced revenue growth in the back half of '21. Is any of the margin pressure you expect this year a function of slowing production to balance inventory? Or will you still grow inventory in excess of sales as the year progresses, given the demand environment?

We would still expect—so the answer is no, we would still expect to grow inventory more modestly this year than last year. We don't have—some of this inventory is directly a function of longer supply chains, things that used to take two weeks are taking four weeks. So there is that element. Again, we haven't baked a significant improvement in that in our assumptions. But under the assumption that we're pushing 10% revenue growth and optimistic about next year, which as we sit here today, that's what we're thinking for both of those, we would expect inventory to go up this year.

Got it. Thanks.

Moving on, we'll go to Ross Gilardi with Bank of America.

Hey, good morning guys. Just curious, Rich, how are production rates? How do they feel right now for your customers? I mean, are they starting to improve? And can you just give any color on how—what kind of variations you might be seeing across some of your key markets?

One, on Slide 7, across our markets, you look, I think we've got everything up mid-single digits or more with the exception of renewable energy. And that we have flat coming off of a very good year. So I think as you look across that, just about everything is really in our favor in terms of overall demand. I think inventory in the channels and restocking is in our favor. I think the capital equipment cycle is in our favor. I think the MRO cycle really started moving more in our favor in the second half of the year. Our distributors have gotten much more bullish and are looking to put inventory in and their revenue for the second half of '21 as well as their outlook for '22 improved. And then even when you look in some of the submarkets within—even some of the markets that were written off as dead a couple of years ago for capital like oil and gas are showing some signs of life. So the overall demand situation is very strong. The erratic demand that we were facing this time last year and probably through the second or third quarter has definitely improved. A year ago, we were scrambling and we had a lot more concerns about over-ordering. I think a lot of that has improved. But everybody is still dealing with issues and it is definitely a more erratic or choppier market environment than would be ideal. And I think that's for us as well as for our customers as well as for our suppliers. But demand is strong.

Yes. The only thing I would add, Ross, just on inventory is when we think about inventory at our customers, both distributors and OEMs, we would look at inventory and say it's still relatively low given the demand levels. So while we've added some inventory in 2021 and expect to do so again in 2022, and we do believe our distributors will add inventory and our OEMs, the inventory levels, particularly at OEM dealers and the aftermarket channels are still relatively low. So I think that's a favorable factor as well heading into '22.

I realize order trends are still very strong. Inventories are low. I was curious more production—your key customers—is actually starting to accelerate to service all this backlog? Or are they still constrained?

Yes. And I think the answer to that is definitely yes. There are well-publicized issues of chips, which has made that market choppier. I think our first quarter comp for automotive is tough. But by the second quarter, I think that fell off last year. So there are some other things out there. Customers are dealing with some chemical issues, paint issues. But I think in general, their capital equipment builds are up. And in particular, I think the MRO cycle is also kicking in pretty strong. So I think I'd say order demand is probably higher than our 7% organic, but I think it is a reality of what people are going to be able to do to hire people, build, et cetera, and we feel it's a pretty reasonable number.

Yes, when we look at a market like off-highway, Ross, off-highway across both '21 and especially as we look at '22 and what our customers are doing, we think it's going to be the strongest market since 2011. That was a super strong year as everybody remembers, but we think it's going to be probably the strongest year in off-highway we've seen since that time. So customers are ramping. As Rich said, it's still a little choppy, particularly in the on-highway markets; our on-highway auto OEMs are still a little choppy but strong and getting stronger.

Okay, got it. Thanks, I'll get back in queue.

And next, we'll go to Courtney Yakavonis with Morgan Stanley.

Hi, thanks guys for the question. I think you talked a little bit about first half versus second half incrementals, but Rich, I think you made a comment that we will see the evidence of pricing in the first quarter results. So can you just help us pair that comment with how we should be thinking about the sequential step-up in margins? And any differences we should be thinking about between Process and Mobile and how that pricing will flow through to margins? Also, Phil, you had mentioned obviously being fairly conservative with respect to supply chain and wage energy pressures, but you are baking in some improvement in manufacturing performance. Can you just help us think about how to quantify how much of an improvement you're baking in for manufacturing improvement? And is that something other than— I would have thought that that was supply chain improvement being reflected in improved manufacturing performance. But is there anything else that would be driving that?

So we do expect—the vast majority of the 4% pricing is in place. It wasn't all January 1; we did some distribution pricing that rolled in February 1. But the pricing would move gradually off of the first quarter number. The second half response that I made was on incrementals, not margins, right? So we're not really expecting a step-up in margins. It's really an issue of the comps on costs. By the time you get to the second half, you had lower margins and all those costs that we're forecasting will still be there. So the incrementals are better. So it's really an incremental story. As we're looking at the year, expect a significant step-up in performance from Q4 to Q1 and some normal seasonality. Typically, our revenue declines a little bit from the first half to the second half in a strong year.

Okay. That's helpful. And then, Phil, can you just help us think about how much improvement you're baking in for manufacturing performance and whether that's purely supply chain-driven or if there are other drivers?

The two are connected. If you don't have parts flowing into your operations smoothly and we ship parts from one plant to another plant as well, all of that definitely affects labor productivity. We haven't baked in perfection. We are still hiring in our plants. We made good progress on onboarding, but we still have some of those costs that we're incurring this year and would expect to incur. That will improve through the course of the year gradually; it's not a step change.

Okay, got it. Thank you.

And next, we'll go to Chris Dankert with Loop Capital.

Hey, morning guys. Thanks for taking my question. We touched on a little bit earlier, you mentioned strongest year in off-highway in over a decade here. I guess, just any comments in terms of growth by segment here? I mean is it fair to assume kind of a low-teen organic in Mobile? Just any kind of triangulation you can give us there would be really appreciated?

Between Mobile and Process, we're expecting pretty close.

Pretty similar.

Within the segments, within Mobile, Phil already mentioned off-highway, drilling and rail, which has been a little slower to come up, but we're seeing that come on strong, and we're optimistic about that this year. Those will probably lead within Mobile, but everything is up. In Process, everything is up as well; general industrial and distribution will be the two leads given current market dynamics and supply chain conditions.

On SG&A, we would expect it to be up. A couple of factors: higher wages, some wage inflation, higher incentive compensation as earnings grow, and higher spending to support sales levels. We expect a gradual return to more normal travel and spending as the year progresses. As a percentage of revenue, with revenue up quite a bit, SG&A should be relatively consistent as a percentage of sales from '21 to '22—up, but more or less in line with sales growth.

Got it. Thanks, and best of luck going forward here.

And next, we'll go to Stanley Elliott with Stifel.

Hey, good morning everyone. Thank you all for taking the question. Quick question, in terms of the order rates and things of yours. Have you all changed how you're processing these orders? Meaning with supply chains being so convoluted and difficult, what's the risk at some point down the road that you're seeing a lot of double ordering? I don't think that's the case now or an issue now just given how lean inventories are. But curious if you've changed the thought process around that for when the environment does fall a little bit?

Yes, I think we try to monitor and try to control that. Our digital platform is a big help for this. If we've been shipping 1,000 bearings a week to an OEM and they start ordering 2,000, it's hard to imagine that their production rates are going up that level, and we're able to start a dialogue with them. That situation today is better than it was a year ago. There's less noise. When this first took off, there was a bit of a panic and people ordered more. Inventory imbalances were worse then. We're seeing less of that now. We certainly monitor distributors and OEMs, and with our salespeople we have good line of sight. Right now, it looks favorable for us.

That sounds fair. And then switching gears, Rich, you mentioned the M&A environment expected to be a little more active in the next couple of years. Is this—are there larger deals still out there? Is it still going to be skewed toward the process side? How quickly do you think you can act on some of these deals as you've obviously been harvesting? Just curious what to expect in the near term?

I think yes, it's definitely slanted to Process. We're looking to mix Mobile up as well, but lubrication and automatic lubrication systems have a big Mobile element and it's a great business. Slanted to Process, and we're focused on small to midsize deals rather than large. In 2020 we slowed down due to the pandemic; the pipeline dried up and didn't restart until late in the year. We worked on a couple of potentially larger ones but chose not to pay the prices that they were going at, with no regrets. As we sit today, we're focused on a sweet spot of $50 million to $200 million of revenue, and I believe you'll see us get back into that this year and next.

Just to add, from a capital allocation standpoint, we have the ability to buy back shares as we did in the fourth quarter. Our full year guide assumes share activity at the fourth quarter level, and we don't normally include any capital allocation in the guide. If we do M&A or buybacks, we report on it after the fact. Both are viable, with a bias toward M&A from a strategic perspective.

Perfect guys. Thanks so much and best of luck.

And we do have a follow-up from Ross Gilardi with Bank of America.

Thanks guys for taking it. I was just wondering if you could discuss just the mix impact of renewables undergoing the rest of the portfolio. And just maybe explain a little bit more about what's actually going on there in the wind markets? I mean there's been a lot of developments globally with policy in China and subsidies and whatnot. But maybe you can just talk a little bit more about just U.S. versus China onshore versus offshore and just how it impacts your business? Thanks.

First, on the mix, renewable energy does mix down Process Industries, but it doesn't mix the company down. So there's some mix within Process as other elements grow more this year while renewable flattens out. Don't look at renewable as mixing the company down in total on the margin rate. On revenue, four straight years of double digits. Last year our double-digit was probably a little more self-help. The market, particularly in China, did soften in the second half. We were able to offset that, and we still grew in the second half. That being said, we saw the slowdown in China. We expect to start the year down in renewables a little—single digits—largely from the slowdown in China. We did see orders pick back up late last year and that continued into this year. Offshore is a bit more favorable for us; it's generally bigger and more durable and fits our value proposition better. For the U.S., we're a relatively small player. There isn't much of a supply chain in the U.S. for this market. Our customers tend to produce in Asia and Europe, and much of what ends up in the U.S. comes from there. We remain very bullish on the China and global markets over the next 3 to 4 years; I view the China situation as a pause, not a pullback.

As I mentioned in my comments, our CapEx in '21 was up and we're going to be higher in '22. There is a fair amount of spend in that CapEx plan for renewable energy in particular, as we continue to invest for growth. As Rich said, we're bullish on the markets long term and we're also putting in manufacturing technologies to help improve manufacturing efficiency across those product lines.

Thanks guys.

I'll make one more comment. The flattening of wind for the year shows the strength of our portfolio's diversity. When wind is up and solar is up in some years and industrial markets are down, we can shift labor and material capacity into the industrial markets and serve both. It's a strength of our portfolio to have things that move in different directions.

Okay. Well, I think that's all the questions. Thanks, everyone, for joining us today. If you have any further questions after today's call, please contact me. Again, this is Neil Frohnapple. Thank you, and this concludes our call.

Thank you. And once again, that does conclude today's call. We thank you for your participation. You may now disconnect.