The Timken Company - Earnings Call - Q3 2019
October 31, 2019
Transcript
Speaker 0
Good morning. My name is Brian, and I will be your conference operator today. As a reminder, this call is being recorded. At this time, I would like to welcome everyone to Timken's Third Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise.
After the speakers' remarks, there will be a Q and A session. Thank you. Mr. Hershiser, you may begin.
Speaker 1
Thanks, Brian, and welcome, everyone, to our third quarter twenty nineteen earnings conference call. This is Jason Hershiser, Manager of Investor Relations for the Timken Company. We appreciate you joining us today. If after our call, you should have further questions, please feel free to contact me directly at (234) 262-7101. Before we begin our remarks this morning, I wanted to point out that we have posted on the company's website presentation materials that we will reference as part of today's review of the quarterly results.
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 Fricasza, our Chief Financial Officer. We will have opening comments this morning from both Rich and Phil before we open up the call for your questions. During the Q and A, I would ask that you please limit your questions to one question and one follow-up at a time to allow everyone an opportunity 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 timkin.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 express written consent, we prohibit any use, recording or transmission of any portion of the call. With that, I would like to thank you for your interest in the Timken Company, and I will now turn the call over to Rich.
Speaker 2
Thanks, Jason. Good morning, everyone, and thank you for joining us today. We grew revenue 4% in the third quarter despite a more significant sequential decline in the top line than we anticipated as we saw softening across several markets and a continued negative impact from currency. Organically, revenue was down 3% with significant declines in Off Highway and Heavy Truck as well as modest declines across industrial markets and distribution channels. Softness was exclusively in North America as OEMs and distributors became increasingly cautious and managed inventory levels down as the quarter progressed.
Despite the weakness, we continue to grow in all other regions of the world as well as in wind, solar, marine and rail. Acquisitions contributed 8%, which netted to 4% top line growth for the quarter. Also worth highlighting, Process Industries revenue was higher than Mobile Industries as we continue to shift our portfolio and improve our mix both organically and inorganically. Given the market conditions, we performed very well on the bottom line with earnings per share up 8% for a record third quarter of $1.14 We held EBIT margins from the second quarter at 15.5%, up 110 basis points from the prior year. This is despite production levels below sales as we continue to modestly reduce inventory levels in the quarter.
Through three quarters, our margins of 15.9% are up 180 basis points from last year despite tariffs, inventory reductions and sequentially declining demand. Process Industries margins year to date are a strong 21.8% and continue to mix the company up. The mobile margins are also a solid 12.4% year to date. Cash flow was very good in the quarter, and we continue to actively deploy capital to value creating opportunities. We purchased about 1% of the outstanding shares in the quarter, and we expect to complete the acquisition of BEKA Lubrication today.
Our balance sheet remains solid. Let me talk briefly about recent acquisitions. First, the two large acquisitions that we completed in the third quarter of last year, Cone Drive and Roll On, have both recently completed one year within the Timken portfolio. We grew revenue and EBITDA over the first twelve months of ownership, and the pro form a multiples would now be below 10 times for the combination. ConeDry's solar business has grown significantly, and we expect double digit growth again next year.
Roll On has and will continue to take Timken into more diverse end markets with different cyclicality and growth rates. We also purchased ABC Bearings last year, and we have quickly integrated ABC into Timken India. We are converting the operation to be capable of producing to Timken quality levels to expand our low cost bearing capabilities. The plant is one of our many cost reduction and growth tactics that are contributing to our strong margin performance year on year and will contribute more next year with another year of traction. In regards to Diamond Chain, I discussed last quarter that the acquisition got off to a much slower start than we anticipated, primarily from low plant productivity and volume.
EBITDA margins improved significantly from the second quarter to the mid teens in the third quarter despite lower seasonal revenue. The improvements were driven from both improved performance and stabilization in the operations as well as cost reductions from the integration. We have implemented over $3,000,000 of annualized cost reductions in the seven months since the acquisition, and we will see further benefit from these actions in the fourth quarter. We expect as I said, we expect to complete the acquisition of BEKA Lubrication Systems today. Automatic lubrication systems apply lubrication to bearings and other points of industrial equipment and vehicles.
This eliminates the labor costs of manual lubrication and extends the life of the equipment through more reliable and precise application. We entered this market with the acquisition of Interlube in 2013. We then scaled our position significantly with the acquisition of Gruneveld in 2017. Combination of Gruneveld and Interlube became a world leader in off highway equipment and on highway trucks and buses. Together, they have been very successful in the markets, have a strong management team in place and have been performing above the corporate averages financially.
But our market position and product offering outside of off highway and truck was small. BEKA Lubrication immediately changes that. BEKA brings a leading position in Germany and a much broader product offering with products specifically designed for wind, food and beverage, packaging and other general industrial applications. We will have one of the broadest product offerings serving diverse markets in the automatic lubrication industry. BEKA has been family owned and operated for three generations, and we're very excited to bring the company into Timken.
While long term, we expect the Gruneveld BEKA combination to mix us up at the margin level, day one BEKA's margins are lower than Gruneveld's and lower than the company average, and we expect the acquisition to mix us down both this quarter and through next year. But we know that there are many synergies between these two entities with opportunities to reduce overhead, improve productivity and expand margins while we grow the top line. We've successfully done it with Lovejoy, Interlube and other privately owned businesses, and we will do it again with VECA. The leadership team is ready to commence the work. Turning to the outlook.
We are taking a very cautious view on the fourth quarter, forecasting a sequential decline from the third quarter of about 4% all in. We expect customers to continue to manage inventory, costs and cash flow tightly to end the year. We will continue to manage our cost structure and inventory levels down in the quarter to reflect reduced demand while we invest in the business for long term growth and success. For the full year, we expect to deliver record earnings per share of 4.7 to $4.75 with EBIT margins over 15% on flattish organic revenue and despite another year of currency headwinds and tariffs. Cash flow in the fourth quarter and the full year will be strong, which will make the incremental debt from the BEKA acquisition minimal, and we will finish the year with a strong balance sheet.
While we will not get specific on 2020 yet, we do not view the sequential decline we are experiencing in the second half of this year necessarily rolling over into 2020. We believe much of softening is normal inventory correction versus end market demand. We have several markets that we expect to continue to grow through 2020, and we have a variety of self help initiatives heading into next year. We are currently planning for revenue to be up sequentially in the first quarter of next year from the fourth quarter of this year. Additionally, while we have contracts still to conclude, we expect price to be modestly positive next year and pricecost to also be positive.
As always, we have a full pipeline of operational excellence initiatives around cost reduction and cash management that will deliver value regardless of the market conditions. And from a capital allocation standpoint, we will end 2019 with our debt levels right in the middle of
Speaker 1
our targets. We expect to generate another strong year of cash flow next year, and we will be in
Speaker 2
a position to continue to deploy that capital towards value creating opportunities. Summary, we continue to take a balanced approach to driving growth, margins, returns and cash flow through industrial cycles. We also continue to take a balanced approach to investing in the long term growth and success of our business while delivering short term results. Our pipeline of outgrowth and operational excellence initiatives remains robust and is evident in our 2019 results. We hope you will join us in New York City on December 12 as we share more on our strategy, goals and plans for the future.
And with that, I will turn it over to Phil.
Speaker 3
Thanks, Rich, and good morning, everyone. For the financial review, I'm going to start on Slide 14 of the materials. Simkin delivered very strong operating results in the third quarter, and you can see a summary of our results on this slide. Revenue came in at $914,000,000 up about 4% from last year. We delivered adjusted EBIT margins of 15.5%, which was 110 basis points more than the prior year.
And adjusted earnings came in at $1.14 per share, a new third quarter record for the company and up about 8% from last year despite a higher tax rate. Turning to Slide 15. Let's take a closer look at our third quarter sales performance. Organically, sales were down about 3% in the quarter, with most of the declines coming in Mobile Industries. Recent acquisitions added about 8% to the top line, while currency translation continued to be a headwind, negatively impacting revenue by over 1%.
On the right hand side of this slide, we outline organic growth by region, so excluding both currency and acquisitions. As you can see, we were down in North America but up across the rest of the world. I'll provide some additional color on regional performance as I go through the segments. Turning to Slide 16. Adjusted EBIT was $142,000,000 or 15.5 percent of sales in the quarter, with with margins up 110 basis points from last year.
Dollars Adjusted EBITDA margins were 19.8% in the quarter, up 140 basis points from last year. Adjusted EBITDA margins were 10 basis points higher sequentially from the second quarter despite lower revenue. The increase in adjusted EBIT was driven by favorable pricemix, lower material and logistics costs and the benefit of acquisitions, offset partially by lower volume and related manufacturing utilization. Let me touch on some of the drivers briefly. As I mentioned, pricemix was positive in the quarter.
Pricing was positive in both segments, and mix was also positive. Note that material and logistics includes tariffs. We're starting to benefit from lower material costs, and logistics costs were lower year on year as well. Tariffs were also favorable. In the quarter, we recorded a small benefit for some tariffs paid in prior periods that are now refundable as the U.
S. Government recently granted tariff exemptions retroactively on certain of our imports from China. With respect to manufacturing, we had strong productivity and cost performance in the quarter as we're benefiting from our more variable cost structure and implementing cost reduction actions. However, this was more than offset by lower production volumes, which produced a net negative impact from manufacturing year on year. We continue to manage SG and A costs well.
Excluding the impact of acquisitions and currency, SG and A expense was roughly flat versus the year ago period as inflation and other spending was mostly offset by lower compensation expense. And finally, our recent acquisitions are contributing positively to our results, adding $11,000,000 of EBIT in the quarter. This represents an adjusted EBIT margin of around 16% on the acquisition revenue, and that's after purchase accounting amortization. As Rich mentioned, Diamond Chain continues to improve with EBIT margins above 10% this past quarter. And we're excited to be closing on the BEKA acquisition later today.
On Slide 17, you'll see that we posted net income of $64,000,000 or $0.84 per diluted share for the quarter on a GAAP basis. Special items in the quarter totaled roughly $23,000,000 of after tax expense, with the largest item being pension and OPEB remeasurement charges. On an adjusted basis, we earned 1.14 per diluted share, up 8% from last year. Note that our share count is down about 2% versus a year ago due to ongoing share buybacks. Our GAAP tax rate in the quarter was approximately 35%.
Excluding discrete and other special items, our adjusted tax rate was just over 28%. This is higher than our prior estimate. As of September 30, our full year forecast calls for an adjusted tax rate of 27%. The higher tax rate in the quarter gets us to that level on a year to date basis. Catch up cost us about $02 per share.
Now let's take a look at our business segment results, starting with Process Industries on Slide 18. Process Industries sales for the third quarter were $459,000,000 up 10% from last year. Organically, sales were down about 1%, with lower revenue in Industrial Services offset mostly by growth in wind energy and marine. We also benefited from positive pricing in the quarter. Acquisitions added 12.5% to the top line, while currency translation was unfavorable by about 1.5.
Looking a bit more closely at the markets. Industrial services revenue was down in the quarter, mainly in North America and and reflects softer demand for industrial gearbox and other repair services. Our growth in wind energy was seen in both Asia and Europe and reflects continued strong market growth and share gains. In Marine, we had higher revenue in the quarter from our ongoing programs with the U. S.
Navy. And finally, Industrial Distribution was roughly flat as we saw growth in Asia and Europe, mostly offset by lower demand in North America. For the quarter, Process Industries EBIT was $96,000,000 Adjusted EBIT was $98,000,000 or 21.4% of sales compared to $84,000,000 or 20.1% of sales last year. The increase in EBIT was driven by favorable price mix, lower tariff costs and the benefit of acquisitions, offset partially by the impact of lower volume. Process Industries adjusted EBIT margins were up 130 basis points year on year.
Our current outlook for Process Industries is for 2019 sales to be up 12% to 13% in total, with acquisitions driving most of the growth. Organically, we're planning for sales to increase about 3% at the midpoint, reflecting growth in wind, solar and marine, offset partially by a decline in industrial services. We expect price cost to be positive for the year and for Process Industries adjusted EBIT margins to be around 21% for the full year, or around 50 basis points higher than last year. Now let's turn to Mobile Industries on Slide 19. In the third quarter, Mobile Industries sales were $455,000,000 down 2% from last year.
Organically, sales were down just under 5%, reflecting lower shipments in off highway and heavy truck, partially offset by growth in rail as well as the impact of positive pricing. Acquisitions added about 4% to the top translation was unfavorable by around 1%. Looking a bit more closely at the markets. In off highway, we were down in all regions and across all subsectors, including agriculture, mining and construction. This reflects lower end user demand as well as customer destocking.
Every truck was down in the quarter, driven mostly by declines in Asia and North America. Our growth in Rail was in Asia and Europe, while The Americas were roughly flat. Automotive was up slightly with higher shipments in The Americas driven by continued strong light truck and SUV market demand. And finally, Aerospace was roughly flat in the quarter. Mobile Industries EBIT was 52,000,000 Adjusted EBIT was $54,000,000 or 11.8% of sales in the quarter compared to $53,000,000 or 11.3% of sales last year.
The increase in EBIT reflects favorable pricemix, lower material and logistics costs and the benefit of acquisitions, offset partially by lower volume and related manufacturing utilization. Mobile Industries adjusted EBIT margins were up 50 basis points year on year. Our outlook for Mobile Industries is for 2019 sales to be roughly flat to down 1% in total. Organically, we're planning for sales to be down about 2.5 at the midpoint compared to 2018. This includes growth in Aerospace and Rail, which is expected to be more than offset by lower shipments in Off Highway and Heavy Truck.
We expect positive pricecost for the year, and we expect Mobile Industries adjusted EBIT margins to be around 12% for the full year up about 100 basis points from last year. Turning to Slide 20, you'll see we generated strong operating cash flow of $145,000,000 during the quarter. After CapEx spending, our third quarter free cash flow was around $101,000,000 Our year to date free cash flow of $272,000,000 is more than double the amount from last year, with the improvement driven primarily by higher earnings and improved working capital performance. We ended the quarter with a strong balance sheet. Net debt to adjusted EBITDA was around two times at September 30, down from the end of twenty eighteen.
With the closure of BEKA expected later today, our pro form a net debt to adjusted EBITDA as of September 30 would be about 2.2x, and I would expect us to end the year below this level given the strong free cash flow we'll generate in the fourth quarter. You can see some highlights with respect to capital allocation at the bottom of the slide, including the repurchase of 750,000 shares in the quarter, which brings our year to date repurchases to just under 1,300,000.0 shares. I'll now review our outlook with a summary on Slide 21. We've lowered our outlook for both sales and earnings to reflect our year to date performance and relatively cautious view on the fourth quarter. We're now planning for 2019 revenue to be up 5% to 6% in total versus last year, with acquisitions driving the growth.
Organically, we expect sales to be roughly flat at the midpoint compared to 2018, driven by growth in several sectors, including wind and solar energy, aerospace, marine and rail, as well as positive pricing for the year. However, this is being offset by lower demand in off highway, heavy truck and industrial services. Acquisitions should add about 7.5% to the top line for the year. This includes the BEKA acquisition we expect to close on later today. We expect currency translation to be negative 2% based on September 30 exchange rates.
On the bottom line, we now estimate that earnings will be in the range of $4.15 to $4.2 per diluted share on a GAAP basis. Excluding anticipated net special charges totaling $0.55 per share, we expect record adjusted earnings per share in the range of $4.7 to $4.75 which at the midpoint would be up 13% from last year. The midpoint of our 2019 outlook implies adjusted EBIT margin expansion of around 125 basis points at the corporate level. And finally, we estimate that we'll generate free cash flow of around $375,000,000 for the year, or almost 120% of GAAP net income at the midpoint. Our cash flow guidance is up slightly from last quarter as we expect improved working capital performance to more than offset the impact of lower earnings.
Before we move to Q and A, I want to remind everyone that we are hosting an Investor Day in New York City on December 12. We hope to see many of you there. The event will also be streamed live over the Internet via webcast. And with that, we'll conclude our formal remarks, and we'll now open the line for questions. Operator?
Speaker 0
Thank We'll take our first question from Joe Ritchie from Goldman Sachs. Please go ahead. Your line is open.
Speaker 4
Thanks. Good morning.
Speaker 2
Good morning. Good morning, Joe.
Speaker 4
Rich, maybe just starting on the 4Q guide, down sequentially, I think you said 4%. Go back into history, and I think experienced something like this was, I guess, back in the 2014 time frame. And so, you know, maybe provide a little bit of color on how today's environment stacks versus 2014 and then your confidence in that most of this is is really inventory correction.
Speaker 2
Okay. I'm looking at the I was looking back on the '14 comp. I think definitely '14 dropped off from '13. So I think we're there was another phenomenon happening at that time, right, that the dollar was moving dramatically against the rest of the world's currency. So I think there were two headwinds happening at that time, and that carried through most of the rest of 2015.
I think we've got a little bit sharper sequential decline from the third quarter to the fourth quarter. And then I think the other thing that's different is we are, in this case, projecting two consecutive sequential declines. So when you take the third quarter and the fourth quarter together, it would be a more pronounced decline than what we saw in 2014, and I think a more pronounced decline than anything we've seen probably in five or six years, so pretty significant. And in regards to inventory versus in demand, we know there's an element of both, that in some cases production levels are down in some markets and inventory is coming down more than that. But we've gotten very clear signals and data from distributors and large OEMs that a significant part of this is inventory.
So I think the question is really around what happens from the fourth quarter well, obviously, how deep the fourth quarter decline is. And sitting here October 31, we think we've been pretty conservative on calling that. But then what happens from the fourth quarter to the first quarter. And as I said in my comments, right now we are planning for a sequential bounce from the fourth quarter to the first quarter, largely because we believe in that inventory correction phenomenon. And we normal seasonality would be up from the fourth quarter to the first quarter.
I think the last time we weren't was 2016. So it's certainly from 2015 to 2016. So it does happen, but it would basically mean that market's going to be on pressure for the full year. And at this point, we don't anticipate that. I think there's obviously a lot of differences in the company between then and now in regards to what we spent the last year and a half at that time working on breaking up the company versus what we've been doing the last few years and building a robust pipeline of commercial activities, cost reduction activities, M and A activities.
So I think the differences in the company and how the company will perform in the same or better or worse market conditions is dramatically different from what it was five years ago, and that will be a factor as well.
Speaker 4
That's helpful color, Rich. And I guess maybe just following up on that last point, the margin expansion in this backdrop with organic declining in both segments, clearly managing the decrementals well. I guess, as you think about some of the things that helped, right, incentive comp probably helped this quarter and I'm assuming as well price cost. How do you think about this over the next ensuing quarters if we kind of stay in a pretty weak backdrop in your ability to manage decremental margins over the next few quarters?
Speaker 2
I think we're in a really good spot the next few quarters. You're right, incentive comp did help in the third quarter as we lowered the outlook. Incentive comp will help next year. It'll be a tailwind next year as well as we look at raising the bar over this year's performance. Said in the comments, we will start the first quarter of twenty twenty.
Pricing will be up. It will be up less than it was 2018 and 2019, but it will be up. We've got a pretty good cyclical cost dynamic, I understand. When I say the cyclical part of cost, meaning material costs, scrap costs, etcetera. And then we've got the self help side of cost, which I said is also robust.
So I think we're in a very good position from a price cost standpoint for the next several quarters.
Speaker 4
Okay. Thank you. I'll get back in queue.
Speaker 0
Thanks. We'll now take our next question from Steven Ochman from Jefferies. Please go ahead. Your line is open.
Speaker 5
Good morning, I'll just on the same thread here a little bit. I think, Phil, you mentioned that your distributor industrial distributor business in North America was down, offset by growth overseas. Are you are you willing to say how much that North America distributor business was down?
Speaker 3
Yeah. We typically don't go into that that level of detail on it, Steve. But, you know, I would say it was down it was down a a fair you know, down meaningfully, and then we were up in in Asia and Europe as we, you know, continue to continue to grow in distribution in Asia as as the installed base matures, as we talked about before. And then we did see some incremental revenue in Europe. But it is the biggest when you think of the guide down third quarter to fourth quarter, we did take the organic guide down.
A big piece of that was distribution. Had it sort of in the mid single digits organically last quarter. We've got it kind of roughly flat this quarter. And the biggest move there would have been North America. And it's really, as I said, reflecting lower end user demand and then our expectations for some inventory destock in the fourth quarter.
And just as we sit here today, what we're hearing from our customers, what we're seeing in terms of the data we get would suggest that, that's likely to happen. So we thought we'd take a relatively cautious view and bake it in. And then frankly, ditto on the mobile side, in heavy truck and off highway, we kind of took those down a little bit more than where they were in July, and it's, again, reflective of the demand environment we saw. But also, given where we're at, we just don't see any reason customers will anything other than probably take longer than typical shutdowns and kind of slow walk the fourth quarter. And so again, we bake that in just to take a relatively cautious view on it.
Speaker 2
I'd add a couple of comments to that, Steve, that aren't direct answers to your questions, but a couple of other things. North America being down 7% in the quarter, North America generally mixes us up, and it mixes the bearing industry in general up. So I think the fact that performing year to date as we have when North America is the weakest geographic market is a strong statement. And then I'd also say on the distribution side, the difference with US distribution versus rest of world distribution is US distribution, a couple of large publicly traded companies, a large private equity company, one large for private held company. But they manage probably inventory a little more aggressively than the rest of the world where you get a lot of privately held businesses.
So I think, again, that dynamic that we're seeing in North America is partially that with inventory correction. And again, I think when you look at our performance despite that, it's a positive. But we also think that bodes well for the first quarter of next year, that some of that is just an inventory correction.
Speaker 5
Okay. And then Rich, is it your assumption that you'll be through with your own Timken inventory reductions at year end and that you'll be able to sort of produce to retail demand in 2020? Is that the plan?
Speaker 2
Yes. I think we are bringing inventory down in the second half in relation to volume. And assuming that we are up sequentially in the first quarter, we would expect production to step back up. We do have, as always, some inventory reduction targets and inventory improvement targets out there and things that we're working on. But on the macro level, I would say the answer to that question is yes.
Speaker 0
We will now take our next question from Steve Barger from KeyBanc Capital Markets. Please go ahead. Your line is open.
Speaker 6
Hey, good morning, guys. This is Ken Newman on for Steve.
Speaker 3
Good morning, Steve. Good morning. Hey, Ken.
Speaker 6
So, you know, we're hearing, that some machinery product lines are planning for double digit declines into early twenty twenty, and, you know, we we expect rail deliveries to be down year over year. Any more detail on what the offsets are specifically on the mobile side? Or do you expect process will offset whatever happens in mobile?
Speaker 2
I didn't hear the first part of your question. Did you say was declining double digits?
Speaker 6
Yeah. We're just hearing some commentary that machinery product lines are planning for some double digit declines.
Speaker 2
Okay.
Speaker 3
Yeah. No. I think, you know, you're speaking specifically to, you know, Timken for, you know, for 2019. I mean, I think what what we're seeing is and I'll and I'll try and at least give some color around as much as I can around 2020. But, you know, what we're seeing relative to 2019 is there's no question, you know, we're feeling it in off highway.
There's no question we're starting to feel it in heavy truck. Mean, of those verticals, if you will, were down north of 10% organically in the third quarter. We're expecting continued declines both sequentially and year on year in the fourth quarter. There's no question we're feeling that. But on the mobile side, we are benefiting from a strong aerospace market.
While we were flat in the quarter, we are expecting aerospace to be up high singles, low doubles for the year. And, you know, global rail continues to be strong. So while we were flat in The Americas in the quarter, we are continuing to build that build that business out outside The US. Saw some really good growth in India, Eastern Europe, and elsewhere in Asia, and that's been really positive. And then, obviously, the automotive business, while I know automotive is getting a lot of negative press these days, we think we've got a really attractive mix.
Light truck and SUV demand is holding up, I think that's mitigating a lot of what would otherwise, you know, otherwise be, you know, pretty negative heavy truck and off highway markets that you see on the market chart. And on the process side, you know, wind is wind continues to grow. It was up double digits again in the quarter. It's gonna be up double digits, we expect, year on year in the fourth and again for the full year. That's, you know, contributing significantly, you know, despite what you you look across the rest of the the verticals.
Marine's also up, which is which is helping. The rest of the vertical is kind of flattish and then the services business being down. So at least relative to Timken, you're seeing a little bit of the benefit of that mix, which we've talked about for several quarters now. Heading into 2020, it's obviously tough We're not giving 2020 guidance today.
But I think it's fair to say a lot of the markets in 2019 that are strong still have pretty good momentum behind them when you think wind, solar, aerospace, marine, have pretty strong fundamentals. So regardless of the equipment environment we're in next year, I mean, markets could continue to grow for sure.
Speaker 2
Ken, would just add the for 2020, the market outlook, not necessarily for Timken, but the one that is certainly seem to be the most negative, and I think it be in those double digit numbers probably has been heavy truck and particularly heavy truck in North America. On the OEM side of that, that's an important market for us, but it's also below 5% of the company revenue from an OEM standpoint. And then from an off highway standpoint, I'd the 2020 outlook has not been that negative and then flat to slightly down and depending on whether it's construction or mining. And then for us, again, what seeing right now is, in some cases, customers reducing dealer inventory, reducing manufacturing inventory. So if that does level off and even if it's down a few percent, we could potentially be up next year when you factor that in.
So I would say outside of heavy truck, we're not seeing a lot of forecasts that are down 10% next year.
Speaker 6
That's very helpful color. The second question here is, we appreciate the color on price cost being positive into 2020. Any help here as to whether that applies to both segments, or is there one where you expect to get more price cost spread versus the other?
Speaker 2
Yes. I would say we it applies to both segments first. And we have generally gotten better price cost coverage in process than mobile and would expect that to be the case in 2020 as well. Helpful. Thanks.
As I said, I would also say mobile we'll add one more comment there. Mobile gets better more benefit proportionally from easing material costs, which we have hit a market here in the last couple of quarters and expect that to carry over in the next year.
Speaker 0
Sorry to interrupting. So we have our next question from David Raso from Evercore. Please go ahead. Your line is open.
Speaker 7
Hi, thank you. And maybe that last comment helped address part of my question. So I'm trying to understand the mobile margins. I mean essentially organic this quarter down 4.8% on sales. Next quarter implied, it gets even worse at down 5.9%.
But the margins up year over year solidly in 3Q, implied again up solidly in 4Q. So maybe that was the last comment there that the input cost relief, the price cost is particularly positive in mobile in the second half of the year. Is that how we're seeing that positive dynamic? And obviously, if you can kind of frame a little bit, if it feels like you're trying to imply that down 5.9% for the fourth quarter in mobile, we'll see, but it might not get much worse than that. I'm just trying to see if I can extrapolate that margin performance in mobile into my thoughts on 2020.
Speaker 2
Yes. I would say, I think you have it directionally, David. Cost price positive, mix helping within there a little bit with rail being a little bit stronger, heavy truck being down, material cost certainly more favorable this year and more in the second half than what we had anticipated coming into the year and largely price being locked ins with the exception of where we passed material surcharges through. And then I would add structural cost reductions that have been taking place and continue to take place as well as
Speaker 3
some mix impact from acquisitions. Yes. Maybe I'd also maybe add, David. I I think the in the manufacturing performance, despite the inventory takeout, I mean we are managing costs extremely well. So we do expect it to be a headwind at the corporate level, but not anywhere near what we would have what we would have had in prior prior years, if you will.
You know, we're flexing down as we need to across some of the softer markets. You know, we've reduced some of our, you know, operative personnel by, you know, north of 700, 800 people so far across the world. And I think we're, you know, we're certainly acting quickly to to keep costs in line despite despite a, you know, lower inventory and and and that sort of thing.
Speaker 7
So is it fair to say after that performance in the second half of the year, if you do the fourth quarter, that mobile, if the revenues are even down next year, that you would expect to hold, broadly speaking, answer, the margins from this year?
Speaker 3
Yeah. I think it's probably I'd say that's probably too early to talk to. I think a lot of that depends on the environment next year, so it's probably a little premature to talk to that. I do wanna comment on the fourth quarter margins. I did catch your note.
And I you know, we do round the margin guide for mobile of approximately 12 and for process of approximately 21 is is rounded. I would say we would not expect we would expect margins to be, you know, up from flat to up from last year, but not quite as much as maybe you were you were showing. And then the reverse will be true, I think,
Speaker 8
on the process side.
Speaker 7
All right. Terrific. All right. I appreciate it. Thank you.
Speaker 0
Thanks, Tim. We'll now take our next question from Joe O'Dea from Vertical Research Partners.
Speaker 8
Similar line of questions, but just on the Process side, it was a good margin in the third quarter and looks like a bigger than normal step down sequentially from 3Q to 4Q. And so trying to understand, I think in the third quarter, it sounds like North America distribution was one of the pinch points. I would expect that that's a continuation in the fourth quarter, but just why we might be seeing some of that larger than normal margin pressure? And then the second part of that being, what does that mean about a setup into next year because it would imply process margins down if we just take the 4Q process margin that you're indicating.
Speaker 2
I'd say, first, there's an element of seasonality there that the fourth quarter company wide margins are generally a little bit lower and production is a little bit lower. There's an inventory takeout element in there, revenue decline in Process sequentially. So I don't think it bodes at all for 2020. So I would say it's not I wouldn't read much more into it than seasonality, inventory reduction and and a and the sequential decline. Now, obviously, if you're forecasting sequential declines for next year, then then there could be some other things, but we're we're not anticipating as we sit here today for process.
Speaker 3
Yeah. Maybe just and maybe a couple things I I would add to that, Joe. I think Rich has got it. The only things I would add would be, I think, mix, as I talked about the with the Services business being a little bit softer and then our expectations relative to Distribution, I think that would be negative for Process from a mix standpoint that I think is definitely impacting there as well. And then probably the last point, Rich mentioned it, we're really excited about BEKA in terms of what we can do with it, but it will come in below the corporate average from a margin standpoint, meaning it would be a lot significantly below the process average if you think about it that way.
So the while while only about 30% of it's gonna go into in the process, I mean, that will be a a little bit of a headwind as well temporarily until we until we drive those synergies and get those margins back up.
Speaker 2
Particularly in the fourth quarter because we're getting it for November and December, which would typically be two two of, if not the two weakest months of the year for all of our business units.
Speaker 8
Understood. On the distribution and what you're seeing with destock and given that I think you have better visibility into some of your large North America distribution partners, any insight on where you think months of inventory will stand at the end of the year just to kind of appreciate what kind of a step down we're seeing here in the back half of the year?
Speaker 2
Yes. I wouldn't say months or days of inventory. But one, I think our distributors get better every year at managing inventory, and it's been a trend for well over a decade. They've leveraged their inventory better in the 2017, 2018 and 2019 upturn than what they did in the past. So as we've talked before, we didn't really see inventory levels ever in fact, the inventory turns improved during that time.
So I think some of what we're seeing is a level of caution there. Some of it is just bringing it down with the realities of of where their market demand is. But we're gonna end the year, you know, relatively low in The US as a as a percentage of sales or as a percentage of cost of goods sold is generally the way we look at it.
Speaker 8
And then just one more on wind. And any perspective on demand patterns there? How to think about current demand levels, bigger picture just in terms of where this is trending sustainability of demand here? Has that been a nice source of strength for you?
Speaker 2
Certainly expect 2020 to be very strong. And I think that also has ripple effects for some of our confidence on the pricing side because a lot of the large bore bearings go into off highway and other markets. And so the demand while some of those markets may be off their peak, the demand in total is strong in what I'll call large industrial bearings. So it's good for the pricing side. So we expect a very strong year in 2020 for wind.
That's one of our longer lead time areas as well. And not looking to call it 2021, but if you look out over the next five years, we are certainly believers in growth of renewable energies globally and continue to grow our position there both in wind and in solar. And I'll just toss in part of the interest in the acquisition of BEKA is that they bring a product line and a market position in wind lubrication systems, which we're excited about.
Speaker 8
Very helpful. Thank you.
Speaker 3
Thanks, Joe.
Speaker 0
We'll now take our next question from Chris Dankert from Longbow Research. Please go ahead. Your line is open.
Speaker 9
Hi, good morning guys.
Speaker 7
Thanks for taking my question.
Speaker 2
Good morning, Chris.
Speaker 9
On the SG and A, flattish on an organic basis. You did highlight some structural cost out. Just can you go into a little bit of detail on what's going on there? Are we talking about just kind of pulling down headcount a bit? Are we looking at the footprint?
Kind of what's bigger picture? And kind of can we expect additional cost out actions going forward here?
Speaker 3
Yes. Hey, Chris. I'll take that. Let me just talk I'll talk to the SG and A first, and then maybe we'll talk a little bit more even cost of sales. But on SG and A, yes, we were roughly flat year on year despite the lower organic revenue, if you will.
While we are working on cost reduction initiatives across our administrative functions and did capture a lot of benefits there, we are also adding some costs. We're building out some of our capabilities outside The US. We're adding salespeople in Africa, for example, to serve that market and other parts of the world. So, I mean, that continues. But I think net net, we kept it under pretty good control.
And then we did benefit from lower compensation expense in the quarter, which was primarily incentive compensation as we adjusted the outlook. So that kind of altogether kind of kept us flat. My comment around headcount was really more around operatives. Obviously, as markets soften, particularly in off highway and heavy truck, we have had to slow down some of production. And we do a pretty good job and a very swift job of flexing down, and we've been able to take out or reduce headcount quite a bit to match demand.
And I think that will continue, and we'll continue to flex with demand. And it's really helped. From a manufacturing standpoint, we show negative $5,000,000 year on year. But given the reduction in inventory, it certainly would have been higher than that were it not for the cost reduction actions and the more variabilized cost structure that we have.
Speaker 2
I would just add is by design, we are trying really to mix into what would generally be higher SG and A markets and businesses for us. Process runs a higher SG and A level than mobile. And as you go beneath that, Lurification Systems runs a higher SG and A model than bearings, etcetera. So when you really look over the last few years, SG and A has been, I think, a bigger contributor to the margin improvement than just what the pure math would show because we've improved the mix, which would have just naturally brought the SG and A up. We've driven a lot of productivity improvements.
We've driven acquisition synergy improvements, and it has been a significant contributor to margins. And as you look forward, I talked about where we've done a lot of Diamond drives integration already, really most of that just in the last quarter. So we'll see the benefits of that this quarter. It'll take us a couple of quarters, but there will be significant integration between Gruneveld and BEKA over the course of the next year. We've got a lot of things happening in other parts of the business.
We're taking out another ERP system just this quarter, which not only simplifies the business and improves our IT cost structure, but allows us to pursue other cost reductions as well. So it's an integral part of our strategy and our operating performance, and it's been a significant contributor to our acquisition results as well as the performance of the business.
Speaker 9
Yes, absolutely. Thank you so much for the color there. Really helpful. And then just to kind of follow-up here. When we look at Europe and Asia, I apologize if I missed this, but growth certainly well ahead of IP.
I know you called out rail as one of the markets that kind of helped lead there. But just any additional color on, you know, was it cross selling? Is it program exposure? Like, what's kind
Speaker 7
of driving the outgrowth in in Asia and and Europe?
Speaker 3
Yeah. I would say it it really is driven a lot by by our mix, Chris, as we talked about. So wind was clearly a contributor. Rail in Europe and Asia has continued to grow. As we said, we were up in distribution.
And I think it's it's really more market driven. We tend to be more industrial tilted toward industrial markets in in Europe and Asia like we like we are as a company. And I think just those markets in particular have have held up really well, continue to grow and and have, you know, enabled us to more than offset the declines we're seeing. And, you know, the heavy truck and and off highway declines are are global to a great degree. And but yet, we've been able to offset that with, you know, with, I would say, the wind, the rail, and distribution probably, are the biggest ones
Speaker 7
that would come to mind.
Speaker 9
Yes. Thanks for the color guys, and good luck in the end of the year here.
Speaker 2
Thanks.
Speaker 0
We'll now take our next question from Justin Bergner. Please go ahead. Your line is open.
Speaker 10
Good morning, Rich. Good morning, Phil.
Speaker 2
Good morning, Justin. Good morning, Justin.
Speaker 10
To start off, and I got on the call a little bit late, so I apologize if anything is redundant. But to start off, I guess, on the first quarter, you suggested you see a sequential revenue bounce driven by seasonality. Are you expecting that to just be sort of in line with normal seasonality or actually stronger than normal seasonality?
Speaker 2
I would say we're planning for normal, which the last few years have been mid to high single digits up from the fourth quarter. We were double digits in one of those years and mid single digits in the other couple of years. And I'd say we're planning for the lower end of that.
Speaker 10
Okay. That's helpful. Secondly, just the GAAP EPS guide came down a lot more than the adjusted EPS guide. I'm not sure if you bridged that at all. Is that higher restructuring expenses, tax rate?
Or what's behind that?
Speaker 3
Yes. I would say it's probably the three main things I would point to, Justin, would be the pension remeasurement charge that we took in the third quarter would then would obviously be in the full year guide that wasn't in last quarter because we didn't have the number calculated. The BEKA acquisition will come in with acquisition related charges that we wouldn't have anticipated or baked into the guidance last quarter. That that would typically be like inventory step up, acquisition fees, etcetera, that would hit. And then the last point would be the tax.
You know, we did we do have some discrete tax items we we're recording during the current year for some prior year reserves that we're we're setting up that are larger than what we would have would have factored in last quarter. Those would be, I would say, the three main items, with the biggest one being the remeasurement charges. And I would point out, at the end of the year, we always have to do a remeasurement of all of our pension and OPEB plans that's required. We don't know as as we sit here today, we don't know what that amount would be, so we don't bake in anything for that. So that could be another number another amount coming in or will be another amount coming in.
Not sure which way it's gonna go at this point, but that'll come in in the fourth quarter, and we will we will not have included that. Does that make sense?
Speaker 10
Yeah. No. That makes sense. It doesn't seem like there's anything too unusual there. And then the price mix was, I guess, a $15,000,000 benefit year on year in the third quarter versus $7,000,000 year on year in the second quarter.
Was that mainly mix? Or are you still getting better pricing through the third quarter?
Speaker 2
I would say pricing in the third quarter was similar to the second quarter. So the improvement from Q2 to Q3 in that column would have been more mix related. But pricing has largely held since the first quarter of the year. Maybe a little bit more has come in through the year, but that's also been offset by material easing. And as material input costs on some of our contracts, we passed some of that through.
So that's largely washed out any midyear price increases we would have realized.
Speaker 10
Okay, got it. Maybe one last one on big picture. Has your acquisition appetite slowed now? I mean I realize BEKA was a really opportunity even if the industrial backdrop is decelerating. But looking forward, are you focused on sort of integration and deleveraging?
Or are you still open to material M and A?
Speaker 2
It depends on how far you're looking out. I would say we're certainly not expecting to do anything else in 2019 or probably early in 2020. As I mentioned in my comments, we feel very good about the three acquisitions we completed last year that they're performing well. We know what we have. Integration has been good.
Management team is stable, etcetera. So and then we got off to a rough start with Diamond. Feel a lot better about that than we did three or four months ago. Definitely, the short term focus is absorb BEKA. Our cash flow, as we said, we're going to end the year with our right about the middle of our targeted debt levels.
Our cash flow tends to be second half weighted. Generally, as we look at next year, would anticipate putting that cash to things other than debt reduction and probably ending our next year at the middle of our targeted range as well.
Speaker 10
Okay. Thanks for taking
Speaker 7
my questions.
Speaker 2
And obviously, and A could be a part of that as well as share buyback could be a part of that as well.
Speaker 10
Okay. Thanks again.
Speaker 0
This time, there appears to be no further questions. I would like to turn the conference back to you for any additional or closing remarks.
Speaker 1
Thanks, Brian, and thank you, everyone, for joining us today. If you have further questions after today's call, please contact me. Again, my name is Jason Hirschiser, and my number is (234) 262-7101. Thank you, and this concludes our call.
Speaker 0
Thank you for your participation. You may now disconnect.