Timken Co (TKR) 2018 Q4 法說會逐字稿

Good morning. My name is John, and I will be your conference operator today. As a reminder, this call is being recorded.

At this time, I would like to welcome everyone to Timken's Fourth Quarter Earnings Release Conference Call. (Operator Instructions)

Mr. Hershiser, you may begin your conference.

Thanks, John, and welcome, everyone, to our fourth quarter 2018 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've 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 both Rich and Phil before we open up the call for your questions. (Operator Instructions)

During today's call, you may hear forward-looking statements related to our future financial results, plans and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today's press release and in our reports filed with the SEC, which are available on the timken.com website.

We have included reconciliations between non-GAAP financial information and its GAAP equivalent in the press release and presentation materials. Today's call is copyrighted by The Timken Company. Without expressed written consent, 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'll now turn the call over to Rich.

Thanks, Jason. Good morning, everyone, and thanks for taking the time to join us today.

We posted another good quarter, with revenue up 17%, earnings per share up 47% and EBIT margins up 250- basis points from the fourth quarter of 2017. Organic growth in the quarter remained robust at 9% year-over-year as we continue to capitalize on growing end markets as well as deliver on our outgrowth initiatives.

Tariffs and costs were headwinds, which we slightly more than offset through pricing and cost reduction initiatives. Inorganically, we grew 10% in the quarter with our recent acquisitions contributing at the EBIT margin level, slightly higher than the company average despite the incremental amortization.

The fourth quarter capped what was an excellent year for Timken. We moved the needle on all 3 facets of our strategy to outgrow our markets, drive operational excellence across the enterprise and create value for the generation of cash and the effective deployment of capital. The strategy is working, and our progress continues. After growing revenue by 13% in 2017, we delivered another 19% revenue growth in 2018, with 13% of that being organic.

Organic results continue to run ahead of industry averages fueled by our mix and our pipeline of outgrowth initiatives. We remain focused on differentiating our products, innovating with our technical and application capabilities and providing world-class service to bring our customers the best value for their bearings and power transmission needs.

As a result, we are winning with OEMs. We are winning with end-users through our distribution network, and we are expanding in diverse geographies around the world.

We continue to lead in our traditional Timken markets, such as mining, metals, agriculture and rail, and we're strengthening our position in newer Timken markets like wind, solar, automation and food and beverage.

We expanded EBIT margins by 300- basis points for the full year to 14%, and our operational excellence initiative was a key driver of the improvement. It was a dynamic cost year with unplanned tariffs and tight global labor and supply markets, but we more than offset the cost increases and we responded to the 13% organic demand increase efficiently.

We managed pricing well and grew share while recovering cost increases through pricing actions. We continued to advance our footprint initiatives, effectively ramping up our 2 new plants in Eastern Europe and our other capacity expansions around the world.

We drove lean and productivity enhancements across all of our operations, and we lowered our SG&A as a percentage of sales by 100- basis points by increasing efficiency across the enterprise. Our customer service was industry leading, and the quality of our products remained outstanding. Overall, our execution was excellent.

2018 was also a very active and effective year for capital allocation. We ended the year with a solid balance sheet despite coming up short of our expectation for the full year for cash flow. We remain highly confident in the cash generation of the company, and we will deliver a significant increase in free cash flow in 2019.

For the fifth consecutive year, we increased our full year dividend payout, we repurchased 2.3 million or approximately 3% of the outstanding shares, we invested $113 million of CapEx into the business, which will yield revenue and margin benefits in 2019 and beyond, and we completed 3 sizable acquisitions.

Our acquisition strategy is to strengthen our portfolio and mix the company up in regards to growth and margins, all while meeting our return hurdles for accretion in year 1 and cost of capital by year 3. All 3 of our 2017 acquisitions, Torsion Control Products, PT Tech and Groeneveld, performed ahead of plan in 2018 and contributed to our record earnings per share as well as our margin expansion. More specifically, they contributed approximately $0.20 to our 2018 earnings per share.

Our 3 acquisitions from 2018, Cone Drive, Rollon and ABC Bearings, have been in the portfolio a little more than 1 quarter and are already positively impacting our results. The management teams are in place, the businesses are growing, we're generating cost and revenue synergies, and we like what the businesses do for both our product and our market mix. We have a stronger package today in the marketplace as a result of these acquisitions.

To highlight an actual synergy from our M&A. In 2018, we converted approximately $200 million of acquired revenue to our Timken digital platforms. As a result, we have better operating systems to run the plants more efficiently, we have increased our visibility and accountability to drive cross-selling, we have enhanced our ability to serve common customers, improved our pricing analytics and identified new opportunities to drive down purchasing as well as SG&A cost. That's just one small example of the value potential we're driving.

Overall, 2018 was an excellent year for Timken. The successful execution of our strategy increased our full year 2018 return on invested capital 12.8% and our earnings per share by 59% to a record $4.18.

Turning to 2019. We will continue to pursue growth while balancing that pursuit with our drive for margins, returns and cash flow. We're planning for another year of growth, with revenue up about 10% before the impact of currency and then split roughly evenly between organic and inorganic. I'll break down the 4% to 6% organic into 4 buckets: price, outgrowth, mix and end-market demand.

Starting with price. We expect 2019 pricing to be similar in magnitude to what we experienced in 2018. We do expect costs to be up again in 2019 from tariffs, material and labor. Cost savings will partially mitigate these increases, and then pricing will slightly more than offset the rest. Like 2018, we expect full year and each quarter for price/cost to be positive and to contribute modestly to margin expansion.

Over 1/2 of our expected 2019 pricing is either carryover from 2018, is already negotiated for 2019 or is already announced in our distribution channels. So we feel very good about the positive impact of pricing, and that's regardless of how the market demand dynamics play out through the balance of the year.

Next is outgrowth. In our industry, the market share is generally won slowly and not in big increments. We target about 1% per year. As demonstrated in our results, we've been winning over the last couple of years, and we will win again in 2019. Again, similar to price, there will be some carryover. There will be some new programs that we have already won that will be ramping up during the year, and there are some yet to be captured in 2019.

Moving onto market mix. Our market mix, both geographic and end-market, is setting up very well for us in 2019. We are skewed to North America, which is a strong and growing market. The recent ISM numbers were strong, employment remains tight, and manufacturing is growing, all of which are good signs for Timken.

There are concerns around global automotive, particularly in Europe and China. We are a niche supplier to the auto industry with our mix skewed to North American light truck and global premium pass car markets. While we don't expect growth in those markets in '19, they also are not contracting.

China consumer is showing signs of weakness, which is impacting on-highway vehicles, but wind is our largest end-market in China, and we expect strong growth in that market to more than offset weakness in autos and trucks.

Process Industries in distribution markets are strong, which relative to Mobile is good for our overall corporate mix. And then many of our off-highway and rail markets remain off of historical peaks and are continuing to expand nicely through the first half of 2019.

Finally, I'll cover our outlook for end-markets. Slide 9 lists some of our major markets and geographies with our outlook for the year. The middle column represents minus 2% to plus 2%. Next column, mid-single digits being around 3% to 6%. And then the right column being expected growth of 7% or more.

You can see that we do not have any markets expected to be down more than 2% for the year, which is helped by our customer, market and geographic mix as well as our outgrowth. We don't expect as many double-digit and plus 20% markets as we experienced in '17 and '18, but we do believe we will see positive organic growth through the year.

As those who follow us know, we have reasonable visibility into most of our demand 3 to 6 months out. So while we don't know if these estimates will hold for the full year, what we do know is that we just grew 9% organically in the fourth quarter, our backlog is up from where it was a year ago, we were up solidly in January, we have price increases in place for the full year of 2019, and with 2 months left in the quarter, we expect first quarter organic revenue growth above 5% before currency.

Bottom-line is that based on what we're seeing, we are going to start the year strong, and then we expect organic growth to continue into the second half. So we've built our plans around a very good start to the year, followed by normal seasonality, which would be a modest decline in sequential revenue and earnings from the first half to the second half, similar to what we experienced in 2018. And then we are also expecting over 5% top line growth as well as earnings accretion from the 2018 acquisitions.

Under the market and revenue assumptions shown on Slide 9, we're guiding to record earnings of $4.80 at the midpoint, margin expansion of around 100- basis points to 15%, including getting to around 12% margins in Mobile for the full year, and the generation of over $300 million in free cash flow.

Our first priorities for capital allocation in 2019 will be CapEx and the dividend. After those, we do remain active in the M&A market. But at this time, we will expect any 2019 transactions to be smaller than 2018. And absent M&A, we will have a bias to debt reduction versus buy-back to start the year, and then we will continue to update you on our plans as the year progresses.

In summary, our strategy is working, and we are executing well. As demonstrated in our 2018 results, we're going to start 2019 strong, and then we're forecasting new levels of record performance for the full year.

I'll now turn it over to Phil to take us through the financials in more detail.

Okay. Thanks, Rich, and good morning, everyone.

For the financial review, I'm going to start on Slide 14. Timken capped an excellent 2018 with strong performance again in the fourth quarter, and you can see a summary of our results on this slide.

Revenue came in at $910 million, up 17% from last year. Adjusted EBIT margins were 13.5% of sales, up 250- basis points year-on-year, and adjusted earnings came in at an even $1 per share, up 47% from last year and a record for the fourth quarter.

Turning to Slide 15. Let's take a closer look at our fourth quarter sales performance. We delivered organic growth of around 9%, reflecting continued strength across most end-markets and sectors, plus the benefit of our outgrowth initiatives and positive pricing. Acquisitions added just over 10% to the top-line. This includes the Cone Drive, ABC Bearings and Rollon acquisitions, all of which closed in the third quarter. And currency translation was negative in the quarter by around 2% due to a stronger U.S. dollar.

Sequentially, sales were up 3% from the third quarter as a result of the acquisitions, offset partially by seasonally lower organic volume and negative currency. We also had 2 less shipping days in the U.S. in the fourth quarter as compared to the third.

On the right-hand side of this slide, we outlined organic growth by region, so excluding both currency and acquisitions. You can see that all regions were up in the quarter organically.

Let me touch on each region briefly. In North America, our largest region, we were up 8%, with most sectors up in the quarter led by growth in distribution, general and heavy industrial and aerospace. In Asia, we were up 13% as we saw continued strength across most sectors led by distribution, rail and off-highway. In Europe, we were up 8%, with notable gains in the rail, wind energy and general and heavy industrial sectors, offset partially by a decline in heavy truck. And in Latin America, we were up 8%, driven mostly by growth in distribution and growth in heavy truck.

Turning to Slide 16. Adjusted EBIT in the quarter was $123 million, up from $85 million last year. Adjusted EBIT was 13.5% of sales in the quarter, up 250- basis points from a year ago. The increase in EBIT was driven by higher volume, favorable price/mix and the benefit of acquisitions, offset partially by higher material and manufacturing costs. This includes an impact of roughly $5 million in the quarter from tariffs.

For 2019, we expect tariffs to negatively impact us by about $25 million in total. This is slightly lower than our prior estimate and is before mitigating tactics.

With mitigating tactics, including pricing, we expect to more than offset the negative impact from tariffs in 2019.

Let me comment further on a few of the other items. As I mentioned, price/mix was positive in the quarter. Pricing was positive in both segments but with more in Process Industries. Mix was also slightly positive in the quarter with the strength in distribution. Price/cost was positive for the fourth quarter and positive for the full year despite material cost inflation and the impact of tariffs. Manufacturing performance was unfavorable in the quarter as the benefits of higher demand were more than offset by the impact of lower production volume as we built inventory in the year ago period, resulting in less fixed-cost absorption. Other manufacturing costs were up slightly as well.

And finally, SG&A and other income came in roughly flat as we continue to control costs and leverage our SG&A cost structure as we grow. Excluding special items, SG&A expense improved 100- basis points year-on-year as a percentage of sales.

On Slide 17, you'll see that we posted net income of $60 million or $0.77 per diluted share for the quarter on a GAAP basis. On an adjusted basis, we earned $1 per share, up 47% from last year and a record for the fourth quarter. In the fourth quarter, our GAAP tax rate was 23.9%. Excluding discrete and other items, our adjusted tax rate in the quarter was 24.8%, down from roughly 30% last year. The lower fourth quarter tax rate brought our full year adjusted tax rate down to 26.5%, which is slightly lower than our prior estimate. For 2019, we expect our adjusted tax rate to hold at this level.

Now let's take a look at our business segment results, starting with Process Industries on Slide 18. Process Industries sales for the fourth quarter were $448 million, up over 27% from last year. Organically, sales were up $47 million or about 13%, reflecting strength across the industrial markets, including distribution and the general and heavy industrial sectors as well as the impact of positive pricing. Wind was up slightly in the quarter, while Marine was roughly flat, and services revenue was down slightly. Acquisitions added around 16% to the top-line, while currency translation was unfavorable by about 2%.

Looking a bit more closely at the markets. In the distribution channel, the strength was broad-based, with all regions up year-on-year led by North America. In the general and heavy industrial sectors, we also saw a broad growth across end markets and regions, with notable gains in metals, oil and gas, and industrial gear drives.

Wind energy was up in the quarter, with almost all of that in Europe. And finally, we had lower services revenue in the quarter due mostly to timing under the new revenue recognition accounting standards.

For the quarter, Process Industries EBIT was $80 million. Adjusted EBIT was $88 million or 19.6% of sales compared to $57 million or 16% of sales last year. The increase in EBIT was driven by higher volume, favorable price/mix and the benefit of acquisitions, offset partially by higher material costs, including tariffs as well as higher SG&A expenses. Process Industries adjusted EBIT margins expanded 360- basis points year-on-year.

Our outlook for Process Industries is for 2019 sales to be up 13% to 15%. Organically, we're planning for sales to increase 6% to 8%, driven by growth in the industrial distribution, wind and heavy and general industrial sectors. Industrial services revenue should be up slightly on the year, and marine revenue is expected to be relatively flat. We're also expecting another year of positive pricing. We expect price/cost to be positive for the year and for Process Industries to maintain adjusted EBIT margins comparable to 2018 despite the impact of purchase accounting amortization from the acquisitions and some new bearing capacity coming online in Asia.

Now let's turn to Mobile Industries on Slide 19. In the fourth quarter, Mobile Industries sales were $462 million, up around 8.5% from last year. Organically, sales were up $24 million or around 5.5%, reflecting growth in the rail, off-highway and aerospace sectors as well as the impact of positive pricing. Automotive was up slightly in the quarter, while heavy truck was roughly flat globally. Acquisitions added 5% to the top-line, while currency translation was unfavorable by about 2%.

Looking a bit more closely at the markets. Rail was up in the quarter, with growth in Europe and Asia, while North American rail is roughly flat. The outlook for rail freight car build in North America remains strong as we enter 2019.

The improvement in off-highway demand was driven mainly by growth in the construction and mining sectors, mostly in Asia and North America. Our growth in aerospace was spread across both defense and commercial applications and the higher automotive shipments were mainly in North America. Overall, demand in the automotive sector where Timken participates remained stable.

Finally, heavy truck was roughly flat versus last year, with the growth in the Americas offset by declines in Europe. We had strong gains in heavy truck for the full year, with OE sales up around 20% globally. In 2019, we expect Class A truck builds in North America to remain relatively strong.

Mobile Industries EBIT was $43 million in the quarter. Adjusted EBIT was $46 million or 10% of sales compared to $41 million or 9.7% of sales last year. The increase in EBIT reflects the impact of higher volume, lower SG&A expenses and the benefit of acquisitions, offset partially by higher material and manufacturing costs. Mobile Industries adjusted EBIT margins were up 30- basis points year-on-year. Sequentially, Mobile margins were down from the third quarter due mostly to normal seasonality, lower production volumes and some unfavorable mix. We remain focused on achieving 12% margins in Mobile, and we expect to get there in 2019.

Turning to '19. Our outlook for Mobile Industries sales is to be up 4% to 6%. Organically, we're planning for sales to increase 3% to 5%, driven by growth in the rail, off-highway and aerospace sectors. Heavy truck is expected to be up slightly, and automotive should be relatively flat. We expect positive pricing again in 2019 and for price/cost to be positive for the year. We're planning for margin expansion for the full year with adjusted EBIT margins of around 12%.

Turning to Slide 20, you'll see that we generated solid operating cash flow of $138 million during the quarter, bringing our total operating cash flow to $333 million for the year. After CapEx spending of $113 million, free cash flow was $220 million in 2018 compared to $132 million last year. The increase in free cash flow reflects higher earnings, partially offset by increased working capital to support the higher sales.

Looking at the fourth quarter a little more closely. Free cash flow fell short of our prior estimate due in part to the timing of cash collections and accounts receivable at year-end. We should pick much of this back up in first quarter.

From a capital allocation standpoint, during the fourth quarter, we invested $50 million in CapEx. We were in the market and bought back over 900,000 shares, which, coupled with our quarterly dividend, resulted in a total capital return of $57 million in the quarter.

You can see some full year highlights in regards to capital allocation at the bottom of this slide. CapEx was around -- was just over 3% of sales for the year. We allocated approximately $831 million to the Cone Drive, Rollon and ABC Bearings acquisitions, all of which are performing well, and we returned $148 million to shareholders through dividends and share buybacks. And we ended the year with net debt of around $1.5 billion or 48.5% of capital. When you pro forma a full year of EBITDA for the acquisitions, net debt to adjusted EBITDA was around 2.2x at December 31.

Looking out to 2019. We'll continue to invest in the business with CapEx at roughly 4% of sales. We're committed to our dividend, and we'll continue to evaluate potential strategic acquisitions. We also have the ability to buy back stock, but in all cases, we intend to maintain a strong balance sheet.

I'll now review our outlook with a summary on Slide 21. We're planning for 2019 revenue to be up 8% to 10% in total versus 2018. Organically, we expect sales to increase 4% to 6%, driven by growth across most sectors as well as the impact of positive pricing and outgrowth initiatives.

As Rich mentioned, organic growth will moderate a bit as we feel the effects of tougher comps this year. But we still see positive momentum and strong fundamentals in most of our end-markets, and our backlog supports our revenue guidance.

In the first quarter, we expect organic revenue to be up both year-on-year and sequentially with strong operating leverage. The rest of the year should reflect normal seasonality with the second quarter being our strongest. Acquisitions made last year should add roughly 5.5% to the top line, and we expect currency translation to be negative 1.5% based on December 31 exchange rates.

On the bottom-line, we estimate that earnings will be in the range of $4.55 to $4.75 per diluted share on a GAAP basis. Excluding anticipated net special charges totaling $0.15 per share, we expect record adjusted earnings per share in the range of $4.70 to $4.90, which at the midpoint of our guidance is up 15% from last year.

The midpoint of our 2019 full year outlook implies adjusted EBIT margin expansion of approximately 100- basis points at the corporate level or around 15% for the year, and that's despite higher depreciation and amortization expense from the acquisitions.

And finally, we estimate that we'll generate very strong free cash flow of around $300 million in 2019.

In closing, the Timken team finished 2018 strong, winning in the marketplace and posting record adjusted earnings per share, and we remain well-positioned to take another step forward in 2019.

This concludes our formal remarks, and we'll now open the line for questions. Operator?

(Operator Instructions) We will now take our first question from Joe O'Dea from Vertical Research.

I just wanted to start on the '19 outlook and just as we continue to hear about tremendous amount of uncertainty out there and just how you kind of gauge expectations in early February and thinking about within the guide where you see some kind of pockets of cushion, if you will, whether you think that's more on the revenue side of things based on the backlog or do you think that's more on sort of price/cost opportunities that you see that are out there.

I think there's certainly upside to the revenue outlook, I guess I would start there. I think coming off the 9%, and we've got 4% to 6% for the full year. And as I said, we feel pretty good that we're going to start north of 5% in the first quarter, and we're 5-ish weeks already into that quarter. So we've got some tapering of growth in our outlook, and I think that's prudent at this point to do, but certainly, I think there could be some upside there. We came in the last year guiding to -- it would be 100- basis points price. We ended up a little over 150. We're looking at a similar number this year, so I don't think there's probably quite as much upside to price, but it's going to be a good number. And I think we always have opportunity to improve on the cost side and the operating side. We've got a reasonable amount in there for out-growth. And usually, those things are months and years in the works, so I don't think there's a huge swing there from a market share standpoint. But certainly, I would say, we feel really good about the first half of the year, really good.

Got it. That's helpful. And then on the free cash flow side of things, one, just the step-up that you anticipate in CapEx in 2019, what that's going toward is 4% more of a sustainable rate, or is that more kind of one-time and project-specific? And also related to that, when we think about 80% conversion, what are you thinking on the working capital side and opportunities down the road to improve that conversion rate?

Yes. Sure, Joe. This is Phil. So on the free cash flow, I mean, obviously, the step-up -- we expect a very a strong year of free cash flow next year north of $300 million, obviously, with the higher earnings and obviously -- and less working capital billed certainly than we had in 2018. Speaking specifically to the CapEx, we've talked before about averaging around 4%, although we have talked about the acquisitions coming in at a lower level than that. So somewhere between that 3.5% and 4% would be normal. And as you look at 2018, we do have capital allocated to some capacity additions in Asia, as we've talked about, adding some Process Industries capacity specifically to serve some of the larger-sized bearing products globally. So that will be coming online. We've got some spending there for that and normal maintenance and then really a variety of other, what I would call, small capacity additions or margin expansion opportunities. So it's well within the range of what we've guided to in the past and what we've targeted in the past. And as we move forward, I think that 3.5% to 4% is probably a good number to think about CapEx for Timken going forward. And then on the working capital, because we do have mid-single-digit organic growth built into the plan or built into the guidance, we would expect to add some working capital sort of commensurate with that, and that would obviously go against the free cash flow, slightly getting us down to that $300 million or, as you said, about 80% conversion. We also have a one-time, where we're going to make it a payout of some deferred compensation to a former executive during the year, which is a reasonably sizable number in the order of around $20 million that will -- that's in there as well. And otherwise, we'd be a little bit north of that number.

Got it. And then lastly, just a clarification. Your comment around pricing, to confirm, did you say, of the pricing that's assumed, basically half of that is already either in there through carryover or what's been announced?

Over half, and while there -- and I did include carryover in that. But more of it would be essentially as of the first of the year or negotiated for and agreed to for some time in the year than carryover. So there is a step-up from what you would have seen, say, the second half of 2018, and over half.

We will now take our next question from David Raso of Evercore ISI.

First question relates to the discussion about the confidence in the sales outlook. If you could indulge us a little bit with when you say above 5% in the first quarter, I think we're all just trying to figure out how much can we assume things slow and you still feel comfortable with the 5%. Can you help us at all with the cadence? And I know the backlog numbers don't usually come out until the 10-K, and in general, the backlog's maybe not the most reliable aspect for the way your business is run, but could you maybe indulge us with where the backlog is at the end of the year for each business?

The 10-K backlog will be up a lot and as a percentage and in dollars, and as we always cautioned, don't bank on that exactly because there's a lot of apples and oranges in that number. But I would say, the backlog is up year-on-year. It's up sequentially. We're going to grow sequentially from the fourth quarter. January was up sequentially from December. I would say all of that is normal. It would be north of 5%, as I said. We would expect it to go up again sequentially, modestly from the first quarter to the second quarter, which, again, would be normal seasonality. And then probably -- obviously, we'd update it when we get there, but what's in this guidance is that the second quarter would be the high-point organically for the year for both revenue and EPS, and then we would see some modest softening in Q3 and Q4, again, fairly similarly to what we saw before. So north of 5%., and obviously, we just came off 9%. And I wouldn't see a year-on-year step-up when -- from a 9% certainly when you look at the comps. But the backlog orders, January, all support that number. And I would put that at very low risk with 7, 8, weeks left in the quarter.

And just in case I misheard you, the second quarter, you said the organic sales growth, the growth rate would be higher than the first quarter? Or are you speaking [organic sequentially]?

No. Sequentially, I would expect that we will -- sequentially, we would go up from Q4 to Q1, sequentially, again up Q1 to Q2, usually less than we would have gone up Q4 to Q1, which is usually where our big step-up is, and then a sequential decline from there. So again, if we're guiding 4% to 6% and we're north of 5% for the first quarter and that puts us to get on to the year at the high-end or above that range to start the year.

Yes. Well, I mean, Rich, just trying to think about to sort of de-risk the guide a little bit, how much you have upfront. So I mean, sort of a cadence of up 7, then up 5, up 4.5, 3.5 kind of gets you to 5. And I think we're all just trying to gauge -- I think your business has a little more longer cycle aspects to it than a lot of people just sort of gauge it as all-short cycle. But your confidence in the first half and your visibility, can you give us some indication where any risks to some businesses where historically you've seen production schedules change dramatically that, at this stage, what you're hearing from your customers, feels a little more secure than maybe other moments of uncertainty?

So I think, first, I would say your point on late cycle markets is accurate. And as you look at our Slide 9 with industrial distribution and general industrial over there, those tend to be a little layered cycle. They also tend to mix us up. And again, backlog is good. Orders through January were good. As you get into, I guess, specific question where we have seen cuts and changes that we wouldn't have foreseen, again, I would say we're in pretty good shape for the next 2 to 3 months. I mean, it's more of a question probably for the later second quarter and beyond that. And I mean, where that's happened before, obviously, automotive, heavy truck and off-highway would be the places where those markets can move. And again, we've got some conservatism in the second half baked in -- into that, but continued year-on-year growth.

And last question and I'll pass the baton. A small nitpicky on the fourth quarter. The interest expense surprised me negatively. Phil, can you help us a bit? We're trying to think through a run-rate interest expense and why it was so high in the fourth quarter?

Sure, David. So it really goes back to the acquisitions that we closed on the third. We did put some financing in place for the 3 acquisitions just given the amount of money that we spent, and only really caught a little bit of the interest in the third quarter, just given the timing. So I think as you're looking at 2019, if you were to take the fourth quarter interest expense and then annualize it, you'd be roughly in the ballpark of what would be a good estimate for 2019.

We will now take our next question from Ross Gilardi of Bank of America.

Maybe on -- we could start off with Mobile and your ability to get to the 12% margin and some of the price increases that are out there. I mean, are they being supported in the market? I mean, some of the bigger OEM customers that you have seem to be struggling a little bit on price/cost, and I'm just wondering if you're seeing increased pushback on some of these price increases in the market as maybe demand softens up a little bit around the edges?

I think, Ross, as we've talked before when it comes to OEMs, I would say we always have pushback even if they know our steel costs are going up and their steel costs are going up, so it's always -- it's never an easy commercial discussion. But we -- I think we've done it 2 years in a row in '17 and '18, where we have moved price not so much in Mobile in '17, but more in '18 and now again in '19, where we have done it and managed to pick up share as we've gone along and done that and feel pretty confident that we're going to be able to do it again in '19. I will also say, though, on Mobile margins, price is important to getting those margins to 12%. The volume, while more modest in the last couple of years, is also important. And then there's also a mix factor in there, and that mix includes rail, and that also includes the '17 and '18 acquisitions, which have mixed us up in Mobile. And then I'll also say that we have a fair amount of -- well, we have a fair amount of cost increases coming out as well, so we had a lot of self-help offsets on the cost side from the ABC Bearing acquisition, bringing on a low cost manufacturing plant with capacity for us, the 2 Eastern European plants, the productivity improvements and some of the capital that we put in last year. So it's not all price.

Got it. And then on Process, guiding margins flattish, I mean, do you kind of see a stabilization here with an eventual push higher? I mean, you mentioned some amortization and some new capacity in Asia, could you help quantify what those 2 factors may be? Or I mean, is it a fair way to look at it by stripping those out is, like, what the underlying margin you're assuming in 2019? Is it actually going up?

Yes. I mean, I would say, Ross, I think you've hit it. So in Process, we've always said once we're north of 20%, I mean, we'd rather grow and stay north of 20% than necessarily run those margins up as high as they could possibly go just because we probably end up shrinking. But really saw a strong margin expansion in Process in '18, as you saw. And as we look to '19, a little bit of the opposite of Mobile. So while the acquisitions mixed Mobile up, on the EBIT line, the acquisitions with all that amortization actually mixing process down a bit. On the EBITDA line, the acquisitions are mixing process flat to up. So it's positive from that perspective. But when that purchase accounting amortization comes in, that is a slight mix down, but we do have more tariffs, obviously, in Process than we do in Mobile. And then the other thing to keep in mind, too, is relative to capacity. I mentioned in my remarks we invested in Mobile a couple of years ago. We're sort of reaping the benefits of that now. We've actually got some new capacity coming online in Asia in 2019 that will help facilitate growth in Process Industries, so it's absolutely a great thing. But as you know, when this capacity comes online, it does have to ramp. And while it ramps, it can be a little bit of a headwind for us. So while we expect strong volume, strong pricing, positive price/cost in Process once again, with the M&A and the capacity in particular, will be a little bit of offset to that, and that's what we're guiding to roughly comparable to 2018. And could there be some upside to that margin? Sure. If we didn't have the M&A or the new capacity, it'd be higher than that, absolutely. But we feel really good about what we're doing to the portfolio in Process and our ability to sustain those margins for years to come.

In that capacity, can you quantify -- I'm sorry, guys, can you quantify that capacity increase? In terms of, like, what does it do to your supply? Is it a 5% capacity increase or whatever the number is? And is any of it presold? I mean, is that associated with a couple of big customers where you got a commitment to buy a lot of that output already? Or do you just sort of put -- are you just putting it in place and assuming the market's going to grow?

I would say more of the latter. We've had a consistent CapEx strategy where we've invested -- we invested in '15 and '16, when we were not growing organically and again, maybe a little bit more of that was cost, but it was also capacity related. We're coming off 2 strong years of organic growth, looking at a third year of good organic growth. And I would say this is putting capacity in to assure that we could have a fourth and a fifth as well. So certainly, some of it would be presold, to use your term. Like in wind, we certainly have some contractual arrangements out there that we're working on that would consume some of this capital, but a lot of Process Industries is not on contracts, and a lot of the distribution business is not. So I would say it's more consistent with where we believe our markets are going long-term. The one other comment I was going to add, Ross, in my prepared comment -- to follow up on Phil's comments on the mix. In my prepared comments, I said the -- our corporate mix was very good, I think, both to support our organic revenue as well as our margins within Process. As Phil said, you got that acquisition impact. You also have -- we're expecting a very good year in wind. And as we said before, wind is good from a corporate EBIT perspective, but also mixes Process Industries down a little bit. On the flip side of that, industrial distribution's going to have a good year as well, but wind is a factor in that as well.

We will now take our next question from Chris Dankert of Longbow Research.

I guess, thinking about Asia more holistically, obviously, great growth in the quarter, you provided some of the detail around that. I guess is it worth breaking out China specifically versus India and some of the other regions? And just kind of how you're thinking about it more granularly into '19? Just kind of what the drivers are there exactly?

Yes. I would say as we listed China on the chart that Rich reviewed just because we wanted to list some of the larger markets and some of the markets that are probably getting the most questions. I mean, we expect really solid growth in China, as you saw up mid-single digits and then probably similar -- I would say, comparable in India as well. And the reason why we wanted to put China on there is obviously a lot of talk about China, Rich covered it in his remarks. But our mix is relatively unique in China relative to some of our other competitors, and we're not as heavily exposed to the on-highway. We're more exposed in the industrial markets and some of the heavy capital goods like wind and metals, and those markets continued to trend upward. So while there's certainly a lot of uncertainty in China and a lot of negativity, particularly around on-highway cars and trucks, our mix really, really sets up well for 2019 and gives us confidence that we expect to be up mid-single digits in China. And then in India, we're a little bit broader in some of our end-market exposure in India and expect another up year there as well.

It's -- to follow-up, we're a little bit more Mobile in India and a little more Process in China. So rail, heavy truck, off-highway equipment in India, that's a little bit of us and that's also a little bit of the market. It's not a huge metals market. It's -- and the wind market is smaller. So I think with that market mix, a little bit heavier in Process Industries, but both good growing markets, not only in 2019 but long-term for Timken.

Got it, got it. That's helpful. And then I know you guys commented a bit in the prepared remarks about capital deployment and allocation. But with the stock, where it's at and kind of M&A being somewhat expended at the -- I guess, put a finer point on how you're thinking about buy-backs versus M&A, where the opportunities are, what the pipeline looks like, that type of thing.

I'll take the buy-back part first. We think buy-back's a very attractive use of our capital and bought back a fairly sizable amount of shares in the fourth quarter as a result of that. I think it's a good option today, and would -- at the higher price frankly as well. So certainly, we've done a lot of buyback. And I would expect over time, we would continue to do a lot of buybacks. As I said in opening comments, as we start the year, coming off just buying back 2.3 million shares, with almost 1 million in the fourth quarter, I would expect our buy-back to start out the year slow as we see how the year develops. If we get to anything that we're looking at from an M&A perspective, we certainly balance both the short-term and as well as the long-term accretion and return. And where our stock has been, it puts a pretty high bar out there as we've talked about in the past for M&A. Then on the pipeline, we still are active in working our pipeline. Certainly, our focus, though, I would tell you, is on making the 3 acquisitions that we just did at the end of 2018 as successful as the 3 that we did in 2017, and they're off to a good start, but that is a greater focus of ours at the moment than adding another one.

We will now take our next question from Joe Ritchie of Goldman Sachs.

This is Ashay Gupta on for Joe. So great color on, like, the organic growth cadence so far, but maybe just extending that to the margin question as well. So you've got 100- basis point margin expansion guide. And I just want to understand how you're thinking about it in the first half versus the second because you got like better growth in the first half but probably a higher tariff headwind. So maybe some color there would be helpful.

Yes, just put that into -- by segment. So Mobile, to be 12% for the full year, we need to be above 12% for the first half. So we're looking for a sequential step-up from where we finished the fourth quarter to start the first quarter and probably a little bit in the second quarter. But I'd just say higher in the first half than the second half on Mobile. Process would not look for meaningful variability through the year, but certainly from a corporate standpoint, because of Mobile, a little bit higher in the first half.

Got it. And I guess just as a follow-up, maybe you could comment on what you're seeing from an inventory level standpoint both at your, like, OEM customers as well as distributors and if you've noticed like a de-stock that happened in 4Q.

I would say when we look between what happened at the end of the year and to start the year in total, our customers were playing inventory a little tight, and we see that fairly regularly at ends of quarters and a little bit more at the end of the year. From a broader perspective versus what happened December 20 versus January 10, I would say inventory in the channels, we believe, is in a very appropriate place for modest growth. So I don't see a big boom from restocking or a big threat of a reduction.

We will now take our next question from Steve Barger of KeyBanc Capital Markets.

It's Ken Newman on for Steve. I wanted to go back to the $7 million impact that you had mentioned on the EBIT bridge. It sounds like you -- that was a headwind from lower absorption due to the high inventory build last year. Any color on how you expect those headwinds to kind of flow in to 2019 and what you can do to mitigate those costs?

Yes. So I think it was -- yes, we just wanted to point out there, Ken, that, obviously, we talked about managing inventory through the year. We've built through the fourth quarter last year and actually took a little bit out, not a lot, but did take a little bit of inventory out in the fourth quarter. And that produced the bulk of that difference that you see as well as kind of normal inflation on the manufacturing line. So as I said, in the -- going into '19, we do expect some inventory build commensurate with the organic growth that we expect. So that will be a little less of a build certainly in '19 than we had in '18, so I've got to overcome that, but as Rich mentioned, with some of the cost reduction initiatives that we're putting in place in our plants around the world, we would expect to offset a fair amount of that impact, if you will, and then still deliver the 100- basis points margin expansion with the volume, some of the mix benefit as well as positive pricing.

I would say a few of my comments from seasonality that '17 would have been a little bit of the outlier where we would typically not build inventory in the fourth quarter of a year. But in the case of '17, with what we saw happening in the market, we thought it was in our best interest to do so. I think '18 is more indicative of what we would see in '19, which would -- again, assuming our outlook holds and that we're slightly down in the second half, we would typically be flat-to-down a little bit in inventory in the fourth quarter. And I think that would be more indicative of what we're thinking in 2019.

Got it. And then from a capital plan, can you just remind us on what you're doing or at least a little more color in terms of the efficiency initiatives? Is there more room for automation or other rapid pay-back programs? And just how you're thinking about capacity and labor in general? Are you running overtime or temps? Or can you get everything out with normal production hours?

I would say we are running efficiently today. We are, I think, expecting within Mobile, as I said earlier, to leverage some of the things that we did through the course of last year and run more efficiently in the plants that we have. And then also, generally, our increased volume is coming out of improved cost position plants such as our 2 newer Eastern European operations. In regards to your question around capital, I would say we definitely have opportunities. We've been doing that fairly systematically, and I think all of that is accounted for in our long-term outlook of 3 to -- 3.5% to 4% CapEx as a percent of sales. I don't see us jumping that up dramatically to take advantage of automation opportunities. But certainly, as you will get a chance to go through our factories and see where we put capital in, in the last 10 years versus where we're running assets that are older than that, you would see improved technology of things like vision inspection technology, more robot material handling, fewer operators in general. And yes, that definitely presents opportunities for us. But we have found, in general, a systematic approach to that has been the best way, and we feel very confident that what we are doing today in our footprint, we can compete and win in the marketplace and make good returns.

Got it. And then just one last quick one for me. You mentioned the M&A pipeline remaining pretty active. Just curious, any change to private market multiples given some of the public market concerns that we're hearing out there?

Certainly, as recently as what we did in the third and fourth quarter of last year, I would say no. And I would say I can't really comment on that because we haven't seen much happen here in the last 2 or 3 months that we've been involved in. So I think that we would have to see how that plays out through the course of the year.

We will now take our next question from Justin Bergner from Gabelli & Co.

Fortunately, most of my questions have been answered. But just to start, would you be able to give a little bit more color on the individual acquisitions, particularly the larger ones? How they're performing, maybe break-out the sales in the fourth quarter?

I'm not sure we're going to break them out. We've got the sales for the 3 of them. Let me touch on each of them. So ABC Bearings, really, a play for -- didn't bring a lot of new product, brought certainly some new customers and some increased exposure to India, but really was a fast way for us to accelerate our manufacturing and product presence and market position in India, brought to us capacity that was not utilized. And it's a, I would say fast, heavy integration into our bearing business with a focus on growth and cost opportunities, and we will see benefits from that as soon the second quarter of this year as we get a couple of quarters behind us. So that's ABC Bearings. On the Cone Drive standpoint, mix -- serve multiple markets there. I would say, first, we were very interested in getting a position in the solar business. The first 4 months of the solar revenue was way above anything they've done historically and well above than what we had modeled when we did the deal, and the outlook for 2019 is also above. They have a small robotics position that they've invested heavily in prior to our acquisition that has quite a bit of upside in revenue, got a modest plan there. But what we've seen of that since the acquisition from the inside, I think, makes us even more excited about the potential of that than what we saw from the outside. The core of the Cone Drive business in the U.S. is double enveloping worm gears, right in the heart of Timken markets, of oil and gas, industrial distribution, et cetera. We've done an enormous amount of sales cross-training there. Really excited by the product line. We've known that product line for many years. The Cone has been a customer of Timken's for decades. Working on a lot of synergies there with our industrial distribution customers, consolidated shipments, ease of ordering, et cetera. And then also do some things in -- slewing e-drives for construction equipment around the world that we're looking to accelerate with our global presence as compared to what they had. So I would say everything there we've seen has been encouraging, and both revenue, cash, EBIT, all running through 5, 6 months now ahead of where we would have modeled in the outlook good. Rollon, I'd flip a little bit more towards the products side and probably replicate what I said with Cone, I mean, it's from the outside since we've gotten on the inside, really excited about the application -- the potential for application of this technology in a lot of places. The management team there has done a very good job of growing that business steadily for the last several years. And we see, as a part of Timken, really the ability to accelerate it and particularly in the U.S. and Europe, where, again, they lacked a lot of scale and have done an admirable job for a small company of building a market position in those 2 markets. But I think with Timken, we will be able to do that faster. As we said when we bought that business, high EBITDA margin business and I'm seeing nothing that would tell us that, that is not sustainable and can put a very high-growth rate on it. So all 3 off to very encouraging starts.

Great. So it seems like your view on '19 is at least as positive for Cone and Rollon today as when you acquired those assets.

Yes, more so.

Yes, I would say, Justin, the run-rate revenue on them is, they're growing and is above what we would have shown you when we bought the companies. And as Rich said, I think the most positive thing is they're growing, they're innovative. EBITDA margin significantly accretive to Timken and then even accretive at the EBIT margin level and that's just -- and they're generating cash and it's just positive all the way around at this point.

Great. And then just 2 quick questions, if I may. The add-back between GAAP, EPS and adjusted EPS, that all relates to sort of restructuring type costs, that doesn't include any non-op pension, right?

It's actually, in the current quarter, the 2 biggest things, Justin, would have been the pension mark-to-market charge in the quarter of about $10 million pretax and then we also had the acquisition-related charges. So when we made the acquisitions, we've got to write inventory up and things like that. And when that turns, it's unusual in nature, so we typically adjust for it to take it out of the adjusted earnings.

Okay, I was referring to 2019.

2019, there'd be a little bit of carryover on the acquisition-related stuff, and then the rest would be normal restructuring.

Okay, great. And then lastly, the acceleration of wind in 2019, is that market or is that more sort of project wins and your ability to outgrow the market?

Both. Good market in China and we are more than holding our own. And we've been, I think, steadily increasing penetration. And so sum of both.

We will take our final question from George Godfrey of CL King.

I just had one question. You're targeting free cash flow to be 100% in net income, probably not this year, but that probably goes to 2020. And the outlook for this year, very positive, good organic growth, margins are going to expand. And I heard your comments about how you're thinking about the capital allocation and the share buyback. But my question is, given where the stock is and free cash flow $300 million this year and the market cap's about $3.2 billion, I don't understand why you wouldn't get more aggressive on buying back the stock at this price if revenue, margins, outlook, free cash flow is so strong. It just seems like a really opportunistic time to do so to be much more aggressive than opportunistic. And that's it.

Yes. So I think, great question. I think as we look at it, we allocated a lot of capital last year to the 3 acquisitions we talked about. And so when we think about our capital allocation framework, it hasn't really changed. We'll start first with let's invest in the business, maintain a strong balance sheet. I mean, that's obviously very important to us to keep the balance sheet strong. And then as we look at -- we have the ability to -- we're going to continue to pay our dividend obviously and then look to do M&A or buy-back as we see opportunities. And I think given what we bought back last year -- we'll continue to look at it as we move through the year -- but given what we bought last year and what we bought in the fourth quarter, I think as Rich said, our approach at least, to start the year, is going to be let's continue to allocate cash to debt reduction, continue to look at both on M&A and then continue to evaluate buy-back as we move through the year. So we've been -- I think probably the word that would describe our capital allocation approach for the last 5 years has been balanced. I mean, we've been balanced across all of those tenets, if you will. I think that'll continue. And on the heels of buying back 2.3 million shares, don't forget, we've got CapEx this year coming up. We've got to pay the dividend. And then what's left over, we'll evaluate and put it to its highest and best use, if you will.

There are no further questions at this time.

Thanks, John, 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 Hershiser, and my number is (234) 262-7101. Thank you, and this concludes our call.