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Executives

Steve Tschiegg - Director of Capital Markets & Investor Relations

James W. Griffith - Chief Executive Officer, President and Director

Glenn A. Eisenberg - Executive Vice President of Finance & Administration

Salvatore J. Miraglia - President of Steel Business

Christopher A. Coughlin - Group President of Mobile and Process Industries Segments

Richard G. Kyle - Group President of Aerospace and Steel Segments

Analysts

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

David Raso - ISI Group Inc., Research Division

Samuel H. Eisner - William Blair & Company L.L.C., Research Division

Eli S. Lustgarten - Longbow Research LLC

Holden Lewis - BB&T Capital Markets, Research Division

Timken (TKR) Q3 2012 Earnings Call October 25, 2012 11:00 AM ET

Operator

Good day, everyone, and welcome to The Timken Company Third Quarter Earnings Release Conference Call. Today's call is being recorded. And at this time, I'd like to turn the conference over to Steve Tschiegg. Please go ahead, sir.

Steve Tschiegg

Thank you, and welcome to our third quarter 2012 Earnings Conference Call. I'm Steve Tschiegg Director of Capital Markets and Investor Relations. Thanks for joining us today. And should you have further questions after our call, please feel free to contact me at (330) 471-7446.

Before we begin our call this morning, I wanted to point out that we posted to the company's website this morning presentation materials to supplement our review of the quarterly results, as part of this earnings teleconference call. This material is also available via a download feature from our earnings call webcast link.

With me today are Jim Griffith, President and CEO; Glenn Eisenberg, Executive Vice President of Finance and Administration and CFO; Sal Miraglia, President of Steel; and Group Presidents, Chris Coughlin and Rich Kyle. We have remarks this morning from Jim and Glenn, and then we'll all be available for Q&A.

[Operator Instructions]

Before we begin, I'd like to remind you that during our conversation today, you may hear forward-looking statements related to future financial results, plans and business operations. Actual results may differ materially from those projected or implied due to a variety of factors. These factors are described in greater detail on today's press release and in our reports filed with the SEC, which are available on our website at www.timken.com. Reconciliations between non-GAAP financial information and its GAAP equivalent are included as part of this press release.

This call is copyrighted by the Timken Company. Any use, recording or transmission of any portion without the expressed written consent of the company is prohibited.

With that, I'll turn the call over to Jim.

James W. Griffith

Thanks, Steve, and good morning. In our earnings announcement today, Timken reported solid performance for the third quarter in the face of weakness in the global economy. Although sales were down, we generated strong operating margins and strong cash from operations despite operating at lower capacity utilization. Our earnings are far stronger at this point of the cycle than in any time in our history, and we still expect near record earnings for the full year 2012. Our current performance echoes what you've been hearing from many others. Uncertainty in the marketplace is causing a dip in demand. Even as certain parts of the world economy continue to grow.

At the end of the second quarter, we indicated that we could see slowing orders based on weakness in Asia and Europe. The slowdown outside the U.S. continues and has now impacted some of our market sectors here in the states. Meanwhile, the general economy in the United States continues to improve, but not at a pace fast enough to offset the impact of global markets.

One notable exception for us is our Aerospace segment, where conditions continue to improve. We've seen the impact of the economic weakness in Asia and Europe for most of the year, with sales this past quarter down 11% and 19%, respectively. In the third quarter, the reduced demand for commodities has translated into lower demand for mining and oil and gas drilling equipment. This significant change is now impacting our Steel and Mobile segment shipments in the United States. Majority of that reduction is reflected in our Steel business revenues for the combination of lower scrapped surcharges and lower volume has had a particularly strong impact on sales revenue.

We are dealing well with the slow down. Our balance sheet is strong, our strategy is sound. Our earnings in the third quarter our testament to the transformation in our earnings power. We maintain strong margins, while the company is operating at roughly 60% capacity utilization. We are trimming production levels and tightening our expense control to respond to the current environment.

It's no accident that our earnings are far stronger at this point in the cycle than in any time in our history. Our business process of applying our knowledge to customer problems, creating differentiated solutions, expanding an attractive segments and achieving excellence and execution is working in all parts of our business, creating value for the long-term.

The capital investment program remains on schedule. 2 major initiatives, the in-line forge press and the automated tube finishing line in our Steel business, are nearly complete. Both projects should make a positive impact on 2013 performance.

During the quarter, we completed an organizational transition triggered by Sal Miraglia's plans to retire at the end of the year after more than 40 years with Timken; Rich Kyle is assuming responsibility for Steel and retains the Aerospace business; and Chris Coughlin is leading both our Mobile and Process Industries businesses.

Our outlook for the remainder of 2012 is built on our expectation that the current combination of global market uncertainty and domestic inventory adjustment will continue at least through the end of the year. We shared the view of many of our peers that this weakness in demand is a short-term adjustment. We expect to see a rebound in demand in 2013, that coupled with our ongoing efforts to reduce fixed costs and increase operating efficiency should position us to deliver both sales and earnings comparable to our results in 2012. We are currently developing detailed plans for the coming year and look forward to sharing more with you when we review year end results.

As I indicated in the start of my comments, we expect to finish 2012 with structural earnings second only to 2011. These results are built on a foundation of the dramatic changes we forged at the company over the past several years. We have a better portfolio with meaningful synergies between our businesses, a more flexible operating structure and capacity situated to better serve local market needs. We continue to drive our strategy focusing on both organic and inorganic growth. We continue to invest in those opportunities that provide sustainable shareholder value. And we're confident that our focus on execution and strategic growth will serve our shareholders well.

Glenn will now review our financial performance and outlook.

Glenn A. Eisenberg

Thanks, Jim. Sales for the third quarter were $1.1 billion, a decrease of $175 million or 14% from 2011, as lower demand across most of the company's end markets, lower material surcharges and currency were partially offset by pricing in the Drives acquisition. From a geographic perspective, sales were down globally compared to last year, with North America down 13%; Europe, 19%; and Asia, 11%. Gross profit of $299 million was down $44 million from a year ago. The decline was driven by weaker demand, lower surcharges and mix, partially offset by pricing and lower material, manufacturing and logistics cost.

Gross margin of 26.2% for the quarter was up 20 basis points from a year ago.

For the quarter, SG&A was $153 million, down $2 million from last year, primarily reflecting lower variable compensation, partially offset by salary and benefit increases and acquisitions. SG&A was 13.4% of sales, an increase of 170 basis points over last year.

Impairment and restructuring charges in the quarter totaled $12 million, up from $1 million in the same period a year ago. The increase was due to expenses related to previously announced plant closures. EBIT for the quarter came in at $135 million or 11.8% of sales, compared to $190 million or 14.4% of sales last year. Excluding the charges incurred for the St. Thomas plant closure and third quarter expenses associated with CDO receipts received earlier in the year, EBIT was $144 million or 12.6% of sales. Net interest expense of $6.7 million for the quarter was down $1 million from last year, primarily due to lower average debt and financing costs.

The tax rate for the quarter was 36.7%, consistent with our prior estimate and lower than 38.5% last year, due to discrete tax items recorded in the third quarter of 2012, partially offset by the impact of restructuring costs due to the company's net operating loss position in Canada and Brazil. For 2012, we expect to stay at the year-to-date rate of roughly 36.5% and then realize a lower rate of 35% in 2013. As a result, net income for the quarter was $81 million or $0.83 per diluted share, excluding the charge related to the St. Thomas plant closure, EPS was $0.92 per share.

Now I'll review our business segment performance. Mobile Industries sales for the quarter were $397 million, down 10% from a year ago. The decline in sales was driven by lower volume across most of the mobile markets, with the exception of rail. In addition, the benefit of the Drives acquisition was mostly offset by the impact of currency.

The Mobile segment had EBIT of $38 million or 9.5% of sales, down from $70 million or 15.7% of sales last year. The decline in EBIT was driven by lower volume and charges related to previously announced plant closures in Brazil and Canada of $13 million in the quarter. The Mobile segment is operating at around 60% of capacity for the quarter, down from 70% a year ago.

Mobile Industries sales for 2012 are expected to be down 4% to 6%. Lower volume resulting from exited business due to the company's market strategy and the negative impact of currency are expected to be partially offset by the benefit of acquisition and improved rail demand.

Process Industries sales for the third quarter were $311 million, down 5% from a year ago. The decrease was a result of weakening industrial demand outside of North America and the impact of currency, partially offset by favorable pricing and the Drives acquisition.

For the quarter, Process Industries EBIT was $60 million or 19.3% of sales, down from $76 million or 23% of sales a year ago. EBIT declined due to lower volume and mix, partially offset by pricing. Capacity utilization was approximately 70% for the quarter, down from 80% a year ago.

Process Industries sales for the 2012 are expected to be up 6% to 8% for the year, primarily due to acquisitions.

Aerospace and Defense sales for the third quarter were $84 million, up 3% from a year ago. Strength in defense-related markets was partially offset by weaker demands in the civil aerospace and motion control sectors.

EBIT for the quarter was $8 million or 9.2% of sales, up from a loss of $2 million a year ago. The improved profitability was due to better pricing and mix in addition to prior year included a $5 million charge related to warranty reserves. Capacity utilization was approximately 50% for the quarter, up from 45% last year.

For 2012, we anticipate Aerospace and Defense sales to be up 8% to 10%, primarily driven by the defense sector.

In our Steel segment, sales were $377 million for the quarter, down 25% from last year. Lower industrial and oil and gas demand, as well as lower surcharges of approximately $70 million were partially offset by increased pricing. Sales into the mobile and highway markets were relatively flat in the quarter.

EBIT for the quarter was $50 million or 13.2% of sales compared to $66 million or 13.2% of sales last year. The decrease in earnings resulted from lower volume, mix and surcharges, which were partially offset by favorable pricing, and lower material and manufacturing cost. Capacity utilization was approximately 60% for the quarter, down from 80% a year ago.

Steel segment sales for 2012 are expected to be down 11% to 13%. Weakening demand in the industrial and oil and gas sectors and lower surcharges are expected to be partially offset by pricing and mix.

Looking at our balance sheet. We ended the quarter with cash of $486 million and net debt of $3 million, compared to net debt of $47 million at the end of last year. The company ended the quarter with liquidity of $1.4 billion. Operating cash flow for the quarter was $130 million, reflecting the company's strong earnings and working capital management, which were partially offset by discretionary pension and VEBA trust contributions totaling $113 million net of tax. Free cash flow for the quarter was $36 million after capital expenditures of $72 million and dividends of $22 million. Free cash flow, excluding the discretionary pension and VEBA trust contributions, was $150 million in the quarter.

The company also repurchased 1.5 million shares during the quarter for $61 million, bringing total shares repurchased this year to 2.5 million at a cost of $112 million. The company has 7.5 million shares remaining under its board authorized share repurchase program.

Turning to our outlook. We have lowered our full year estimates, given the expectation of lower shipments to customers in many of our global end markets. Sales for 2012 are now projected to be down 3% to 5% versus last year, as lower volume, surcharges and the impact of currency are partially offset by the benefit of pricing and acquisitions. Earnings per diluted share for 2012 are expected to be $4.75 to $4.95. Included in this estimate is the benefit of CDO receipts of approximately $0.70 per share and the cost associated with the St. Thomas plant closure of approximately $0.30 per share.

The company expects cash from operating activities to be $535 million. This includes discretionary pension and VEBA trust contributions totaling $245 million, and the benefit of CDO receipts totaling approximately $70 million, both net of tax. The company's free cash flow estimate of $145 million is higher than our prior outlook, as the impact of lower earnings is expected to be more than offset by improved working capital and lower capital expenditures now estimated to be $300 million, while dividends are unchanged at roughly $90 million. Excluding the discretionary pension and VEBA trust contributions and CDO receipts, free cash flow for the year is now expected to be $320 million.

This ends our formal remarks. And now, we'll take any questions that you have. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And we will take our first question today from Stephen Volkmann from Jefferies.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

I'm wondering if you can comment just a little bit on sort of the cadence of the quarter, was this sort of a big adjustment in September? Is October looking any bit different? I guess, I'm just trying to get a sense of where we are in the whole inventory destock phase.

Salvatore J. Miraglia

Stephen, this is Sal Miraglia. I can give you a view of that or some color from the Steel businesses point of view. We definitely are seeing softer demand as we look into the fourth quarter because of the combination of inventory adjustments that our customers are making in light of that softness, coupled with the fact they overshot a bit earlier on in the year. We have a little bit more of a magnifier within the Steel business because there have been imports that were attracted by the healthy energy market in North America, and that puddle has to evaporate to some extent. So we kind of see the third quarter -- we saw that softness. It'll stay soft, maybe a little softer in the fourth quarter, not only because of the stocking but because of the normal seasonality. But it's not terrible. It's just that softening that we've seen, and we believe that those inventories will adjust throughout the rest of this year and probably a little bit into the first quarter of next year.

Christopher A. Coughlin

Yes, Stephen, this is Chris. Relative to the Mobile Process side, September was a little bit weaker than we would have hoped, so that's a little bit the answer to that question. If you look into the fourth quarter, though, generally speaking on the Process side, our run rates are holding up pretty good relative to the third quarter, and in fact, we're expecting a little bit higher revenue in the fourth quarter relative to the third quarter on the Process side. So on the Mobile side, we also believe the run rates are fine. They're holding together fine. The one caveat in our Mobile business, we are expecting our OE customers to be taking in a significant amount of shutdowns in the holiday period, which we believe is going to have some impact on us in the fourth quarter. We believe the end market demand rates are relatively stable. But everybody is very cautious, everybody's taking inventory out and we are expecting to see more shutdowns in this fourth quarter than we would have seen in the previous fourth quarter a year ago.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

That's great color. And maybe if I could, Sal, a quick follow-up. I guess this should be the time of the year when you're starting to renegotiate sort of base price contracts with your customers, and I'm curious what type of trends you're seeing in that regard.

Salvatore J. Miraglia

Yes, Stephen. At the current time, we'll -- things are fairly positive as far as what we see. We're looking at rollover pricing, small adjustments in different places. But for the most part, it's looking pretty steady.

Christopher A. Coughlin

I would echo those comments on the Bearings and Power Transmission side. There are no major surprises in that area.

Operator

[Operator Instructions] We will take the next question from David Raso with ISI Group.

David Raso - ISI Group Inc., Research Division

My questions on the Steel margins for the full year 2012. Can you give us some insight on how you're looking at the full year margins?

Salvatore J. Miraglia

Yes, David. This is Sal again. You'll recall we had some pretty solid and strong performance in the first 2 quarters, where we came in at roughly about 78%[ph]. We finished the third quarter quite frankly with a relatively weak utilization rate of about 60%, pretty healthy at about 13% EBIT margin. We had said we thought we would be able to maintain low single digits even in weaker environments. I expect we're going to be a bit poorer than that in the fourth quarter just because of the additional seasonality and shutdown conditions, coupled with the affiliation of the softer environment. But frankly, we're pretty happy with how we're operating. We have good, healthy margins in the third quarter, be very, I think, a positive EBIT wise in the fourth quarter, maybe just under the double-digit range but with pretty soft levels, we're actually only expecting to operate at about 50% of capacity. So things that we've done to change our portfolio, to change our labor contract, to variabilize our labor, the investments that we've made are beginning to really show pretty positively and changing essentially what our performance level is looking like at this time.

David Raso - ISI Group Inc., Research Division

Sal, if, say, we use 9% for the fourth quarter, that would be 14.8% for the full year. And especially, if you can delve a little bit more into the resetting the contracts for next year, when we try to think about, at least I know it's early, but how we should think about the margins for next year for Steel? I would assume they're lower than the 14.8% and that's what the 12% comes in at. But just trying to understand those negotiations you're having, have you already locked in some prices that are similar to what you got this year, or is it still negotiating where there's still a lot of wiggle room and what the actual results will be?

Salvatore J. Miraglia

No, actually, Dave, we've got about 1/3 of our contracts that have been completed where we've got, just what I described, lower pricing. We've got 2/3, we're about 85%, 90% contract basis, only 10%, 15% that's spot basis that's underway. A couple of things that we did last year were 2-year contracts which, in this environment, is actually positive for us, and a few that will run their way through the middle of next year, particularly the new domestic auto companies that run on a slightly different schedule. But all in all, we're looking at pretty flat pricing from that point of view. And so what you've seen this year, I think, is something you can expect to see next year, more dependent I think on just how strong demand will be more than anything else. I was told, by the way, I may have misspoken. I meant low double-digit margins. I may have said single-digit, that was just my mouth getting in the way.

David Raso - ISI Group Inc., Research Division

Okay. So if we say fourth quarter is something like 11, it's a bit north of 15 for the year? Sal, it's an interesting point, what percent of your contracts don't have to be renewed to start 2013? And which ones are -- or how much is the 2-year set-up of the ones that don't have to be repriced until some [ph]...

Salvatore J. Miraglia

We'll probably -- I'm taking a good stab at this, but then I think it's notionally correct. We got about 85% of our contracts that will be renewed before the year is over on a contract basis. It might be a little different on a tonnage coverage basis because some of them are Automotive-based, which have a pretty solid base stream on tonnage. But from a contractual base, 80%, 85% will finish up before the year is over.

David Raso - ISI Group Inc., Research Division

So basically, 85-ish percent of the 85% that you sell on contract still has to be renegotiated. But 1/3 of those negotiations have taken place and the pricing is similar to the prior contract?

Salvatore J. Miraglia

Yes. Yes, rollover pricing, that's correct.

David Raso - ISI Group Inc., Research Division

And that said, and then just the final question I had about, I know it's a bit early, but thinking about the margins, given how high they were in the first half of the year, I assume it's -- is it safe to say that the 15% for this year, we should think lower? But I'm trying to gauge that versus, say, the fourth quarter comes in at 11%. This quarter, we just printed was 13.2%. Just trying to get some feel how we should think about it for full year '13, just bigger than a breadbasket-type comment.

Glenn A. Eisenberg

David, this is Glenn. [indiscernible] you've now taken Steels not margins, you said 9% and then you took it to 11% in the fourth quarter. And I think what Sal was saying was really more of an issue for the full year where he believes he's coming in. We do expect the fourth quarter for Steel to see still some volume pressures and surcharge pressures, which is going to impact the top line and bring it down sequentially from the third to fourth. And while we continue to expect to leverage well, we also have maintenance shutdowns planned for the fourth quarter as well. So we're looking at, call it, more of a middle single-digit kind of margin for the fourth quarter, which still gives them very healthy margins for the full year in the double-digit plus category that Sal was referencing. And then you just look at it assuming kind of a comparable market because we're getting, let's say, comparable pricing. As Jim said, the expectation on the macro view is that we're expected to see a second half recovery next year. So our view is that sequentially, you would see kind of that trough in the fourth quarter picking up gradually, but picking up then for second, third and fourth. And then depending upon how strong you feel the recovery is, where we'll come out. But just want to make sure you're not misinterpreting...

David Raso - ISI Group Inc., Research Division

I just keep hearing different things. I just want to make sure we all understand the call. You're saying fourth quarter mid-single-ish for Steel, say 5%, that gets you 14% for the full year. I just want to make sure that's not a moving number off the call, and I get questions on "What did they just say?" Everything mid-single for the fourth?

Glenn A. Eisenberg

Right. We would say that's correct.

David Raso - ISI Group Inc., Research Division

Okay, okay. I appreciate it.

Operator

Our next question will come from Samuel Eisner with William Blair Investments.

Samuel H. Eisner - William Blair & Company L.L.C., Research Division

Just had a couple of questions in line with what Dave was asking on Steel, I mean, what is your break-even level now on Steel in terms of utilization rates? Historically, I thought it was closer to 55%. Has that now come down pretty meaningfully?

Salvatore J. Miraglia

Yes, we believe we're down below that, Sam. We're going to be positive for the fourth quarter, and we're going to be operating at just under 50% of our melt utilization. So as I mentioned, when I was speaking to David, we're actually pretty happy about the performance level of the business, given the demand that we're seeing. So yes, we've made some substantial progress and pushing breakeven down pretty low.

Samuel H. Eisner - William Blair & Company L.L.C., Research Division

And Sal, is that from the labor negotiations or is that -- I mean, I know that with the new investment coming online, that's supposed to also decrease your kind of your cost going forward. So I'm just curious what had driven a lot of that decline.

Salvatore J. Miraglia

I think it's a basket of things quite frankly, Sam. We definitely changed the portfolio of our products moving towards more value-added products, both in the products themselves and in how far forward in value-add, we've taken various different product lines and streams. We've backward integrated into raw materials and recycling, so that's given us some stability of raw material. We definitely, with our last contract, when we committed to make the major investments that we're making, got a more variable labor condition than what we had before, including incentives, which would disappear with lower volumes within our labor contract areas. So that basket of things has improved our overall performance pretty well. And in addition to other investments that we've made to push not only labor costs down but yields up that improve our overall performance level.

Samuel H. Eisner - William Blair & Company L.L.C., Research Division

Great. That's excellent color. And then Chris, I guess, switching over to Process, can you talk a little bit about how the mix on the distributors played out in the quarter? I know that, I think historically, that's been a little bit higher at least for the first 9 months of the year. Kind of what was the percentage of industrial distributors this quarter?

Christopher A. Coughlin

Yes, it was down a little bit. As part of the bridge on the margin going from the 4-point bridge on the margins year-on-year. It's still pretty good. It's in the mid-60s range. The mix within distribution was actually a little bit negative. I mean, in other words, what I mean by that is the mix inside distribution is not all uniform. Although in total, it's obviously very attractive. So yes, there was clearly some pressure on that during the third quarter, primarily driven by Asia and overseas markets.

Samuel H. Eisner - William Blair & Company L.L.C., Research Division

Great. And then just to dive into Asia. I guess, the headline, it was down 11%, but how is that progressed at least through the 3 months of the quarter? And kind of what is your expectation looking out over the next 3 months and maybe even into 2013?

Christopher A. Coughlin

Yes. So, I mean, let me bridge this for you. Asia was pretty much in-line with what we had communicated in the second quarter. I mean, we were down the 10% year-on-year. And it was reasonably close to the second quarter if you account for the seasonality. But once again, it remain relatively stable. On the positive side, a number of our markets, such as rail, off-highway and the heavy industries, continue to achieve revenue that's flat to slightly higher year-on-year growth. Considering the environment, we're pretty happy with those results. However, we do continue to see significant weakness in the wind energy market, particularly China in that case, and within the Asian industrial distribution markets. With regards to distribution, it's clear that some of our Asian distribution network is now destocking inventory, but that's a little bit part of the story of the revenue decline. Moving forward, we remain cautious on Asia. But our general guidance is basically consistent with last quarter. Our demands stabilized, it's stabilized at lower levels, unfortunately, but we expect to see things remain relatively stable with the recent quarter. Unfortunately, as of now, we do not see a significant turn in that. But likewise, we had clearly stabilized in the demand side of it over the last couple quarters.

Operator

[Operator Instructions] And we will now go to Eli Lustgarten with Longbow Securities.

Eli S. Lustgarten - Longbow Research LLC

You gave us reasonably decent guidance, about 5% margins in Steel. Can you talk a little bit [indiscernible]

[Technical Difficulty]

Eli S. Lustgarten - Longbow Research LLC

We'll try again. Can we talk a little bit about margins in the Industrial side and Bearings and Power Transmission side, particularly with the -- are we looking at the fourth quarter margins being softer in both Bearing and Process, and up in Aerospace as we've seen the trends, that sort of trend, what would you be expecting for the fourth quarter?

Salvatore J. Miraglia

All right. Well, let me break it down into the segments for you, Eli. Let's start with Mobile. If you look at the margin decrease, third quarter year-on-year, 50% of that was the restructuring relative to the previously announced closures of St. Thomas in the Brazilian facilities. Plus, if you factor that in, we were in the 12%-plus range on a structural margin basis. The balance of the year change. It was also driven mostly by manufacturing and by S&A cost pressures. So beyond the restructuring, you're just basically seeing the impact of volume, if you look third quarter year-on-year. Moving forward, we're obviously focused on the cost control. We've got a lot of actions going on around discretionary spending, managing workforce, things of that nature, to control the cost given the pressure on the revenue side. That said, we expect to have structural EBIT margins remain in the double digits for the balance of the year. On the Process side, the margins for the quarter were still very, very good at 19%. Several comments for those of you who were not on the call, third quarter call last year, we clearly stated that the 23%, we hit during that quarter, was not really sustainable in our viewpoint. We had a very excellent distribution mix and then -- and also then the mix inside distribution was very good for my previous other comments. That said, the bridge and the year-on-year margins is clearly centered on 2 things. It's centered on the volume and the cost pressure around that, and it's also centered on the mix change that I have discussed. Once again, in response to that we're obviously taken steps to reduce our variable cost, work on our work force and we've gotten very aggressive on the spending and, once again, we remain -- we expect to see margins remaining in the 20% range in the fourth quarter.

Richard G. Kyle

Eli, this Rich. You asked about Aerospace as well. In Jim's comments, you mentioned that Aerospace is one of our markets that's improving. On the revenue side, we expect Aerospace to be up both sequentially and year-over-year on the top line. On the bottom line, we expect it to come in around the 10% margin level that we've been averaging for the year, still working to long-term get that up several hundred more basis points. But don't expect a dramatic change in the fourth quarter on the margin side.

Eli S. Lustgarten - Longbow Research LLC

Just looking out into next year, do you think the inventory liquidation basically come to an end by the end of this year, and we can have a more normal volume or does this go on as the Steel moves into the first quarter?

Salvatore J. Miraglia

Eli, this is Sal. I believe we'll see a hangover of inventory liquidation in through the first quarter of next year. But continuously lessening as we go through that, there are some customers today who have more or less reached the end of it, others who have not, so there's a spectrum that I believe that the adjustments will continue into next year, quite frankly.

Eli S. Lustgarten - Longbow Research LLC

I appreciate that. Can we talk a little bit about the Mobile and Process side for that?

Salvatore J. Miraglia

Well, as I stated, we have begun to see a little bit of destocking in the Asia distribution channels. In fact, also in North America, if you looked at the third quarter, inventory within the channels actually decreased somewhat. I would say, though, for the Bearings and Power Transmission side of the business, this is not a major issue for us. It's not a big theme, it's not a big problem, so we obviously monitor it closely. But there has not been a significant buildup of inventory in the channels.

Eli S. Lustgarten - Longbow Research LLC

And so this is strictly related to volume and OEM productions, if we look at [indiscernible]

Salvatore J. Miraglia

Well, yes, I think, as you know, Eli, distribution works on replenishment models. And when demand drops, obviously, the replenishment models will begin to tweak back the inventories, so there's clearly some of that kind of impact. So clearly, the inventories are getting tweaked a little bit but, once again, it's not a major theme or a major issue for us within the Process Industries business at this point in time.

Operator

And we'll now go to Holden Lewis with BB&T Capital Markets.

Holden Lewis - BB&T Capital Markets, Research Division

A couple of things, first, you sort of gave a teaser in your prepared comments that you kind of thought that '13 might look a lot like 2012. I guess, I'm just trying to get some clarity as to why you think that is in light of -- typically Q4 is stronger than Q3, I believe, the fact that Q4 was so much weaker than Q3 makes for a pretty dreadful jumping off point. So to be arguing that you're looking at kind of flat '13 versus '12, I'm just sort of curious, does that assume that you get improvement in business conditions, or is there a certain restructuring and things like that, that are going to drive a certain amount of cost that you can quantify for us? How should I be thinking about that?

Glenn A. Eisenberg

Holden, this is Glenn. Let me take maybe a first cut at it, because I think our concerns, to some extent, was obviously at fourth quarter that is one seasonally our lowest. We did expect that to be down. But without normally talking about our next year, we would do in the normal course at the end of January when we report our fourth quarter results, and then try to give you a detailed view of all of our markets outlook and earnings. Our concern, given just the uncertainty in the marketplace, was obviously, the fourth quarter implication or implied earnings, we wanted at least put some color to it. When we preface it, it's as much just more driven off of what we're seeing again from the macro numbers, our econometric firms that we use, it says 2013, at least at this stage of the game, should mirror what we saw in 2012, if you will. Where in '12, we had a very strong first half of the year. Clearly, a weak second half. We expected to finish weak. But then in 2013, the expectation is we've kind of leveled off. The first half of next year will be weak, but call it comparable to what we saw on the second half of '12, and then to pickup in the second half of the year. So we wanted to say based upon the kind of a comparable economic scenario, albeit, obviously, the 2 halves are different, we would expect to have comparable performance, or said differently, we feel we've operated very well this year. We feel we leveraged very well in the markets that we have. In fact, that were operating even currently at 60% capacity, and the strong results that we're getting within the business, it was more of a message to say that, our expectations wouldn't change if you laid that economic scenario out there. We're not, right now. We're saying this is kind from a macro view, this is what we're hearing as well from peer companies that are reporting, but our, call it -- when we come out at the end of January we'll put, obviously, a lot more need to it, what our expectation by the segments are for the end market demand, as well as the overall profitability for the company. But we didn't want you to walk away with just hanging there with an implied fourth quarter without at least giving you some color for next year.

James W. Griffith

Holden, this is Jim. I just add to what Glenn said. Just to reinforce the other comment that was in my prepared remarks, this is also based on our belief that what's happening in the fourth quarter is not a structural economy issue, it is an adjustment in the economy. And therefore is short-term. And that's what then builds that mirror 2013 to 2012 view of the world [ph].

Holden Lewis - BB&T Capital Markets, Research Division

Got you. With regards to cost, you said you're working on discretionary, you're working on maybe sort of adjusting labor overtime, things like that. I mean, are you able to sort of put maybe a range of numbers out there, or what kind of cost you might be able to sort of flex out of the model for the time being?

James W. Griffith

I don't think that's an appropriate thing for us to give at this point. Again, we're focusing on sustaining our margins. And that means, when volume goes down, then fixed cost have to come out of the business. And I think the success that we had in the third quarter of sustaining margins is an indicator of the capability of this organization to do that.

Holden Lewis - BB&T Capital Markets, Research Division

Okay. And then the next question I kind of have is going back to Steel. I mean, obviously, you're seeing the tonnage and all that sort of come down a bit. You do, as well as others in the industry, are planning on adding capacity to the industry. Is there any concern now that lead times have to come down, demand has come down, is there any concerns at least the pricing and things of that nature that, now all this new capacity is looking a little frightening from utilization and margin standpoint, versus where it was maybe 6 months ago?

Salvatore J. Miraglia

Well, Holden, I suppose you'd all depends on the kind of time frame you want to think in terms of -- certainly, everybody who is dealing with spot business will see a softening as there's excess availability at the current time, not only from local production but also from imports. Again, we're not in that particular kind of a business model. We're in a model that looks at annual contracts. Over the long-term, I think everyone is very bullish on what the demand levels would be, and that this local capacity to produce and serve will be put to very good use. There's a strong projection that the Mobile Automotive sector will grow. It's been the most healthy of the markets this year. So far, that has not been very negatively affected even by the climatic conditions that we've seen and its expected to get stronger yet. I have every expectation and others who are looking at it, that the energy markets will see health come back again as at time goes on. So over the long-term, this is not an unhealthy environment that we've got right now. We're just experiencing what I believe is an instantaneous slowdown couple -- that was cost by a couple of different things, not the least of which is slowing Asia, Europe a bit in recession right now. Our own climate with the elections and the uncertainty about taxes and fiscal clip [ph] and regulatory conditions, et cetera, that has everyone just acting very cautiously, coupled with having perhaps overreacted and restoring inventories prior to now, and I think we will pass. So I'm not at all personally negatively looking upon the nature of the investments being made in the industry for the long-term. Short-term, there will be some effects, yes.

Richard G. Kyle

Holden, this is Rich. I would add that, in our case, all of our investments also yield productivity and yield savings. And obviously, the return on them is much higher if they're running full and if they're running 60% utilization. But they will certainly help us flex our costs. And those -- some of those assets are coming online now and in the second quarter of next year, and that gives us confidence in helping us sustain our margins in a softer market, if that occurs.

Holden Lewis - BB&T Capital Markets, Research Division

Well, that's what I was going to ask I mean, obviously, these ads due do a lot for you from a return standpoint. But you feel that at 50% utilization, you still get benefits from that?

Salvatore J. Miraglia

Yes, absolutely. Absolutely. For example, the intermediate finishing line, takes a great deal of labor out of our finishing operations. So regardless of what level of utilization we would see, we would be doing it with far less intensity than we would have seen before. The other investments being in line towards press improves yield, and that just absolutely reduces the loss intensity of any business we'd have. And then, the testing[ph] operations will not be commissioned until 2014, but that takes -- that puts an incredible kicker in the yields out of our melt operations, which would be very, very positively affecting, regardless of whether the demand is softer or strong.

Holden Lewis - BB&T Capital Markets, Research Division

Historically, in Steel, when things have gotten tough, people have raced just to fill volumes, so you tend to take lower margin-type jobs. Are we seeing that at this point, or we're kind of holding bay on that until we see how brief or sustainable the demand lull is? And when would you expect that maybe those mixed issues might show up if things stay the way they are today?

Salvatore J. Miraglia

Well, Holden, I'm not going to comment about the industry. Let me just come back to the fact that I mentioned a bit earlier when we addressed this question. At current time, we are having success with rollover pricing, meaning not much deterioration at all. We expect to continue operating in that realm. And so far, it's been fine.

Holden Lewis - BB&T Capital Markets, Research Division

Okay, excellent.

Operator

[Operator Instructions] And gentlemen, it appears we have no other questions, so I'd like to turn it back to Jim Griffith for any additional or closing remarks. Please go ahead, sir.

James W. Griffith

Thank you. I want to emphasize in closing that Timken is, today, a much stronger company than we were just a few years ago. And the results from our third quarter demonstrate that.

I think to respond a little bit to the last line of questioning, the fact that this company is increasingly selling its products into differentiated applications, in differentiated markets, changes the earnings capability of the company. The third quarter proved it, and we look forward to reviewing with you our full year results after the end of the year. Thank you.

Operator

Thank you very much. And that does conclude our confidence for today. I'd like to thank everyone for your participation. And you may now disconnect.

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