Timken Co (TKR) 2016 Q3 法說會逐字稿

Good morning. My name is Lisa, 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 the Timken's third-quarter earnings release conference call.

(Operator Instructions)

Thank you. Jason Hershiser, you may begin your conference.

Thank you, Lisa, and welcome to our third-quarter 2016 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 want 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. 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 Rich and Phil before we open up the call for your questions. During the Q&A, I would ask that you please limit your questions to one question and one follow-up at a time, to allow everyone 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 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 express written consent, we prohibit any use, recording or transmission of any portion of the call. With that, I would like to thank you for your interest in The Timken Company, and I will now turn the call over to Rich.

Thanks, Jason, and congratulations to both you and Shelly on your expanded responsibilities. Good morning, everyone. Thanks for taking the time to join us today. I'll start with a few comments about our third-quarter performance, and how we see the rest of the year. And then, I'll turn it over to Phil who will go further into the detailed numbers.

Given the global market conditions, I'm pleased with how we continued to perform in the third quarter. We delivered $0.49 per share of adjusted earnings on revenue of $657 million, while we continued to drive the Company's strategic initiatives forward. I will comment on the markets first, and then how we are advancing the Company through these markets.

Our revenue came in slightly lower than we expected, with continued softness across most of our end markets. I'll start with the positive. Automotive, wind, and the defense commercial aerospace sectors remain strong, bearing and power transmission markets globally. Demand remains solid, and our customers are projecting continued strong equipment builds, and aftermarket consumption. Beyond those three sectors, essentially all the other markets for our products and services remain depressed, and while we see some signs of leveling off, and possibly some small pockets of increases, we do not yet see signs of a sustained improvement in demand.

To shed a little more light on some specific markets, our global distribution channel which serves a broad array of general industrial markets with particular emphasis on the aftermarket, remains weak heading into the fourth quarter, and we saw no material improvement in order rates. Capital equipment in heavy industries such as ag, mining, metals, and oil and gas remain at low levels, and aftermarket demand in these segments is also weak. Rail and heavy truck are declining for us, and we expect that to carry over into the start of 2017. As a result, we've lowered our full-year 2016 revenue outlook from down 6%, to down 7% to 8%, reflecting this continued softness across our markets.

As we look to 2017, we expect to end this year with a lower backlog and a lower run rate, and with organic revenue being down, which will carry over into at least the first quarter of 2017. We are holding the midpoint of our full-year 2016 guidance at $1.95 adjusted earnings per share, primarily as a result of our continued focus on cost reduction, productivity and margin expansion initiatives. Organically, we're executing well, with a continued focus on winning new customer applications, and differentiating our products and service, all while carefully managing price and mix.

Our consolidated year-to-date adjusted EBIT margins of 9.7% are below the low end of our targeted ranges for both mobile and process. And while an improvement in demand could quickly get us back into the ranges, we are continuing to take actions which will both improve margins in this weak market, as well as position us to reach new levels of performance when our markets improve.

In addition to the bearing plant in the UK that we closed in the second quarter, we have a second bearing operation in South Africa that will be closed in the fourth quarter, and two more bearing plants in the United States planned for closure in 2017. Our new plant in Romania is on track for production early next year, and we continue to drive productivity and cost reductions across our global plants and supply chains in addition to excellent customer service, and working capital management.

On SG&A, we are well into our third year of steady cost reductions through a wide array of productivity initiatives. During the quarter, we absorbed the incremental SG&A from the Lovejoy acquisition, while sequentially continuing to lower our total spend in the quarter.

A quick comment on Lovejoy. We're three months post-acquisition, and we are very pleased with the business and the product lines. We remain confident in both the short-term margin expansion opportunities and the long-term growth opportunities that this business brings to Timken. It's an excellent strategic fit, and we will continue to pursue similar opportunities.

In regards to capital allocation, our cash flow for the year has been strong, our balance sheet is solid, and you can expect to continue to see us active across the four pillars of our capital allocation framework.

In my final comment, while we don't expect short-term recovery in our end markets, we remain confident that the underlying drivers of demand for our products, our services, and our technology all remain intact. And that our markets will rebound off today's levels. And when they do, we will be in an excellent position to capitalize and deliver new levels of performance for The Timken Company. In the meantime, we'll continue to work our outgrowth operational excellence and capital allocation initiatives to deliver value and position Timken for long-term success. With that, I'll turn it over to Phil.

Thanks, Rich, and good morning, everyone. I'm going to start on slide 8 in the investor presentation. For the third quarter, Timken posted sales of $657 million, down 7.1% from last year. Organically, our sales were down 9.2% in the quarter. The impact of currency year-on-year was also negative in the period, reducing our sales by $7 million or 1%. On the positive side, the net benefit of acquisitions including the recently completed Lovejoy acquisition added sales of $22 million or 3.1% in the quarter.

On the bottom right of this slide, you'll see our geographic performance. Sales in North America were down 7% from last year. If you exclude the net benefit of acquisitions, sales in North America were down roughly 12% organically, driven mainly by market weakness in rail, industrial services and heavy industries. Excluding currency, our sales were down 7% in Europe, 2% in Asia, and 4% in Latin America.

Let me touch on each of these briefly. In Europe, results were driven mainly by weak rail markets and lower aerospace shipments due in part to the closure of our [aero] bearing plant in the UK earlier this year. This was offset partially by share gains in wind energy, and a slight benefit from the Lovejoy acquisition. In Asia, China drove the decline, as we had lower shipments in wind energy and weakness across the industrial landscape, offset partially by gains in automotive. And Latin America's results reflect continued weakness in Brazil.

On slide 9, you can see that our gross profit in the third quarter was $168 million or 25.5% of sales, down 210 basis points from last year, as the impact of lower volume, price mix and higher acquisition-related and other special charges were only partially offset by favorable material and operating costs. SG&A expense in the quarter was $110 million, down $11 million from last year. The decrease reflects our ongoing cost reduction initiatives and lower discretionary spending, offset partially by incremental SG&A from the Belts and Lovejoy acquisitions. SG&A was 16.7% of sales in the quarter, which is 40 basis points favorable from last year despite the lower revenue.

Below the SG&A line, you can see we that have $5 million of impairment and restructuring charges in the quarter, related to plant closures and other cost reduction initiatives. We also had $10 million in pension settlement charges, primarily related to the wind-up of a defined benefit plan in Canada which included an annuity purchase and lump sum payouts. Our third-quarter EBIT was $42 million on a GAAP basis. When you back out the adjustments listed on this slide, adjusted EBIT was $63 million or 9.6% of sales, compared to $76 million or 10.8% of sales last year.

On slide 10, you can see that the decline in adjusted EBIT was driven by lower volume and price mix, offset partially by lower material, manufacturing and SG&A costs. On slide 11, you'll see that we posted net income of $21 million or $0.26 per diluted share for the quarter on a GAAP basis. On an adjusted basis, our net income was $39 million or $0.49 per share, compared to $0.55 per share last year. Note that EPS benefited from share buybacks, including 480,000 shares repurchased during the third quarter.

Our GAAP tax rate in the quarter was 39.1%, which reflects our inability to record a tax benefit for the pension charges in Canada. Our adjusted tax rate was 29.5% in the quarter, bringing our year-to-date rate to 30.5%. We expect to maintain 30.5% for the fourth quarter and the full year.

Now turning to slide 12. Let's take a look at our business segment performance, starting with mobile industries. In the third quarter, mobile industries sales were $353 million, down 10.9% from last year. The impact of currency year-on-year reduced sales by $3 million or just under 1%, and the net benefit of acquisitions including the Belts acquisition completed in the third quarter of last year added sales of $6 million or 1.5%. Organically, sales were down 11.6% driven by declines in the rail, aerospace, heavy truck and off-highway sectors, as well as unfavorable pricing year-on-year.

Looking a bit more closely at the markets, rail and heavy trucks saw the largest percentage declines year-on-year, driven by lower freight rail car and Class 8 truck production in North America. Off-highway was next. Mining and construction were down, while agriculture was relatively stable in the quarter, although market fundamentals remain weak in this sector. Aerospace was impacted by the closure of our plant in the UK earlier this year, as well as lower defense-related shipments. Automotive markets on the other hand, remained relatively strong.

For the third quarter mobile industries EBIT was $24 million, adjusted EBIT was $31 million or 8.7% of sales, compared to $46 million or 11.6% of sales last year. The decrease in earnings was driven by lower volume and price mix, offset partially by favorable material and manufacturing costs, and lower SG&A expenses. Our outlook for mobile industries is for 2016 sales to be down roughly 8% in the aggregate. The net impact of acquisitions is expected to add around 2%, while currency is expected to reduce revenue by 1.5%. So organically, we're planning for sales to decline 8% to 9%, driven by lower demand across the mobile end markets, with the exception of automotive where we continue to expect growth year-on-year.

Now let's turn to process industries. Slide 13 shows that process industry sales for the third quarter were $304 million, a decrease of 2.2% from last year. The impact of currency year-on-year reduced sales by $4 million or 1.2%, and the benefit of acquisitions, including the recently completed Lovejoy acquisition and the Belts acquisition from last year, added sales of $16 million or [5.2]%. Organically sales were down 6.2%, driven by lower shipments in the heavy industries and wind energy sectors, and lower demand for industrial services, offset partially by higher military Marine revenue.

Looking a bit more closely at the markets, our performance in heavy industries and industrial services was impacted year-on-year, by year-on-year declines in oil and gas, and other commodity related sectors. Wind energy was mixed in the quarter, with lower shipments in the Americas and Asia, but continued growth in Europe. Industrial distribution was relatively stable, although market fundamentals remain soft in this sector as well.

For the quarter, process industries EBIT was $41 million, adjusted EBIT was $44 million or 14.5% of sales, compared to $45 million or 14.7% of sales last year. The decrease in earnings resulted from lower volume and price mix, offset partially by favorable material costs and SG&A expenses, and the benefit of acquisitions. Our outlook for process industries is for 2016 sales to be down roughly 7% in aggregate. Acquisitions are expected to add around 4%, while currency is expected to reduce revenue by 1.5%. Organically, we're planning for sales to be down 9% to 10%, driven primarily by declines in the industrial aftermarket and heavy industries.

Turning to slide 14, you'll see that net cash from operating activities was $75 million during the quarter. After CapEx of $34 million, free cash flow for the quarter was $41 million, or slightly above adjusted net income. Our free cash flow in the period was below last year's level due to lower earnings, less cash generated from working capital, and higher CapEx spending and tax payments. We also had some positive hedging settlements in the year ago period.

Looking at the balance sheet and capital allocation, we ended the quarter with net debt of $532 million or 28% of capital. During the quarter, we completed the Lovejoy acquisition, and we returned $35 million to shareholders through the repurchase of 480,000 shares, and the payment of our 377th consecutive quarterly dividend.

Turning to our outlook on slide15, as Rich mentioned, we are adjusting our revenue outlook to reflect the current view of the markets. We're now planning for 2016 sales to be down 7% to 8% in aggregate, with currency negatively impacting us on the top line by around 1.5%, and the net benefit of acquisitions adding around 3%. So organically, we're planning for sales to be down around 9% this year at the corporate level.

On the bottom line, we expect GAAP earnings per diluted share to be the range of $1.77 to $1.83 per share. Despite the further weakening we're seeing in the markets, we remain focused on operational excellence initiatives, and expect adjusted earnings per diluted share in the range of $1.92 to $1.98 for the year, maintaining the midpoint of our previous guidance range. We expect to generate free cash flow of around $240 million for the year, which is more than 1.5 times adjusted net income. And that's after CapEx spending of around 5% of sales, which includes spending for a new bearing plant in Romania as part of our strategic footprint initiatives.

In summary, end markets remain challenging, but we continue to execute well, generate strong free cash flow, and smartly deploy our capital to drive shareholder value. Our team is focused on execution, and positioning the Company for long-term earnings growth. With that, we'll conclude our formal remarks, and we'll now open the line for questions. Operator?

(Operator Instructions)

Ross Gilardi, Bank of America Merrill Lynch.

Good morning, Ross.

Yes, I just want to ask you about free cash flow. If you guys deliver on your guidance, I think Timken will generate an average of $[250] million in free cash flow over the last five years, which is almost 10% of your market cap. So are we at the point, where this is just an annuity? Do you feel like a $250 million free cash flow number is sustainable going forward, and are you seeing valuations for acquisitions finally come in, with all the pressures in the industrial markets?

Sure. Great question, Ross, this is Phil. I'll take the first part, and I think Rich will take the second part. Relative to free cash flow, we feel, we do feel as though over the last two or three years, there has been a structural shift in terms of our ability to generate cash. Our pensions are fully funded now, we derisked those. We believe the Company is now a consistent cash generator, and you've seen it in the numbers we've delivered over the last three years.

So we target greater than 100% of adjusted net income. That continues to be the target. We have run higher than that the last two years, and some of that has been working capital. As sales have come down, we've seen some positive cash flow from working capital, but going forward, we would expect to continue to generate strong free cash flow at or north of that 100% level.

Ross, on the M&A landscape, I would say we have not seen any relief in what would be historically high multiples. What we're multiplying by, though is obviously well off-peak. So just look at our last two acquisitions, we acquired Carlstar Belts business fairly early in the ag downturn. We saw it, and they had started experiencing it, but by the time, we bought Lovejoy, it was much farther, later in the cycle. But both a reflection of relatively low borrowing costs. And then I think good cost synergies versus organic growth opportunities, the multiples remain relatively high.

So given that, I mean, what do you do now? Because you guys are obviously going to try to remain disciplined. Are you in a situation where you could just continue to return more cash, or do you build it up on the balance sheet?

I would not expect us to build it up on the balance sheet. We, as you look forward, we are focused on our capital allocation, our four pillars of it, and we're focused on maintaining our investment grade metrics. But to your point when you look at the -- where we are at a relatively lightly levered and in the low end of our ranges, and in the cash flow, we will have quite a bit of cash to deploy.

We'll continue to invest in the business, a relatively high year this year of CapEx, expect another relatively high year next year as a percentage of sales, continue to pay the dividend. And then, as we look at buyback and M&A, I'd say we have a slight bias to M&A. The buyback creates a little shorter term, faster accretion. But the M&A has longer-term upside to it. So I certainly think we have a little bit of bias there.

But we will to your point, maintain the discipline, and I think it will all depend on the level of opportunities. If we could get three or four more Lovejoys next year, you would see us dial back the buyback. If we get one Lovejoy next year, you will see us fairly active, I would believe in buying back shares.

Thanks very much.

Thanks, Ross.

Eli Lustgarten, Longbow Securities.

I have a full mouthful. Good morning, everyone.

Good morning, Eli.

Can we talk a little bit about, with the changes that you have seen, you took your -- well, you kept the earnings, which is terrific -- but you have taken your outlook and fundamental demand down about 1% in each sector. Can you give us some color what's going on with mobile really, just rail and truck? But can you give us some idea what's happening, particularly because not only is it the fourth quarter, but it's going to spill in -- you indicated it's going to spill into 2017.

Can give us any idea of what's happening in fundamental demand, what's happening in pricing across these markets, and how it's impacting on the fourth quarter, but probably -- it looks like a difficult first-quarter, first half in 2017?

I think, let me start with the pricing piece. Nothing has, I would say changed with pricing from what we talked about the last couple of quarters, a tough pricing market. We'll be slightly negative on price for the full year, still in that 1%-ish range that we've been talking about.

So look at next year, certainly not going to be a strong price environment for us again, but by same token, we're not out chasing business with price either, and are pretty confident in our ability to keep that, to be relatively small factor, and would expect price cost to continue to be positive.

On the markets, I would say general softness across the board, and as Phil highlighted as he went through his comments, I mean, there's a couple places where we saw some sequential improvement, but very modest, and not necessarily the order flow to support that we really think that anything there is taking off on a continued level of strength. So I would characterize it, first and foremost, from our reduction in revenue guidance, broad weakness.

And then to highlight the two specific markets, rail for us, year-on-year, we're about 50% North America, and that market is down north of 20%. So that one is a big drag on us and we expected it to be down, but it's down more than what we had anticipated. And I would say heavy truck as well, which is why we highlighted it as down in that range as well, which is a sizable number for us as well.

Yes, I would just add a couple of things, Eli, just to provide a little bit more color. I think Rich is right, it's pretty broad and it's mostly market. There are a couple of instances, and I'm thinking specifically to aerospace and wind, where we've seen some push outs into next year. So that might be a little bit more timing. But I would say it's predominately the broad market weakness that Rich talked about earlier.

And to follow-up, can we talk a little bit about inventory levels, are we assuming inventory [liquidation] is basically over? I suspect there might be some in the fourth quarter, because of the market weakness. But can you talk a little bit about inventory levels and your ability to hold margins basically where they are now? And whether or not they can improve at all in 2017 until volume begins to improve?

I think that was two questions, Eli. (laughter)

Sorry.

So on inventory, I would say that we've continued to see our inventory, our customer's inventory, and channel OEM distribution bring inventory down with sales. So we're down organically, significantly year-over-year and 3%-ish sequentially, and we continue to see those inventory levels drop modestly with that. So as we look across, how much inventory our distributors have, our customers have of our product, we don't see any gross imbalances.

That being said, as you look across equipment, idle equipment, we certainly still have not -- the consumption, the end consumption of our product, the end use of our product is higher than our production levels, meaning there is more rail cars parked. They are still consuming things like that, versus but the miles are being driven, farmers are putting the time on combines, et cetera, et cetera. So we have not seen that, I think, level off in virtually and all of our capital markets.

On the margin side, I'm not ready to really comment on 2017. I already mentioned we would expect price to be a little bit unfavorable. We would expect price cost in total to be favorable. We roll into next year with some carryover costs, some good cost reduction activity still taking place.

And I think the wildcard in margins is going to be volume, as it has been. And with volume leveling off, we could not only hold, but expand margins I believe with the cost reduction activity. But as you said, we start off the year, we expect to start off the year with the volume down, through at least the first quarter. So more to come on that in -- as we get into providing guidance for next year.

Great. Thank you very much.

Thanks, Eli.

Stephen Volkmann, Jefferies.

Hi, good morning.

Good morning, Steve.

I sort of have a semi-similar question, I guess. I don't know how far you'll want to go with it. But Rich you said, I think in the outset that you weren't at your targeted margins or where you're below the low end, or something. And then you had talked about the UK plants, South America, the two in US to close in 2017, the new Romania plant.

I'm just curious as you add up all of those things that you are doing, since none of us can really forecast volume, assuming volume is flat, and you do these things that you described, does that gets you to where you want to be margin-wise, or would you still have work to do?

Hi, sure, Steve, this is Phil. I mean, I think -- let me tee it up and ask Rich to expand on it. So I mean, you're right. We're doing a lot, and the footprint activities that we've been working on for several years now, really are all designed to give us a more competitive cost structure, that we can then obviously leverage when the volumes come -- when the volume returns. And we will -- that will be a huge tailwind for us, when the new plant is fully ramped.

A lot of times, keep in mind, when we take plants down by the time, by the time we close a plant, it's has been rationalized down over many quarters, some cases, many years. So the impact of closing a plant sometimes isn't as large as you might think, just because we have been realizing those benefits over a long period of time.

But there's no question that the footprint shifts that we have done into low-cost countries have helped the bottom line, are helping the bottom line today, in terms of what we move to some of our existing footprint. It will help the bottom line in the future as the new plant in Romania, for example comes online.

And that, and we would expect with volume, when we think about our margin walking back up if you will, to the ranges or even into the high end of the ranges, obviously volume is important. We're continuing to focus on working, selling products in markets where there is richer mix for us, so process industries maybe versus some of the OE markets and mobile. And then continuing with the cost discipline both on the SG&A side and the manufacturing side.

So I'll let Rich comment on the prospects for the margins going forward. But all-in, the cost reductions that we've generated this year are significant, and we would expect to maintain most of those heading into the future.

Steve, so I would answer your question first, as yes, I think we can get back into those margins at today's volume levels leveling off. But we've been chasing the volume down really since late 2014, and it wouldn't happen immediately. Obviously, if we got some rebound, I think that's really where you would see the strength of everything that we have been doing, and the elements of that, that are structural and not coming back into the business.

Mix plays a role as Phil highlighted, but if we saw it leveling off, we could get back, yes, to those target margins. But not instantaneously, because we're still chasing it down, and that's why we are below them today.

Okay, great. Any chance, you have an idea about the incremental cost saves that accrue in 2017, just from things you've already done?

Yes, obviously, we generated quite a significant, we talked about $[60] million coming into the year, last quarter the full year cost save was [$98 million]. As we sit here today, it's closer to [$100 million], probably a little bit north of [$100 million] even. As far as into next year, there will clearly be some carryover benefit. I would say the savings were more front-end loaded this year, than what we would have seen last year. But I think there is a lot of moving pieces, and a lot of puts and takes relative to 2017. And I think we are probably best to defer that to January, February when we come out with the fourth quarter.

Okay. Fair enough. Thank you.

Thanks, Steve.

David Raso, Evercore ISI.

Hi, good morning.

Good morning, David.

I was trying to think about the overall year-over-year sale cadence, especially the way you refer to 2017 starting off. The implied fourth quarter has a further degradation in the sale decline. It's about 9%, 10%. Just to help us a bit trying to quantify how we start the year. The comps get a little bit easier on organic, but not a ton from fourth quarter, first-quarter, when we're talking like the year ago comp.

Should we think of the year starting sort of similar to the fourth quarter sales decline? Or enough markets that you're seeing at least leveling off that we should at least want to be positive about it, that maybe the fourth quarter year-over-year decline is the worst we'll see?

Yes, let me start with the fourth quarter is significantly harder for us to call from a revenue perspective than our other quarters, and it's really just a function of our customer base, and the fact that we're a parts supplier and a service provider. So we've got the backlog, we've got good visibility to it, but we get -- last year we actually got pull-ins, and we got some increased service business. We got some pull-ins on parts, in past years, we've had push-outs. So that timing of December versus January, last year we saw some January pull-in into December. We're not expecting that this year, but that is always a little bit of a challenge for us. But over two quarters, it's just noise and movement between them.

As we have grown the services business, the aftermarket versus our OEM over the last five-ish years, the fourth quarter to the first quarter, would generally be flat to maybe down a little bit. And as we look at normal seasonality, that's a pretty good benchmark, which is why we're looking at the first quarter year-on-year being down.

As you said, the comps get easier as the year goes. We have seen some leveling off of orders, which would support maybe normal seasonality next year, which would mean sequentially first-quarter to second-quarter improving.

It sounds like the fourth quarter is down 9%, 10%, maybe the first quarter is down slightly less, but it's still down at least high single. What are you seeing on your orders, if you can indulge me with that? I mean, are your orders down less than 10%? I mean, I know your backlog does not usually go out, 6, 9, 10 months, but still I'm just trying to think about when can we start to get comfort that, you call it third quarter, fourth quarter that sales should be back to at least flat?

Yes, I think (Multiple speakers) I'd say you're probably a little high on that first quarter number, because of the year-on-year comp but -- (multiple speakers)

You're saying high, meaning not down quite as high as high single-digit? (multiple speakers) you're hoping a little bit better than that? Okay.

Correct. Yes, probably little more mid to high versus high. The order input in some segments has certainly, as you look at last year at this time we would have been really chewing through with a lot of backlog, particularly in the fourth quarter, and we're really not expecting to do that. So definitely order input versus shipment is --has become healthier. And again, it's a broad statement.

So there's pockets of the world and pockets of our business that -- where they're be ups and downs in that. But it is definitely healthier from where it would have been a year ago, and six months ago, but we're also at a lot lower shipment level. We can't sit here, and say the orders have picked up. It's just the order shipment backlog metrics would be trending better.

Well, I mean, you got to (multiple speakers) somewhere. So I guess, which businesses then is the book-to-bill at 1, above 1, at least close to 1, to answer the question? Where do you expect to start to see some of the first signs of, at least flattening year-over-year to ideally some growth? Are there some end markets at least showing book-to-bill close to 1?

Well, yes, certainly as I talked about the strength, I mean, would expect it to be greater than 1 in wind going forward, and that may not be true in any particular quarter. But on a year-on-year, next few years, we're expecting it to continue grow in wind.

Automotive has leveled, but at a strong place. And then, I think probably the big one, where I'd say it's leveled off more to a 1 is industrial distribution, where we're not -- I mean, last year at this time, it would have been well under and it's pretty close to level today. So to your point, it's a good starting place.

Okay, that's helpful. Thank you very much.

And then, we hit on it, but the two that are obviously still negative is rail and heavy truck, is where we're forecasting that's going to continue to chew that up. But again, those would be included in my statement, that if you add all the pluses and minuses, and it's a much healthier book-to-bill ratio than what it has been.

Okay, thank you.

Thanks, David.

Joe O'Dea, Vertical Research Partners.

Hi, good morning.

Good morning, Joe.

Just on the fourth quarter, a little bit more, in terms of the outlook and what's implied there. And it looks like just sequentially, we see a little bit more softening on the mobile side than on the process side.

But just to understand whether or not the outlook is really calling for stable trends from 3Q into 4Q, and it's more seasonality effect, it would depreciation for some of the tough things to call in terms of pull forward or push out. But just to try to get a handle, do you feel like things are stable here, and the outlook is more seasonality into the end of the year, or where you see some incremental softening from 3Q into 4Q?

So I would definitely, with seasonality that within the mobile business fourth quarter, more OEM content, fewer shipping days, holidays, global statement, that is usually the lightest quarter for automotive builds, equipment builds on the OEM basis. And on the flip side of that, on process industries, our services business fourth quarter, strongest quarter of the year within that part of the process industries.

Distribution tends to move a little bit more with whether the markets are going up and down, but it doesn't have that fourth quarter fall off that you see with the OEMs. So seasonality would be the biggest issue. And then within that, rail and heavy truck softness.

Right. Got it. And then, on the pricing front, when you talk about price costs positive next year, could you talk maybe specifically to the raw materials side of it? And I think the way contracts are structured, most of the things should be flow through. But particularly within the distribution channel, do you think that you're facing price headwinds, it's going to be tough to pass on any cost increases there, or do you view that as more neutral?

From last year to this year, we had the big step down in scrap surcharges which is most -- what a lot of our North American, our European pricing is built off of, which again some of that gets passed through, some of it's negotiated, some of it is held onto, would not expect that to be a big favorable next year. In fact, probably more likely, it's a unfavorable, but some of that will depend on the strengths of the markets.

But this year would be probably a record low level for scrap prices, and some time a reflection of the strength of the dollar, weak markets, et cetera. So we don't expect much help there, like we've got this year. But we have some carryover on other material and purchasing components, raw material tactics, that went through last year. Phil and I just came out of review from this morning with our global purchasing teams, and feel pretty good that net of all that, we will have some good favorable cost reduction heading into next year.

Got it. And then, you've just mentioned a couple times, that the carryover headwind into 1Q, can you quantify just what you think that represents as a headwind for the year?

Yes, it's kind of tough, Joe. I mean, this is Phil. I would say a little bit further to the conversation we had earlier. I mean, when we think about what our guidance would imply. If you look at the second half, if you take the second half, and you annualize it, it's probably a 2% hole if you will, relative to 2016, just doing the math on the second half versus the full-year guidance. And then you obviously, a lot will depend on what happens within the markets, heading into next year.

We, obviously, we believe as we sit here today, rail and heavy truck will continue to decline, and the fundamentals there remain very weak. Obviously, automotive is a question, it's still running relatively strong, although obviously we're keeping an eye on it, and staying pretty close to our customers there. So it's difficult to say, relative to the full-year what might happen beyond that. But clearly, the second half will start us off in about a -- I'll call it a [2 percentage-ish] kind of hole, first half.

First half.

So yes, I think to, [as I said] go back to the math that we were running there with David, we'd be looking to starting the year with a [mid-ish] single-digit decline from prior-year, and as the year goes on, the comps get easier. And obviously we see how the markets develop and with a healthier book-to-bill ratio, how things progress from there. But starting the year off, mid single-digits organically.

Got it. That's really helpful. Thank you.

Ken Newman, KeyBanc Capital Markets.

Good morning, guys.

Good morning, Ken.

So I'll ask the 2017 growth question a little bit differently. You talked about organic growth, maybe organic weakness persisting into 2017. But if markets in 2017 begin to flatten out volume-wise, where do you see the incremental impact on re-accelerating organic growth coming from? Would that really be a function of mix of pricing, or would you have to take market share in order to get that?

Yes, Ken, this is Phil. I would say, relative to -- if things flatten out in the markets, market share has been a big thrust of ours, relative to gaining, outgrowing our markets. We've done very well over the past couple of years, in wind for example. We did very well in rail, up until the market decline. But I mean, even if we got back to more of a normal MRO and replacement cycle on some of the markets that are bouncing along the bottom, that would be a -- that would certainly be a shot in the arm.

So if we could get for example, mining, and some of the off-highway commodity-related sectors, heavy industries back to a normal replacement cycle, versus we have seen some extensions up to this point, now would that be a shot in the arm. Obviously, mix will play a role relative to where we target our efforts. And then clearly, the outgrowth initiatives, we continue to pursue across our end markets. I talked about wind and rail, but we're really targeting initiatives across all the markets through our DeltaX initiative.

I would stand with our early cycle cyclicality of, we've been under-producing our revenue, and lowering our inventory. Our customers are under-buying and under-producing, and the end users are under-buying and reducing their inventory, which is typical of our cycle. So you have to see that leveling off, and then again getting a book-to-bill ratio of 1 is step one.

Don't see anything in the short term that leads to that. But to Phil's first comment, I believe it was a normalization of the repair and maintenance cycle and an equalization of consumption across that, will actually lead to an increase in demand for us. And we will leverage that increase in demand very well.

Got it. And then, for my follow-up, if you could you talk a little about the pricing environment? I know that you're not expecting a lot of strength going into next year, but are you seeing increasing price competition from competitors looking to take share, either with the OEMs or through distribution?

Well, I would say, I think our price discipline of holding price -- is certainly hurting our ability to improve our penetration. So with OEMs, you're designed into an application. There's always price pressure. There's also a desire not to change bearing suppliers, because it is a lot of work and costs money, and takes testing, et cetera.

But it's obviously, a very easy one. Well, if you don't move price here, you don't get any new business in that entire cycle. So I think it's definitely hurting our initiative to improve our penetration and outgrow.

That being said, I think we're holding our positions. I think we're holding our market share, and we're doing it with 1%-ish across the board on price. So I think I would leave it at that.

Okay. I guess, one more follow-up. I mean, is there anybody out there being irrational with pricing as you look at it, not trying to name names or anything?

I think I will leave it, at where I was. So I don't think I would want to expand on any of that. I think we're confident in our ability to hold our position, our market share position with 1% [down] price. I don't see anybody's irrational behavior affecting that. But you can look at a lot of bearing companies profitability, and question that so.

Understood, thanks.

Thanks, Ken.

Justin Bergner, Gabelli & Company.

Good morning.

Good morning, Justin.

The first question is, in terms of the lowered revenue guidance, organic revenue guidance for the year. I mean, it looks like 100 to 150 basis point guide down, and some other industrial companies exposed to the heavy industrial part of the economy have seen more of a flattening out, as we get into the fourth quarter. So perhaps, it would be helpful if you could take us through what end markets have led to your revised view coming out of third quarter versus coming out of second quarter?

Sure. I'll start Justin, and then Rich can expand on it from there. So let's start first with, so you are correct, we are going down about 1.5% on the guide. Now as we look at it in terms of what our expectations were, I'd say that was roughly, we'd say that was roughly split between third quarter and fourth quarter as we looked at it, call it guide, the July guide to the October guide. So a part of that's in the results we have today. The other half would be in the fourth quarter. And as we looked at it, I would say, it's primarily markets, but there's also some other things going on.

But in end markets that'd be hit, like for example, in mobile, it'd be heavy truck, would be probably be the single largest driver. We also, aerospace would have been adjusted, and that's really more push-outs than what I would call market per se, just it's really the timing of when we are going to ship the helicopter transmissions and the like. And then we did take LVS down slightly. Obviously, some of our customers are taking a little bit of production out, not a lot, but there was a little bit coming out of there.

As you move over to the process side, it was primarily wind, and again I think a piece of that would be market, but probably more of that would be the push-outs. We had had some expectations for the fourth quarter, that now look like they will get pushed into next year. I mean, wind is, as I said, wind was a little bit of a mixed bag in the quarter. We were down in the Americas and in Asia. Europe still very strong, we're gaining share. We have a positive outlook for wind, going forward, heading into next year. But clearly, guide to guide, we took it down.

And then, our industrial services business, frankly with the oil and gas activity and the like, that probably was a little bit lower than what we had anticipated three months ago. Obviously, the military Marine business is -- remains strong, but on the industrial services, probably a little bit coming out of there, which I would characterize as market. So it was broad, it was a little bit, almost everywhere, but those were the key drivers if that helps.

Yes, that's very helpful, thank you. In terms of the organic revenue guide, you're suggesting that you're holding share in your markets. Was the assumptions for three months ago that you could gain share, and now you've decided to not give too much in price, and maintain share. So is there a slightly lower outgrowth expectation as well?

No, I would not say that's a big factor in the change in guidance. So I think probably a factor, as we look over the next year. And our outgrowth initiative is not to outgrow markets 5% or 6% per year. I mean, it's more modest than that. So we're looking at a percent. So that would not be something I would point to.

Okay, thank you. On the price cost side, it's not expected to hear that you are going to see negative material cost into 2017. Is that just a function of the timing of your contracts, and as the sort of the higher steel price kicks through, we'll see the material cost shift from being a tailwind to being a headwind?

No, I wouldn't say we are going to have negative material costs, say we don't have the big improvement that we had from 2015 to 2016. And then, the scrap surcharge element of material could be -- and as it sits right now, if it's stays flat for the year, we'd be fine. It'd be immaterial one way or the other.

But it's probably more likely than not that, that will be higher just because of that. But that's one element, and it's well less than half of what we pay for steel. And then, obviously we buy a lot of other processing and components besides steel. So overall next year, I would look for our input costs to be favorable.

And that would be on the non-steel inputs declining?

Yes, but I would not say steel is going up either.

Okay. Got it. And then finally, are there pension headwinds that we should expect in 2017?

No, Justin, I'd say not material. We'd be looking at roughly flattish on the pension and the OPEB at this point.

Okay. Thanks, Rich. Thanks, Phil.

Thanks, Justin.

Stanley Elliott, Stifel.

Good morning, Stanley.

Hey, guys. Good morning. Thank you for taking my question. A quick question for you on the auto business. I used to think that you all had visibility, let's say, kind of three to six month a period of time. It sounds like that there's a fair amount of confidence, I guess, if you want to use that word, heading into next year. Is it more new platform wins, new program wins, or just the segments of the market where you guys are competing the most?

Well, I would say we have a forecast and a plan. The automotive company certainly have a plan, but we have very short lead time into those automotive operations. So it is, and contractually, our agreements, are we will supply this part to this application, and we have the share. But they have the right to push orders out, or pull orders in.

So my statement around automotive is strong. We're heavy light truck, we're heavy, more premium cars, and those markets, currently the order book is still good, and the forecast for next year is flattish, at what could be our [already] peak level. So that is not any contractual guarantee, and but if we see a pickup truck in production increase next year, we'd benefit from that. If we see a decrease, it would go against us.

Great. And given what you're seeing in the order books, the changes that you've made to the footprint, with new factory coming online, other things coming out. Do you envision needing to take any additional major restructuring as we look into next year, assuming that we look at markets leveling off, how you're planning that right now?

I would expect our restructuring to not go up from this year. So it'd be in that line. I would expect it to continue to be on the high end, because obviously we've got a couple of plant closures carrying over into next year, that we've already communicated, we're working on some other things. But we've been phasing that over time, and would expect us to not have anything abnormal next year on that.

Great, guys. Thanks, and best of luck.

Thanks, Stanley.

Larry Pfeffer, Avondale Partners.

Hey, good morning, guys.

Hey, Larry.

So I know it's still early in the Carlstar acquisition, and really early in Lovejoy, but obviously the strategy on the power transmission side of the house, trying to cross-sell and lever that into your other relationships. So just curious, A, how those are going, and B, how you're thinking about the power transmission portfolio as we move forward?

I feel really good about both of them. As I mentioned earlier, we caught the Lovejoy one at a little bit lower revenue. So our revenue primarily because of the agricultural market with the Belts acquisition, came under some significant pressure. So we're probably a little late to get some costs out there, new to the business, and maybe a little bit more cautious than we have. But we've done that over the course of the year that we had it. We've also got a good line of sight on the costs for a lot of the synergy case.

We just integrated them into come in the third quarter in our North American logistics network. That makes distributor's ordering that product much easier, it gives inventory visibility, and really puts them on a different plane, in regards to ease of doing business with our North American distributors.

We've done a lot of cross-training on the products, and a lot of sales opportunities. We are -- in an absolute basis, maybe little behind the synergy case, because of the markets, but just went through this, and we think we have good line of sight to hitting the sales synergy targets going forward, even in a tough market. So remain bullish and confident on our ability to create both the strategic value of a stronger package of brands, products, scale for both the bearings as well as the PT, and also on delivering a good financial case on it.

Got you. And when you referenced, earlier in the call looking at acquisition targets, would PT still be the area you're looking at more, or anything new on the bearing front?

I would say, we -- PT is more, because there is more availability and more fragmentation, and we're always looking at bearings. But the availability and candidates that we believe would fit with our package and our strategy, there's just frankly a lot fewer of them.

Right. That make sense. Just kind of changing gears a little bit, but curious on the geography. Obviously, saw Latin America and APAC get little less bad this quarter, whereas the developed markets slid a little bit. Would you expect that pattern to continue through the end of the year and into Q1, or is that just noise between quarters?

Yes, I'd say it's probably little bit too early to call there. I would say that -- I think you're right. I mean, North America clearly, remains probably our most depressed market, and that has been exacerbated more recently with rail and heavy truck declining on the heels of the off-highway declines we saw earlier in the year and into last year. And I think some of the -- when you get outside of the US, it can be very business specific. So for example, in Europe, I talked about the share gains we had in wind energy, that came on which improved that a little bit.

I would say within Europe for example, though Eastern Europe is clearly trending better than Western Europe, and that has been a trend we've seen all year. And in Asia, it's really been a story around China continues to decline. We have lower shipments in wind, the industrial markets are weak, we did see some growth in automotive in the premium car space, and that was a positive.

And then Latin America was really -- remains depressed. Although you are correct, I think sequentially we were a little bit improved there, but it remains a pretty weak market. So hard to call heading into next year, but we do not see any major changes at this point.

Okay. Thanks, guys.

Thanks, Larry.

It appears there are no further questions at this time. Mr. Hershiser, I'd like to turn the conference back to you for any additional or closing remarks.

Thank you, Lisa, and thank you everyone for joining us today. If you have further questions, please call me. Again, my name is Jason Hershiser, and my number is 234-262-7101. Thank you, and this concludes our call.

Ladies and gentlemen, that does conclude today's conference call. Thank you for your participation.