Timken Co (TKR) 2012 Q2 法說會逐字稿

Good morning, my name is Augusta, and I will be your conference operator today. As a reminder, this call is being recorded. At this time, I would like to welcome everyone to the Timken second-quarter earnings release conference call. All lines have been place on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session.

(Operator Instructions).

Thank you, Mr. Steve Tschiegg, you may begin your conference.

Thank you, and welcome to our second-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, 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; Rich Kyle, President of our Mobile and Aerospace and Defense Businesses; Chris Coughlin, President of Process Industries, and Sal Miraglia, President of Steel. We have remarks this morning from Jim and Glenn, and then all of us will be available for Q&A. At that time, I would ask that you please limit your questions to one question and one follow-up at a time, to allow an opportunity for everyone to participate.

Before we begin, I would 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 in 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 it's GAAP equivalent are included as part of the press release. This call is copyrighted by the Timken Company. Any use, recording or transmission of any portion without the express written consent of the Company is prohibited. With that, I will turn the call over to Jim.

Thanks, Steve, and good morning, everyone. As you saw in our release, Timken reported a very solid second quarter. We posted revenues of $1.3 billion, in line with the second quarter of last year, as the impact of our acquisitions offset weakness in some market segments. Our profitability remains strong, continuing to demonstrate the improved earnings power of the new Timken Company. Having said that, many companies are reporting a slowing of the global economy, and in the second quarter we began to feel the impact.

North America remains our strongest market. We continue to see growing demand in the railroad, energy, and mining sectors, and in the aftermarket. But we saw a tempering of that growth toward the end of the second quarter, and anticipate further slowing in the last half of the year. Our customers are managing the situation very well, taking conservative positions with their inventory levels. This is translating into a general slowness for Timken, rather than a dramatic reduction.

In Asia, demand has slowed significantly for us, with year-over-year sales down 14% in the second quarter. The impact on Timken is greater than for the economy as a whole, given our exposure to infrastructure markets, and especially wind. We now anticipate the second half will not rebound, as we had previously expected. Turning to Europe, our revenues dropped by 8% in the second quarter, a distinct change from the first quarter of the year. This is another market where we have now scaled back our expectations for recovery in the second half of the year.

As a direct result of lower market expectations, we reduced our estimate of earnings for the balance of the year. I would like to point out that our current outlook, which we shared in today's earnings release, will result in 2012 annual earnings beating a record for the Company.

We continue to take actions to grow the Company, and to strengthen it's performance. From a growth perspective, our recent strategic acquisitions of Philadelphia Gear and Drives added 5% to the top line during the second quarter, helping counter lower demand in other areas.

From a performance viewpoint, we announced plans to close our Canadian bearing plant in St. Thomas, Ontario, and consolidate those operations into existing US facilities. St. Thomas has been operating at low levels of capacity utilization, and consolidating its production in other plants improves our overall competitiveness.

Our investment program in the steel business is proceeding on schedule. The intermediate finishing line designed to automate our steel tubing production starts operating at the end of 2012. This will be followed by our new forge press, which comes online early in 2013, a ladle refiner in late 2013, and the Faircrest caster in early 2014. When complete, the steel business will have 20% better labor productivity,10% better energy efficiency, and 15% more capacity in our most attractive segments.

Looking ahead, prudence is our mainstay. As we see the economy changing, we are operationally prepared, confident in our ability to stay our strategic course, and weather the winds of change with a buoyancy that reflects the new and transformed Timken company.

This is because we have diversified our Company, expanding in new geographies, products, and services where we create value for our customers. For example, we are now making and repairing gear boxes, as well as providing a line of premium roller chain and other mechanical power transmission solutions.

We are leaner, and our cost structure is more variable. Our ability to tightly control our supply chain and manage costs is better aligned to respond to market variability. We combined all this with a fundamental change in our ability to execute. We are relentless in this area, which will serve us well in facing the current global market. Glenn will now review our financial performance and outlook.

Thanks, Jim. Sales for the second quarter were $1.3 billion, an increase of $14 million or 1% over 2011, as favorable pricing and mix were mostly offset by lower demand. The benefit of acquisitions which accounted for 5% growth, was offset by the negative impact of currency and lower material surcharges. From a geographic perspective, sales in North America were up 7% versus the prior year, primarily driven by acquisitions, while Asia was down 8%, and Europe was down 14%.

Gross profit of $377 million was up $27 million from a year ago. The improvement was driven by pricing, mix, acquisitions, and lower material costs, which were partially offset by weaker demand, lower surcharges and currency. Gross margin of 28.1% for the quarter, was up 170 basis points over a year ago.

For the quarter SG&A was $163 million, up $9 million from last year, primarily reflecting acquisitions. SG&A was 12.1% of sales, an increase of 50 basis points over last year. Impairment and restructuring charges in the quarter totaled $17 million, up from $6 million in the same period a year ago. The increase was due to the announced closure of a bearing production plant in St. Thomas, Ontario, Canada.

Other income for the quarter totaled $106 million, up from $1 million in the same period a year ago, primarily due to the $110 million received from the Continued Dumping and Subsidy Offset Act or CDO. EBIT for the quarter came in at $303 million or 22.6% of sales, compared to $192 million or 14.4% of sales last year. Excluding the benefit of CDO receipts and the charges incurred for the bearing plant closure, EBIT was $212 million or 15.7% of sales.

Net interest expense of $7.4 million for the quarter was down slightly from last year, primarily due to lower financing costs. The tax rate for the quarter was 38%, compared to 33.5% last year, and our prior estimate of 34%. Charges related to the bearing plant closure increased the rate by roughly 2 percentage points, due to the Company's net operating loss position in Canada. The remaining increase was primarily due to a lower percentage of the Company's earnings coming from lower tax rate foreign jurisdictions.

For 2012, we expect to stay at the year-to-date rate of roughly 36.5%, and then return to a 34% tax rate in 2013. As a result, net income for the quarter was $184 million or $1.86 per diluted share. This includes the benefit of CDO receipts of $0.70 per share, and the charge related to the St. Thomas plant closure of $0.18 per share.

Now I will review our business segment performance. Mobile industry sales for the quarter were $448 million, down 4% from a year ago. The benefit of acquisitions and improved rail demand, was more than offset by currency and lower volume in other mobile markets, including the impact of exited business.

The mobile segment had EBIT of $49 million or 10.9% of sales, compared to $71 million or 15.3% of sales last year. The decline in EBIT was primarily due to a $17 million charge related to the St. Thomas plant closure. Weaker demand and currency also negatively impacted results, but were partially offset by acquisitions. Excluding the impact of the St. Thomas charge, margins for the quarter were 14.8%.

Mobile Industries sales for 2012 are expected to be flat to down 5%. The benefit of the Drive's acquisition and demand in off highway and rail sectors is expected to be offset by lower demand in light vehicle and heavy truck sectors, as well as the negative impact of currency.

Process Industries sales for the second quarter were $338 million, up 10% from a year ago driven by acquisitions and pricing. Partially offsetting this was the negative impact of currency and lower volume, driven by reduced demand outside North America, including wind energy.

For the quarter, Process Industries EBIT was $71 million or 21.1% of sales, up from $69 million or 22.3% of sales last year. EBIT benefited from the higher pricing and acquisitions, partially offset by lower volume and currency. Process Industries sales for 2012 are expected to be up 7% to 12% for the year, due to acquisitions and industrial distribution demand.

Aerospace and Defense sales for the second quarter were $87 million, up 4% from a year ago. Higher demand, led by defense and motion control sectors contributed to most of the increase. EBIT for the quarter was $8 million or 9.1% of sales, up from $3 million or 3% of sales a year ago. The improved profitability was due to higher volume, while the prior year included a $3 million inventory write-down. For 2012, we anticipate Aerospace and Defense sales to be up 10% to 15%, primarily driven by stronger defense and civil aerospace markets.

Steel sales of $500 million for the quarter were down slightly from last year. Increased pricing and favorable mix were more than offset by lower industrial and mobile and highway demand, as well as surcharges, which were down approximately $30 million, due to lower raw material costs.

EBIT for the quarter was $89 million or 17.8% of sales, compared to $71 million or 14.1% of sales last year. The increase resulted from improved pricing and lower material costs, which were partially offset by lower volume and surcharges. Steel segment sales for 2012 are expected to be flat to down 5%. Weakening end market demand 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 $510 million and net cash of $16 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, with no significant debt maturities until 2014. Operating cash flow for the quarter was $275 million, reflecting the Company's strong earnings and lower working capital requirements. During the quarter, the Company received CDO disbursements of $110 million, which were used to fund discretionary pension contributions.

Free cash flow for the quarter was $183 million, after capital expenditures of $69 million and dividends of $22 million. The Company also repurchased 500,000 of it's shares in the quarter for $26 million, bringing shares repurchased so far this year to 1 million at a cost of $52 million. The Company now has 9 million shares remaining under it's Board-authorized share repurchase program, and expects to continue to be in the market, repurchasing additional shares this year.

Turning to our outlook, we have lowered our full-year estimates, given the expectation of further global weakening in many of our end markets for the remainder of 2012. Sales for 2012 are now projected to be up slightly versus last year, as the benefit of pricing and acquisitions are mostly offset by lower volume, surcharges, and the impact of currency.

Earnings per diluted share for 2012 are expected to be $5.00 to $5.30. Included in this estimate is the benefit of CDO receipts of approximately $0.70 per share, and the costs associated with the St. Thomas plant closure of approximately $0.30 per share. The Company expects cash from operating activities to be $545 million. This includes discretionary pension and VEBA trust contributions totaling $220 million, and the benefit of CDO receipts totaling approximately $70 million, both net of tax.

The Company's free cash flow estimate of $140 million remains unchanged from our prior outlook, as the impact of lower earnings is expected to be offset by improved working capital and lower capital expenditures, which are now expected to be $315 million, while dividends are unchanged at roughly $90 million. Excluding discretionary pension and VEBA trust contributions and CDO receipts, free cash flow for the year is expected to remain at $290 million. This ends our formal remarks, and now we will be happy to answer any questions. Operator?

Thank you.

(Operator Instructions)

Our first question will come from Holden Lewis of BB&T.

Great, thank you. Good morning.

Wanted to ask you about something in the operating profit compilation. To get to your operating profit number of $215 million, which is the $1.34, if I add up your four segments, it gives me a segment income of about $217 million. If I strip out your corporate of $23 million and your eliminations, I get sort of a residual of about a $22 million gain.

There's usually a residual, but not usually one any near that size. It looks like it kind of boosted the operating profit a little bit more than it usually does. Any insight into as what that other residual profit is?

Yes, the only thing I'd have to go and look through, make sure I picked up all your pieces. I believe it's the CDO benefits that we had. When you look at the segmented results, which you are talking about, it would include the charges associated with St. Thomas, primarily in the Mobile group. When you look at the other income, which is where the other discrete item is, which is the CDO of $110 million, that would show up in other income, and would not be in the unallocated corporate costs that would be on that sheet. So my guess is the difference that we are talking about, is that amount.

(Multiple Speakers). To get to your $1.34 which could exclude the CDOSA, Ï mean that's the $215 million in operating income, right?

That's correct.

Okay. So if I take the $215 million, and then I subtract out the -- basically, if you add up your four segments, it gives you about $217 million. And you take out the corporate of $23 million, and the eliminations which is nothing, I mean -- that's -- to get to the 215, that takes that out that CDOSA? And $20 million would be too small a number anyway, right?

Again, we can take this off line. The only thing I that I can think about, again, the difference is, if you were to -- call it the $0.52, which is the benefit of the CDO which is $0.70, and the St. Thomas charge of $0.18, gets you that $0.52, which to your point nets to that $1.34. Again, it could be where we're off is on the tax rate or other input, my guess is it's the St. Thomas number, given that the magnitude which we are talking about is in that range.

Okay. So we can address it off line.

Could you also give a little bit of insight as to -- you don't give this to us until you get the K -- what was sort of the split between, the corporate wide purposes, the organic volume growth, the price mix, sort of the acquisition contribution, the ForEx drag?

You're saying for period for the second quarter?

Yes, do you happen to have those breakouts?

Yes, effectively, when we say we're up 1%. We talked about the benefit of acquisitions we said was around 5%, and that was offset by currency and surcharges. Currency negatively impacted us at around 3%, and surcharges around 2%. So those kind of, if you will, washed out each other. And then we would say the benefit of price and mix, which would have been up around 5%, was offset by volume down around 4%.

Great. All right. Thank you.

(Operator Instructions).

We will go next to David Raso of ISI Group.

Hi, two questions, one bigger picture, and one just on mobile. It seems like the outlook, the revenue is the key thing, that people are surprised it's down so much year-over-year, from the first half growth. And a lot of it seems to be related a bit, really to the international businesses, being down even more than you would have thought.

But a lot of the international weakness is not necessarily that new, especially the Asian piece. So I'm trying to understand, how much of a recovery did you have baked into the second half for Asia and Europe? And I guess, what happened during the quarter where it became -- not to be rude about it -- but kind of novel that the international wasn't strong.

It seems that the biggest delta here, is the area that was may be a little more understood that was going to be weak. North America is more the weakening aspect of most outlooks in the last say, month or two. So just, going from the comments of the last few of months at different conferences and so forth, to this release. I'm just trying to understand what changed in the quarter.

And then secondarily, I want to focus on the mobile sales guidance in particular, which is particularly interesting.

Let me take at least a first cut of it, David, and ask the others to provide a little bit more color. But when we when we look at what's changed from the second half outlook versus the first half, we're looking at call it -- around using rounded numbers, and a matter of fact, even use relative to the expectations that we had set three months ago.

Our volume or I should say, sales plus or minus are now looking to be down around $400 million-ish. The good news is, we continue to leverage that well. So when we look at the earnings outlook change, we are leveraging those sales at around 25% on the downturn. Having said that, around half of it is due to volume. The other half of it is due to lower surcharges, so we're expecting to see on average, lower material cost environment than the first half as well as from a currency standpoint.

So if you backed out surcharges, you backed out currency, really that explains -- we only have half of the decline, first half, second half. And from the standpoint of international, we clearly are looking, and had in Jim's comments spoken earlier that we did expect a rebound, in Asia and China in-particular. We saw in the first two quarters of this year, we did see year-over-year declines in Asia, but we expected that to pick up. Right now, we are not seeing it, so our expectation is that it won't rebound. But Chris, maybe you want to provide some color on Asia?

Yes, David, well, a couple things, one and I will speak for the total Corporation on these comments. As you know, we have been cautioning on Asia for nine months now. However, we did expect to see the strengthening as the year progressed. That obviously has not happened.

In the second quarter, our total Asia sales were down 9%. We have got significant weakness in wind energy, particularly in China. The heavy industries are also very weak, which would be for us steel, cement, anything tied into the commodity and the construction kind of stuff. That's obviously not news to any of you. You are seeing similar results from other companies.

So that was offset a little bit by some strength in rail. But generally speaking, if you look at Asia as a region, we have more weakness than we would have expected.

Now moving forward on that, we do believe we are stabilizing at these levels, so we do not expect to see a significant drop from where we're at. That said, we see no evidence of any significant recovery in our market space, in either India or China, and for that matter they drive, obviously most of the region. So there's the color on it.

And Glenn, just so I heard you properly, the revenues came down roughly 400 - a $1 million from before. You are saying 200 surcharge, the 200 as volume -- I'm sorry, I think you then split it between kind of true volume and currency?

Yes.

Or did I miss that?

Yes. No, we said a little more than half of that would have been volume. So just giving you a magnitude.

Sure.

So just from that the end market demand, call it from our standpoint, again midpoint to midpoint, of our guidance change is roughly around $250 million-ish of that decline. So the other, call it 150 is a combination of surcharges which is the bulk of it, and the impact of currency.

Okay. The margins are holding up well. Obviously, the surcharge being half of it explains, you should lose less on the surcharge so to speak. So that kind of defends why the margins held up well this quarter, and could continue, because again, half the revenue loss is surcharge.

But trying to think of, what does this mean for the rest of the year going to 2013. The way that you are looking at your the end markets, the level of accuracy of the second half guidance, are you also baking in any inventory reduction in this process through some below retail? Or is in kind of more in line? Or, I mean, people are just trying to figure out is, is there some conservatism in this revenue guidance, because it looks a little more harsh than say, other companies, first half, second half?

Dave, this is Jim. And again, let me respond at the corporate level.

The -- your question upon inventory reduction for us, the place that we're seeing the biggest change from that perspective is from the steel business, and it's particularly in the energy market. Sal talked last time about the fact that in 2011 when markets were tight there was -- our customers built inventory, and brought some inventory in from overseas to supplement. With gas prices mitigating, or oil prices mitigating in the second quarter, and natural gas prices are already low, we are seeing a different level of conservatism in that patch, in oil patch particular around inventory. And that's a big piece of the second half revenue decline.

Now having said that, in terms of turning it around from a potential up side, we are not seeing a significant reduction in actual drilling activity. And that's where we look at it, and we say our customers are being prudent in this sense, in taking inventory down, as opposed to we see a dramatic reduction in the end market.

But how about your own inventory, from now to year-end, the way you're looking at retail, end demand versus what you are posting as your sales guidance? What probably happens to your inventory sequentially, between now and year-end?

David, this is Chris. We will take some of our inventory down, is the fact of the matter. And that is -- will be relatively in line with the revenue and the growth that we have.

I would not term that to be a major issue for us. It's just the proper management, relative to the supply chains, and relative to the volume levels we are running at. But that said, we are not looking at a huge inventory drop for the balance of the year, although it will be down.

Yes, back to my comments on execution, a very big difference in the Timken Company in 2012, is we are sitting with our inventories across the enterprise in very good shape. And so, it's just managing it prudently, to keep them in proportion to our sales revenue.

So to my last question then on mobile, the back half guidance, you are basically implying sales to be down 6.5% or so for the second half of the year. I'm curious the -- walking away from losing, however you want to call it, auto sales, the $45 million in the second quarter, light and heavy truck. Does that continue in the next two quarters? Are you basically saying, down 6.5% with absorbing a walk away from $45 million per quarter, or in a way, was this more captured more in the first half? I am just trying to understand how you think about, it in your reporting.

Well, the guidance was 150 for the full year. Don't recall exactly what the first quarter number was, but it's slightly heavier weighted to the first half with the $45 million, and now maybe it was $40 -- $40ish million in the first quarter. But still a significant headwind to overcome to get to that, and that in the second quarter, it was roughly 10% of revenue.

And then we also, in the second quarter, Glenn hit on currency. We had about a 5% year-over-year head wind on currency, which we expect to continue for the majority of the year as well. So you put those two together, and it's certainly more than the 6%. So we are netting out growth from a volume perspective in the markets in general.

Now that's helpful. So if -- just for comps, if you add back the auto lost business, you are basically saying, up 3%, 4% mobile in the back half. You will have one more quarter of Drive, so it's more like saying flat third quarter, call fourth quarter up 4%, and the currency drag is going to be probably bigger in the third quarter than fourth quarter. But end of the day, you are talking low single digit growth, flattish growth, on a kind of a core basis.

Yes.

When I go through the individual markets -- basically I am trying to get a feel how conservative you feel that number is, or is it spot on? Because when you look at the ag, construction, mining -- and we can have our own thoughts about is 2013 down or not, I mean that is not the discussion here in terms of the next quarter or two. We are not exactly hearing notable production cuts there. You are hearing in truck, obviously, rail is still doing pretty well. So I guess obviously, what it comes back down to is mobile is 60% or OUS.

It's got to be just a notable change in how you are looking at the back half on international I would think, on top of a little US truck. It just seems -- the international has got to be where the major change was in the back half, on mobile I suspect. Or maybe you're hearing more from your construction, ag, even auto customers than maybe we are hearing them articulate this earnings season about their back half production.

Well, first I would say, we went from a guidance standpoint to flat to up slightly, to flat to down slightly. So it wasn't --

But it wasn't implying -- growth in the back half, end of the day. But the back half growth is pretty much insignificant. So I'll let you finish. What changed in the back half versus the prior guidance?

Let me talk first a little bit about the -- finish out the second quarter year-on-year comparables. So if you look at them year-on-year, the acquisition was about plus 5%, currency, minus 5%. Light vehicle and heavy truck exits about minus10%, which leaves you to get to the minus 4%, minus 5%, minus 6% on the market side. And look, talking about the segments, year-over-year, all segments, all markets are up.

Taking out, and from a pure volume standpoint with the exception of heavy truck, which for us was down pretty significantly in the second quarter. And you compare that sequentially to the first quarter, all of our markets were down sequentially from the second quarter to, from the first quarter. And as we look into the third quarter we don't see the order book and the demand signals from our customers to support a reversal of that.

So that's essentially why the guidance flipped from, again, up a few percent, to down a few percent. So I wouldn't certainly characterize it as any sort of free fall, but the second quarter was lighter than what we expected. And as we finish the quarter, we expect the third quarter to be softer than what we would have expected three months back as well.

Okay, I appreciate the color. Sorry for going through the paces, the detail. But pace of the mobile, it's lower outlook, it's pretty broad. I mean, it's not a particular end market per se. I mean, it's a continued sequential decline the next quarter or two.

Yes, and --

The order book is telling you.

Yes, and as you said, I mean some of the markets are good. I mean, rail was still growing year-over-year, but even there we see some softening of the sequential growth rates. So still growing, but at a softer rate than what it was.

All right. I appreciate the color. Thank you.

Our next question comes from Gary Farber of CL King.

Yes, I was just wondering when you look at, well, I guess two questions, one is just on the competitor's side. Can you talk about either an individual business segments or geographies, what the competitive environment is for the product? And then, just sort of looking at your major geographies that you have in your presentation, I mean what's -- it's not a huge range of guidance, but what's the difference between the high end and the low end, as far as your assumptions in your major geographies?

Okay. Let's start with competitors, and let's stick with North America and start there. North American market remains pretty good. We see pretty good demand in North America, and all of the global competition I would say is heavily focused on North America, because the global -- the rest of the international bearing markets are obviously having issues.

In Asia, I would say the competition is most intense there. The market there, particularly in -- and now for us, remember this is industrial. We're not in the automotive markets in Asia at all. So in the industrial markets the slowdown there has been significant, and a lot of the competition has new capacity, as well as the Timken Company has capacity. So I would characterize the Asia market to be the most intense and competitive from that perspective.

Europe is just sort of trudging along from our perspective. We're not, once again, a big player in European automotive, so that's not a huge issue for us. But it's sort of going along, and I would not call the competition intense in Europe at this point in time. I think everybody is just working their way through the issues there, would be my characterization of it.

What's -- and in North America if more companies and competitors are sort of focused on that market, is that sort of baked into your guidance through the back half of the year, that the level of intensity could increase?

I don't know specifically. I think we're obviously, very strong in North America, and we are the big player in the North American market. So that's a very good thing for us. We expect to have a pretty good year North America.

My only point was, obviously, the competition whose home markets are weaker obviously, are competing here. So we don't see any huge competitive problem from that perspective in the North American market. So that would be the comment I would have on it.

Right. And then just on the range of your -- even though its sort of a tight range, the range of guidance, what's the assumption at the low end versus the high end for those three major geographies?

Again, the bandwidth is not that great, when you think about sales are going to be up slightly. Obviously, that is going to be a big driver. The expectation that there -- that Asia will be, plus or minus, how much it is going to grow, is tough to gauge. Because again, we have been fairly -- don't have a big bandwidth around the top line.

So the bottom line is really how well will we leverage it. So it obviously depends as much on the mix of business we have, the material issues that we're grappling with. The capacity, obviously is a big issue. I think it's less, plus or minus on the geographies, as much as just overall demand.

And in North America, I mean, what's the assumption on the low end of your guidance for the outlook?

Again, I'd make the same comment. Right now North America continues to be the strongest market that we're participating in. It's obviously, our largest exposure to the market. But what we see, is the continued steady state if you will from the current environment.

But the bandwidth, we don't think is that great. Again, at the top line we have had a fairly narrow view of what our top line will be. So it's just execution and how well we leverage that. And again, we expect to continue to leverage the down side very well by managing our cost structure, and continuing to be aggressive in our execution.

Right. Okay, thanks.

(Operator Instructions).

We will go next to Samuel Eisner of William Blair.

Good morning, everyone.

Good morning.

Just had a couple questions regarding utilization rates. I know that you mentioned that Asia obviously you're seeing increased competition based on that last question. So can you maybe talk about what your utilization rates are in China at the moment, maybe obviously with rail -- or with wind continuing to be extremely weak?

Yes. Well, a couple things. One it's important to note that we operate a global manufacturing stream. So my point on that, is you really can't look at a given country and deduce anything on specifically around utilization rates. But we're in the 70%, 75% range of utilization.

To be clear, we really like to be in the 80% kind of range. So we're not far off of the optimal range we want to be at. We do not operate at high levels. Our business model is a high service kind of business model, so we do not try to operate at 100% of our utilization.

So all in all, we're managing that okay. Obviously, you have seen the St. Thomas announcement. That's an issue. But we're not severely stressed I would say, from our manufacturing infrastructure at this point in time. It's just we are sort of leveling off is the term I would use.

And that I guess versus your 80% where you like to operate, that 70%, 75%, is that primarily because of new investments that have come online? Or because of the material down tick on the existing capacity that you already had in the market?

Yes, a combination thereof. We obviously continue to invest, particularly in new products and things of that nature. So we clearly have capacity coming online. We though, are obviously then managing some of our other capacity, once again as evidenced by the St. Thomas closure. So we continue to manage it, and that's where we sit on it.

And then, Sal, on the steel business. I know that you mentioned last quarter that the declining, or you were expecting a weakening of volumes, and that would allow you to take some maintenance ahead of scheduled maintenance. What are the current utilization rates, and how are you thinking about that, as well as volumes in the second half of the year?

Yes. Well, we operated -- and yes, Sam, this is Sal. We operated our second quarter at about 70% utilization. So that's right in line with where we said. We indicated we would probably perform second quarter about as we did in first, and it's almost identical. And frankly, with a little bit lower utilization rate, so we had a better product mix during that period as well.

We do expect to see softening in the second half, not terrible, but definitely a bit lighter. We had talked about the conditions associated with inventory overshoots, in terms of customer supply chains, which is coming to be recognized. We talked a little bit about the attracted imports that came in the fourth quarter of 2011, first and [a little] second quarter of 2012 because of the inability of the North American industry to supply last year. And right now, we believe that will have to reconcile itself, and we expect to see that happening during the third quarter, and probably take a bit of time during there. So not terrible, but definitely a bit softer, which is why the guidance we've given indicates that we are probably going to be down a bit, as opposed to where we were originally.

Understood. And then, if I look back at your performance -- and I'm not saying the environment is like this now -- but if I look back at your steel performance back in 2008, you had margins that were really increasing during the time of declining scrap steel environments. And then basically, the volumes fell off, and the margins fell off as well.

So how are you thinking about that, with volumes seemingly coming down, and even though surcharges are benefiting the margin this quarter, would you expect that benefit to trail off towards the end of the year?

I believe we will see a bit of pressure on margins, just because of the softness that we will see regarding this inventory gain. We have got a little bit other head winds too, with the -- you have seen scrap prices fall quite considerably. They were down $115 in the last two months and $200 since February, and so we are going to have a little bit longer wait to recover our surcharges. So that will put a little pressure on our third quarter.

Frankly, there is another -- a couple unique things that occurred to us. Early in July, we had two unplanned plant outages, a week at our Harrison plant, and two weeks at our Faircrest plant because of liquid metal leakages, one at a caster, one at an electric [arc] furnace that we're recovering from right now. But that will pressure our third quarter, a little more than otherwise.

But having said that, we still don't see things getting terrible. We just see a lot of caution among our customers right now. With the oil at $88 a barrel, there's a bit more conservatism in terms of energy customers dealing with things. There's a little bit of confusion regarding the forecasts in the industry about where drill -- rig counts will go. There's one, Spears and Associates that are predicting up, and Raymond James, down by double the amount they expect up.

So people are just a little nervous and being a bit conservative. And with the supply chains with adequate inventories in them right now, they are just playing it very close, as we are, by the way, playing it very close in terms of that. So we don't see it getting terrible, we just see it softening a bit until these inventories sop up.

Got you. That's a very thorough answer. I appreciate it.

And then quickly on the bearing business, maybe for both mobile, as well as in process. What are the inventory levels looking like at your customers, and maybe specifically within the industrial distribution market, how are inventory levels looking there? And how does that affect, I think other analysts are asking about this, because it will affect production rates coming forward?

Yes, we have obviously very good visibility of that issue because we measure that very carefully with our distributors sales to the end users, versus what we sell to them. It looks great. Unlike 2008, where you had massive event builds in the channels, we have no inventory build whatsoever of Timken product in the channels. And that's exactly what we want to see.

We also have made changes in the way we commercially interact with our distributors, to make sure they're not incented to build inventory either. So that issue looks really good for us, and we're very happy with where it is. And thus, it's no impact whatsoever of consequence in the industrial distribution arena.

Yes, I would echo similar for the mobile and aerospace. We have no channel inventory problems. Inventory is in excellent condition, from the standpoint of being at the proper level of turns and we're able to respond to ups or downs quite quickly.

Appreciate it, thanks very much.

Our next question comes from Eli Lustgarten of Longbow Securities.

Good morning, everyone.

Good morning, Eli.

One, let me get one clarification, I think, Glenn, during your presentation you said the tax rate in the second half of the year 36.5% ongoing. Your first half on an operating basis is 34%. The difference between the 34% and the 38% was the CDSO and the charge on that. So is something happening -- are earnings mix being more OUS, and is that offset causing the 36.5% tax rate in second half of the year?

No. It's when we calculate the rate, we always do it on an annual basis and then the second quarter trues it up. So roughly, there still will be additional St. Thomas charges in the second half, that again won't be deductible for us, because of our NOL position. The assumption on the change in foreign earnings would not have changed from the first half assumption. And that is why ultimately we say we get back to the 34% rate, after we get through this year when those charges are done, and there is a more normal environment.

So it's basically just the -- closing the plant that's causing the higher rate. Nothing else?

As far as the comparison between the second half and the first, that's right.

I just want to make sure I understand. You clearly indicate that the big problem in steel in the second half is this inventory liquidation.

In the bearing side of the business, the lower volume, is that caused by weaker demand? Or is that your customers sensing a changed environment, and taking their inventories down even though it's not a matter of the inventories being high? But basically they are trimming their level to the OEM level?

We're not seeing any dramatic inventory reductions. I would say the customers are -- I think Jim used the word, playing it prudently, and responding to what they've seen in some softening, or maybe softening in growth projections in some cases. Don't see inventory being a major positive or negative factor in our outlook.

So basically, it's a pull through of the demand -- so demand is slowing, you're just taking it down directly in the bearing business second half of the year?

Correct.

Now in the mobile side, your adjusted margins were still mid-teens. How bad do margins get, given this weakening outlook in the second half of the year? Can we hold them at double digits in the environment we are talking about?

Yes, we still have -- Glenn, what do we have, about $0.12 of restructuring in the forecast?

Yes, I am ex-ing out the restructuring, obviously.

Yes, and outside that, our target is in the teens, with the possible exception of the fourth quarter, but still would expect to hold double digits even then, with the normal seasonality.

Okay. The process business, I guess, has come off. Is that a change of environment also, from the double digit growth? And can profitability stay in the $20 millions given the lower volume?

Yes, Eli, the issues with process are clearly international, and specifically, Asia in particular is giving us some pain. Europe is a little bit of an issue for us. I mean, it's down mid-single digits in the distribution market, but it's trudging along. For the balance of the year we, effectively expect the second quarter to carry forward, from the third and fourth quarters is pretty much what we expect to see happen.

We expect to see the margin hanging around the level where it is at now. The second quarter margin, price was effectively offset by currency and volume. And the 1% down year-over-year was primarily just some cost pressure from the S&A, manufacturing at the slightly reduced volumes that we saw. So I mean, I think you just look at the second quarter, and you can pretty much see what we expect in the third and fourth.

I guess the real fear that shaping in the market, because it is not hammered, is your second half guidance is under $2 a share. It's in the $1.75 kind of range, I guess versus $1.85 range from the first half or so. Is that's the run rate that you expect while, until the business improves? Or the inventory, I guess steel has inventory that we can start thinking of 2013 as a more normalized number somewhere in between what we are seeing in the second half of the year, and what we will see for the full year?

Again, we will put it in perspective. Clearly, when you go to the midpoint you get to that, call it $1.84 second half, and we probably expect that to be fairly similar between the third and the fourth quarter, albeit as Rich said, normally we get some seasonality in the fourth quarter, but just timing and -- the causes that -- call it, to be fairly comparable. But again, if you said that that's the current run rate, so we're doing the $0.90-plus a quarter for the next couple, and you annualize that, we're at the second best year we ever had.

So again, from our standpoint, the decline that we are seeing, again, is markets that are softer than we expected. Albeit, it's kind of interesting, if you looked at the beginning of the year, they are not too far different than where we thought they would be at that time. And in fact, because the first quarter was so strong, we increased our expectations that the market would continue to grow, and in fact, it's kind of come back slightly below what our original expectation is.

So the key part on our standpoint is that we continue to leverage it well. We have managed the costs very well. We are managing the business well. Now there are obviously market conditions we can't control. Some of the negative impact is currency, translation as well.

But as we look out, next year obviously, we will go through our plan, and we will provide our normal outlook, in the normal course. But if we are saying things don't get worse, they just maintain, we are still operating at a fairly good level, and obviously can leverage it even better, if we knew it was going to be sustainable by taking certain other actions. But we continue to keep a good eye on our cost structure, given the uncertainty that we're seeing out there.

And with the stock getting hammered as it is right now, would you -- is it, can we, is it fair to say, maybe you will consider being much more aggressive in share repurchase than you have been historically? You have got the stock authorization, you just haven't executed it very much. But when your stock is trading down 18% at the moment, and I was just wondering whether, with such an unleveraged balance sheet, would you become a little bit more aggressive in repurchasing of shares?

Yes. No, it's a great question, Eli. Obviously, we've been in the market for the first half of this year, greater than normally we would have been in the first half, repurchasing 1 million shares. We have averaged it around $52 a share. So if you liked it at $52, you should really like the benefit of buying it in the $30s.

We did comment in the opening remarks, that we do expect to be in the marketplace, continuing to repurchase shares. Again, the Board authorized a substantial program for us in February of this year increasing that, with our expectations, given the strong balance sheet, given the strong cash flow of the Company, that we still can keep to our balanced approach of funding the CapEx budget for growth opportunities, dealing with our pension and OPEB liabilities. And obviously in the current interest rate environment providing some head winds, the increased dividend that we had earlier and acquisitions.

So with the strong balance sheet, we would expect to continue to pursue all of those different areas. But obviously, in the $30s, the stock is even more attractive, and frankly, it was attractive in the $50s. So obviously, we will report out, as we go each quarter, as far how much we will buy back, but it's a function of balancing all those different items.

All right. Thank you very much.

We will go next to Holden Lewis of BB&T.

Thanks. Wanted to go back to the commentary you made around, sort of the steel business. I think you talked about -- the steel held up very well in the quarter. But you sort of talked about the -- maybe some inventory culling that's taking place there.

I mean, are we expecting that even though the bearings are somewhat weaker this quarter and steel held up quite well, are we expecting that a fair bit of the incremental weakness we are expecting in the second half is going to come from the steel side of the business? I mean, or the inventory culling, I guess, the unplanned shortages, utilization coming down a little bit. I mean the guidance that you provided for the second half is so poor, is that disproportionately coming from steel now, rather than the bearing side, which we kind of saw it in Q2.

The comment I guess I would make, and again, Sal can provide color, is the change in outlook for steel is the most dramatic of our other four operating segments, second half to first. In part given the strength that we saw in steel in the first half. But I wouldn't, overplay the fact that given the current material environment we're in, when you see the top line coming down more significantly in steel, it's because of the fact that we have that surcharge mechanism that insulates ourselves from exactly this issue of material costs rising and lowering that we can't control.

So within steel, probably a good half of the decline in our outlook for second half versus the first in our change, is just a result of those surcharges coming down. The other half again, being more market driven, which puts it more in line with what's going on at least within the mobile outlook for the business as well, so similar markets.

But even that half that's volume -- I mean if you're seeing inventories getting culled, and obviously there's a fair degree of operating leverage in that steel business. So if half of the issue is surcharge, and the other half is volume, how much of that half that is volume, is going to be a function of lower tonnage and things like that, of the steel business because of inventory and things like in a?

Yes, Holden, this is Sal. I mean you, -- that's exactly right. The half of the sales dollar, the decline that we are talking about is because scrap prices are $200 a ton lower, although we expect that that will start to strengthen and increase, even as early as August, that we're seeing signs of that right now. So you may see that return.

But this inventory reconciling that needs to go on. The combination of customers who have a bit more in their pipelines than they actually need, given their uncertainty because of the nature of the economy right now, and the imports that we've seen is going to result in a bit lower volume.

But what we do believe is, is that what we've done in terms of improving our own efficiencies and right-sizing our pricing is that our volumes will hold pretty -- our margins will hold pretty reasonably. Not as high as you've seen, but something in the low double digits. And I think you're going to find that's pretty reasonable, when you consider the nature of the slowdown that we're seeing because of this conservatism regarding exactly when the demand will pick up again.

Okay. And then are you planning on -- don't you usually do planned outages in steel sort of in Q3? You kind of had some unplanned outages, are you still looking at planned outages in Q3 as well?

Yes, we will still have -- there will be two kinds of outages that we will plan on, Holden. One is simply that which we will not run because the demand is not as strong as we expected.

And then we also have some plans that were there, because of the necessity to hook up some of the equipment to the -- that are in line with the capital projects we have. In particular the inline forge press at the Faircrest Steel Plant will require about a week of down time, in order to make the connections that lie right within the spectrum of flow of product from our soaking pits into our rolling mills, with the press in between. But that's about it. It would be the combination of those two.

Okay. And then just last thing on acquisitions, just remind us when do the acquisitions sort of anniversary into the mobile and process business? Then maybe give us, since you're going to put that balance sheet to use, give us a sense of what the likelihood is that you can convert some of your pipeline today, to something over the next 12 to 18 months?

I think the Philly Gear was in the third quarter --

July, July of last year or so. (Multiple Speakers).

And the Drive was in the fourth quarter --

And the Drive was in October of this year. So we have had Drives for nine months, we had Philly Gear for just over a year.

And you question on the acquisitions again, part of the reason of having the strong balance sheet that we have, is we continue to look at acquisitions to implement the strategic plan of the Company. Which, again, is to continue to grow and diversify within that mechanical power transmission space that you've seen the Philly Gear and the Drives acquisition illustratively are where we're targeting. So we continue to believe there are good opportunities out there, and we will be able to utilize some of our balance sheet for the acquisitions, as well as share repurchases and the other -- and dealing with the pensions and so forth.

But we continue to be very disciplined in our acquisitions. But obviously, we're seeing a fair amount of activity in the marketplace, which is good. The issue obviously is there are a lot of sellers right now, and particularly could be because of the concern of where the economy is, and is this the right time to be selling? So we will continue to be active and hopefully be able to execute and get good strategic acquisitions that continue to complement our business.

Okay. Thank you.

And Holden, just one last comment too, so we can -- well, we can circle back. I think we figured out the difference in the question you started with, which was the St. Thomas closures.

When you look at the segment data, that is we are burdening mobile if you will, by that charge in the segmented results. So when you add that up, then you compared it to the as-adjusted if you will, excluding that St. Thomas, so the delta is probably roughly that $17 million. But take a look at it, and if it's not that number, give us a holler, and then we will work you through it.

Got it. Will do, thanks.

Thank you.

That is all the time that we have for questions. I would like to turn the call to Jim Griffith for closing remarks.

In closing, I am going back to my opening comments, and let me repeat. We had a very solid second quarter, and the Company is running extremely well. And to reinforce, we are projecting record results for 2012. We have taken prudent action to deal with the global economy, and we look forward to reviewing the results with you at the end of the third quarter.

That does conclude today's conference. Thank you all for your participation.