Timken Co (TKR) 2013 Q2 法說會逐字稿

Good morning, my name is Vicky, and I will be your conference operator today.

As a reminder, this call is being recorded.

At this time, I would like to welcome everyone to Timken's second-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session.

(Operator Instructions)

Mr. Schiegg, you may begin your conference.

Thank you and welcome to our second-quarter 2013 earnings conference call.

I am 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 through 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 Administration and CFO; and Group Presidents, Chris Coughlin and Rich Kyle. We have remarks this morning from Jim and Glenn, and then we will all be available for Q and 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 its 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'll turn the call over to Jim.

Thanks, Steve, and good morning, everyone.

In our earnings announcement earlier today, we reported second quarter sales of $1.1 billion, and earnings of $0.86 per diluted share. Our results reflect another quarter of solid performance, even in the face of weak macroeconomic conditions. Especially in this sluggish economy, these results highlight the impact of the changes we have made in recent years to transform and improve the Company's performance. For example, we maintained double digit margins across all segments in the first half of the year, even while operating at 57% of capacity, further evidence of the positive impact coming from executing our strategy.

We continue to focus on structurally improving our performance, and strategically changing our business portfolio with progress in both areas. We completed two acquisitions this quarter, Smith Services and Standard Machine, to further broaden our industrial services capabilities, and increase the geographic markets we serve. We closed our Canadian bearing plant in St. Thomas, Ontario as planned. We started up the second ladle refining station at our Faircrest Steel Plant. Other key investments, our new in line forge press, and the intermediate finishing line went into production earlier this year. These investments enable us to realize benefits through operational efficiencies, and open new market opportunities for the Timken Company.

Our performance in this economy, combined with our continuing steps to strategically reposition the Company, demonstrate the Company's upside potential as the market conditions improve. During the quarter, we also returned $104 million in capital to shareholders, with the purchase of 1.4 million shares of Company stock, and the payment of the 364th consecutive quarterly dividend.

Lower demand across our end markets, including off-highway, industrial distribution and the oil and gas sectors has tempered our expectations for the year. While we saw continued improvement in demand during the first half of the year, the pace was much slower than we anticipated. By now we had expected to see signs of a robust recovery shaping up for the second half of 2013, resulting from an end to inventory destocking, especially in the mining and energy sectors.

Instead we see slow growth again in the second half. In the face of uncertainty, customers are trimming production schedules and tightly controlling their inventory levels. With the exception of the light vehicle market in North America, this is happening broadly across our target markets, in China, in India, and in Europe, as well as here in the United States. As a result, we have lowered our expectations for 2013 and have revised our earnings outlook accordingly. We now anticipate a limited recovery in the second half, but are well prepared to leverage a rebound, as the markets recover.

We remain confident in our ability to deliver solid performance in 2013, stemming from our success in driving efficiencies across the Company resulting in sustainable margin levels and earnings power, even in the face of lower demand and capacity utilization, and the benefits from our capital investment program.

As a final note, let me just add a brief comment on our June 10 announcement that the Timken board has formed a strategy committee of independent directors, and retained Goldman Sachs to evaluate a potential separation of the Steel business and to review the Company's corporate governance and capital allocation strategy. As we noted at that time, the Company expects to report the results of the committee's evaluation by the end of the third quarter. Therefore, it would be inappropriate for us to address questions about the committees ongoing work during today's teleconference.

Now, here is Glenn, who will review our financial performance for the quarter in more detail.

Thanks, Jim.

Sales for the second quarter were $1.1 billion, a decrease of $217 million, or 16% from 2012. The decline is a result of lower demand, primarily in the Company's off-highway, industrial distribution, and oil and gas markets, as well as the impact of the Company's market strategy in the Mobile Industry segment. In addition, sales were negatively impacted by lower surcharges. The decline was partially offset by acquisitions and pricing. From a geographic perspective, all major regions were down, with the greatest impact coming from North America with sales down 20%.

Gross profit of $302 million was down $75 million from a year ago. The decrease was driven by lower volume and negative mix, which were partially offset by lower material costs, net of surcharges, and pricing. The gross margin of 26.8% for the quarter was down 130 basis points from a year ago. Impairment and restructuring costs, primarily related to the previously announced plant closes in Saint Thomas and Sao Paulo, totaled $7 million in the quarter, down from $17 in the same period a year ago. Other expense for the quarter totaled $1 million, compared to income of $106 million in the same period a year ago.

Last year's income was primarily due to the receipt of $110 million from the Continued Dumping and Subsidy Offset Act or CDO. For the quarter, SG&A was $160 million, down $3 million from last year, due to lower variable compensation and reduced discretionary spending, partially offset by acquisitions. SG&A was 14.2% of sales, an increase of 210 basis points over last year. As a result, EBIT for the quarter came in at $135 million, or 11.9% of sales, 250 basis points lower than last year, after adjusting for CDO receipts received last year. Net interest expense of $5.7 million for the quarter was down $2 million from last year, primarily driven by higher capitalized interest and lower average debt balances.

The tax rate for the quarter was 35.8%, compared to 38% last year. The decline in the rate from a year ago was primarily due to a higher percentage of the Company's earnings coming from lower tax rate foreign jurisdictions. Looking ahead, we continue to expect the full year tax rate to be 33%, while the third and fourth quarter tax rates should be comparable to those quarters last year. As a result, net income for the quarter was $82.8 million, or $0.86 per diluted share, compared to $1.86 per diluted share last year. Excluding the cost related to the plant closures, and the benefit of CDO receipts, earnings per share were $0.93 for the current quarter, compared to $1.35 a year ago.

Now I will review our business segment performance. Mobile Industry sales for the quarter were $393 million, down 12% from a year ago. The decrease was driven by lower volume across most end markets, lead by mining, construction and rail. In addition, there was a $30 million decline due to the Company's shift toward higher returning sectors of the mobile equipment market. The sales decline was partially offset by revenue from the Interlube Systems acquisition. The Mobile segment had EBIT of $52 million, or 13.3% of sales, compared to $49 million, or 10.9% of sales last year. The improvement was a result of lower plant closure costs at $11 million. The impact of reduced demand was partially offset by lower manufacturing costs and SG&A.

The outlook for Mobile Industry sales for 2013 is to be down 7% to 12%, primarily due to lower mining and rail demand, and lower light vehicle and heavy truck sales, resulting from the Company's strategy of focusing on markets which offer long-term attractive returns. For 2013, we expect the final piece of this market repositioning strategy to reduce sales by approximately $150 million. Partially offsetting the sales decline, is growth in the automotive after-market business. Process Industry sales for the second quarter were $317 million, down 6% from a year ago, due to lower volume from both industrial distribution and OE demand, partially offset by pricing and acquisitions.

For the quarter, Process Industry's EBIT was $55 million or 17.2% of sales, down from $71 million or 21.1% of sales last year. The decrease in EBIT was primarily the result of lower volume, partially offset by favorable pricing, lower SG&A, and the benefit of acquisitions. Process Industry sales for 2013 are expected to be down 2% to 7%, driven by weaker OE demand primarily in the metals and wind energy markets. Industrial distribution demand is expected to be down slightly for the full year, benefiting from a recovery in the second half. Partially offsetting the lower end market demand are acquisitions which are expected to add approximately 5% to the top line.

Aerospace sales for the first quarter were $82 million, down 6% from a year ago. Lower volume, primarily in the motion control sector, was partially offset by pricing. EBIT for the quarter of $8 million or 9.6% of sales, compared to $8 million or 9.1% of sales a year ago. Lower volume was offset by the benefit of lower SG&A and higher pricing. For 2013, we anticipate Aerospace sales to be up 3% to 8%, driven by a strong order book, with most end markets expected to be up for the year. Steel sales of $354 million for the quarter were down 29% from last year. The decline was due to lower demand in the oil and gas, and industrial market sectors, which was partially offset by higher mobile and highway demand.

In addition, surcharges were down $49 million, due to low raw material costs and volume. EBIT for the quarter was $42 million or 11.9% of sales, compared to $89 million or 17.8% of sales last year. The decrease resulted from lower volume, surcharges and unfavorable mix, partially offset by lower manufacturing and material costs. Steel sales for 2013 are expected to be down 15% to 20% due to continued customer destocking in the oil and gas, and industrial markets. In addition, surcharges are expected to be down for the year.

Looking at our balance sheet, we ended the quarter with cash of $397 million, and net debt of $66 million. This compares to a net cash position of $107 million at the end of last year. Operating cash flow for the quarter was $175 million, driven by the Company's earnings and lower working capital requirements. Free cash flow for the quarter was $72 million, after capital expenditures of $82 million and dividends of $22 million. The Company also purchased 1.4 million of its shares, during the quarter, for $82 million. The Company has approximately 6 million shares remaining under it's board-authorized share-repurchase program. In addition, the Company invested $53 million during the quarter on acquisitions of Standard Machine and Smith Services, further expanding the Company's industrial service and repair offering.

The Company's unfunded pension obligations were approximately $250 million at the end of the second quarter. The Company does not anticipate making further discretionary pension contributions in 2013, beyond the amount contributed in the first quarter, as it expects it's pension plans to be essentially fully funded by the end of the year, given the recent increase in interest rates. In this morning's press release, we commented on our lower market outlook for the second half. We now anticipate an overall decline in sales for the year of around 10% compared to 2012, driven primarily by lower demand and surcharges, as well as the impact of our tactical shift in Mobile Industries.

We expect earnings per diluted share to be in the range of $3.30 to $3.60. Included in our earnings outlook are costs of $0.15 per share relating to our two previously announced plant closures. For 2013, the Company expects cash from operating activities to be $475 million. Free cash flow is expected to be $25 million after capital expenditures of $360 million, and dividends of roughly $90 million. Excluding the discretionary pension contributions made in the first quarter, free cash flow is expected to increase from our prior estimate to around $90 million for the year, benefiting from reduced working capital requirements.

This ends our formal remarks, and now we will be happy to answer any questions you have. Operator?

(Operator Instructions)

Eli Lustgarten with Longbow Securities.

Can we talk a little bit about the revised outlook, and its impact, not only with low volume but expected profitability for the year? I mean, all of a sudden Process instead of being flat is down, you have weaker Aerospace. Mobile we understand probably more. But what happened, what was really changed that Process goes so negative, and Aerospace is weaker? Can you talk about the expected profitability improvement, it was 17%-something in Process, but it sounds like we are not going to get back to the 20% plus that we got there, because of the lower volume. And the same thing with Aerospace. It looks like the profitability is a little weaker. Things change much in the second half of the year?

Eli, this is Jim.

Let me take it first, and then we will throw it to the two Group Presidents to respond to the questions on the specific segments. If you look at a macro level at Timken, it is the facts that I laid out, or the perspective, I'll say, I laid out in my comments. As we went into this year, we expected a much stronger second half than the first half. And we did that because we were hearing from major customers that they, in particular the mining and energy sector, that they had overinventoried, over bought in 2012, and that it would take them six to nine months to burn through that inventory, and then they would get back to balancing their production levels with their sales levels.

And, in fact, I will say those markets, mining particularly, is weaker than either we or they thought it would be at this point. And therefore that de-inventory has not ended. It's going to continue to happen in the second half. That then translates down to some of the general economy we deal with, and Chris will talk about Process, but industrial distributors are then reacting to that by also looking at their inventory levels, and tightening their belts. So, effectively, that is the change in the outlook for the year, and what drives it. It's that changing perception of what the economy would be. With that as a general, let me throw it to Chris to respond to Process, which is probably the biggest area you were focusing on.

Yes, good morning, Eli.

Yes, let me just take a minute, I can give you the color I think you are looking for. On the first quarter call, we stated that the second quarter would still be challenging but we expected some sequential improvement from the first quarter. From that perspective, it was pretty much what we expected. On the positive side, the second quarter revenue was 12% higher than first quarter. Volume was about 75% of that, acquisition was the balance. However, if you looked on it year-on-year quarter, we were down the 6%, as mentioned. With all that said, we continue to see relatively softer market conditions than what we expected at the beginning of the year, across many of the industries and many of the geographies.

If you break it down in the two segments within that, let's start with distribution, second quarter revenue was 8% up versus the first quarter. However, obviously, the first quarter was a weak quarter as you already know. Distributors remain cautious with their inventory positions, as Jim noted, and our overrate exposure to mining infrastructure and energy continues to be a little bit of a drag for us in the distribution space. On the original equipment side of the business, the market remains sluggish. Companies continue to be conservative around their capital investment programs, and that hurts our original equipment business. So in summary of all that, I mean the good news is we saw the sequential improvement in the revenue the second quarter to the first quarter.

And, although we see slower growth in the second half than what we expected going into the year, we expect to see sequential improvement in revenue across both the third and fourth quarter, as we move quarter to quarter. The negative of that is clearly it's not at the rate that we would have expected heading into the year. On the margins, the margin moved from 15% to 17% from first quarter to second quarter. Obviously, we are not satisfied with that. And to your direct question on the 20% target, yes, we aren't going to hit the 20% target for the year. However, we do, once again, expect to see sequential improvement moving through the year. We will continue to manage the costs aggressively, and positioning our infrastructure to operate at these lower than planned volume levels. So, there's the color I had on it, Eli.

Eli, this is Rich.

I will comment on Aero, since you asked about that as well. We planned on, and anticipated, that the second half would be significantly higher than the first half. And that is still anticipated. We also expect to leverage that sequential improvement in volume, strong to the bottom line, expect a few 100 basis point margin improvement over 10%-ish percent that we ran in the first half. So, that is still the case. And we have the order book trends to certainly support that in the longer lead time parts of this business. That being said, we did take the full year down a little bit. And part of that is driven by a portion of that business that is more driven by industrial markets, ie machine tool business, than the pure Aerospace play. So, we still expect the second half to be significantly stronger than the first half in that segment.

Any quick comments on the same thing in Mobile, might as well finish it?

Yes, okay. In Mobile, revenue was down 13% year-on-year, and was essentially flat to the first quarter. That revenue decrease quarter-to-quarter was 50% exited business, 50% volume as Glenn had highlighted. The volume portion of the issues in Mobile are almost primarily around off highway and a little bit of rail. And all of that is tied to mining, which I think you are all up to speed on what is going on in that area. The margin performance was excellent, 13%, well above the prior year, although, part of that was driven by the change in restructuring.

But once again, very solid profit performance. Excellent cost control, in a weak volume environment is primarily what is driving that. Moving forward, we expect to see downward pressure on revenue in the third and fourth quarter. The last major automotive platform that we are exiting is beginning to ramp down. And that is going to take our revenue down in the second half, if the market assumptions that we have stay valid. So, coupled with the weakness in the off highway sector, we see no recovery in mining in 2013 from our perspective. And we expect structural EBIT margins to stay where they are at. We see no reason for any movement in any of the margin expectations.

Stephen Volkmann with Jefferies.

Hi, good morning, excuse me.

I'm wondering if we can -- first of all, just briefly, how much is mining of your revenue base directly and indirectly through the whole Company?

Well, yes, that's a little bit tricky, right? Because in the after-markets, we don't really know completely where the end use product is actually used. We believe that is in the 5% range from a company perspective. Does that sound right to you guys? But there is an after-market component of that, that's a very tricky number for us to get at. That said, we know our after-market business is a big player in the mining market. So, that is the color. Sorry I can't be more definitive on the after-market, but it's hugely fragmented as you might imagine.

Steve, this is Jim.

Let me just add to what Chris said, the comment that he made before to Eli's question. The impact of mining changes are bigger than that, because much of what we do in rail, for example, is heavy haul and rail is, I don't know, 5%, 6%, 7% of the Company. And so, when the mining capital programs go down, both the utilization of our products in rail, and also the capital programs, particularly in developing markets in the rail sector get pulled back. So, the ultimate impact is bigger than just the revenue impact to the mines, and to the mining equipment companies.

Yes, to echo Jim's point, our services business would get hit by mining, our after-market business does, our direct OE business does. So, it's spread through our diversified industrial customer base. But, it's a very difficult number to tell you exactly what that is. But it is significant.

Right. I was trying to think about it in those broad terms, it sounds like rough order of magnitude 10% wouldn't be terribly off?

Yes, 10% or 15%, I'd say, in terms of the way it affects us.

Yes, that's probably good, yes, sorry for not being more explicit.

No, I understand. So, that's helpful.

And what I'm trying to do then, is if we tease that part out, Jim, how do you feel about the destock/restock issue, that when you mentioned that more destocking would be necessary in the various mining exposed segments. But what about the rest of general industrial, and so forth?

Yes, Stephen, this is Chris.

We clearly have distributors globally being very cautious on inventory. And so, that is effectively destocking, given what they are seeing. And that, to your point, would be across the broad diversified industrial base. But, other than that issue and the mining issue, I would not say that we see inventory being a huge problem beyond those two points. Point being, any kind of market turn, we expect to see a pretty quick acceleration, given where the inventories are at, put aside the mining issue which I'm sure many of you heard the cat story yesterday -- putting aside those two issues.

Okay, great, that's helpful.

And then just quickly, any comment on pricing, seeing any weakness anywhere?

On the bearing side, we did our annual price increase and distribution in June, in US distribution. So, no, I mean there is no change in our distribution approach to pricing. Clearly on the OE side, it's competitive out there, but it's not a material change of consequence.

I will add on the Steel side, as you know, we use a surcharge mechanism. So, year-over-year in the second quarter, our customers are paying 6%-ish less per unit of steel than they would have a year ago. But that is a direct reflection of our input cost. So, from a margin standpoint for us, in a gross basis, it's neutral. And then from base pricing standpoint, prices are generally holding.

(Operator Instructions)

James Kawai with SunTrust.

Hey, good morning.

I just want to dig into guidance a little bit. If I take the second quarter and trend it out sequentially, being sequentially flat, I basically come up to the midpoint of your guidance range. $360 million exit charges, and minus 10% for revenues. I think you spoke about Mobile sequentially weakening a little bit, with the program roll offs and things like that. Then, you spoke about Process sequentially improving through the rest of the year. I guess some seasonality helps there. Can you confirm that. It sounds like they are a wash, and the variable is going to be what happens to Steel? Any color you can give there would be helpful?

I'll start, just from (technical difficulties) enterprise standpoint, it's still our belief, and you heard Jim and Rich, in particular, talk that, yes, sequentially, we continue to believe that we are going to see an improvement at the top line. And that is even with the seasonality that we would normally expect to see in, call it the third quarter, as well as the exited business throughout the year. But it is, obviously, more modest than what we had initially in the guidance, that we would have provided further. So, from that respect, just call it a sequential increase with the exception of, again, Mobile because of the seasonality for them in the third quarter.

From a profitability standpoint, again, we continue to leverage reasonably well given the environment. We continue to focus on the costs. However, in the third quarter, we would expect, as well, to see a little bit of a, instead seeing the sequential improvement in earnings following sales, we will probably see that dip down a bit in the third quarter before rebounding in the fourth. One -- We have the seasonality with the lower sales coming out of Mobile. But also, Steel is using this as an opportunity to view maintenance within both its Harrison and Faircrest steel facilities. So, those two will weight us down in, call it the third quarter, before rebounding again in the fourth.

All right, got you.

And then, on the Steel business, just looking at it sequentially, revenues were up slightly, but profitability was up very significantly on an incremental margin basis. Any insights you can give there? I know there are some destocking in the fourth quarter, and then a rebound in the first quarter, as you produce to end markets, but any thoughts there in terms of improved profitability. Is that some of the new projects starting to kick in?

Yes, I'll talk about the top line first. So, in addition to what you saw, quarter, from the revenue standpoint, our orders would have improved sequentially in the mid-single digits, so call it 5%-ish Q2 from Q1, and we would expect that level to hold. So again, that would have been more modest maybe than what we would have been anticipating a quarter ago. But still, sequentially improving on the top line. I have some seasonality that takes place, usually in the fourth quarter with some lower production schedules, not just internally, but with our customers. So the fourth quarter is usually a little bit lighter. But, in the implied guidance though, would be that we would be up second half to first half mid-single digits on the top line. On the bottom line, expect roughly flattish, and there is a variety of pluses and minuses in that.

We have our mix getting a little bit better, first half very strong automotive, second half a little stronger in some of the other segments. I've mentioned the seasonality, Glenn mentioned some of the maintenance work that hits the bottom line. Our internal inventory reduction is we believe behind us. We took a little bit more inventory out in the second quarter, and that would be behind us which would help. So again, a variety of pluses and minuses. Specifically you asked about the projects. We expect a small net contribution from our projects, and that is when I say net, we've got increased spending on the Castor project, which comes on line next year. Some reduced spending, and some benefit from the projects that have been finished up in the first half, and that nets out to a small improvement, second half versus first half.

Ross Gilardi with Bank of America.

Yes, good morning, thanks very much.

Jim, I realize you are very committed to your repricing strategy and that has paid huge dividends to the Company. But, just wondering, in this sluggish environment, do you think you are losing more market share? Obviously, you've walked away from a lot of business, but are you vulnerable to more market share losses than you would have anticipated, to those maybe less disciplined than you on pricing, as you continue to emphasize pricing over volume? And then, I know you've talked about the Japanese yen many times before, and you've changed your mix over the last five years, but are you seeing anything different there recently?

I think it's important to recognize that when we talk about pricing, what we are really talking about is selecting markets where the value creation of the Timken Company is real and is recognized. At this point, when you look at the performance of the Company at this level of the cycle, you have to look at that, and say that has been an extremely successful strategy. If we were playing the game that has historically been pursued by the industries that we are in, and were chasing volume with price, we would be seeing margins dropping down to zero, or worse, in this kind of an environment.

And that's traditionally what's happened in the industry. So, the focused strategy of the Timken Company, which is to focus the Company and shift the Company places where we are creating value for customers, and they are seeing enough value to be willing to pay for it, is a core strategy of the Company.

Yes, I would add to that, this is Rich on the Steel side. The US is a net importer of most of our products. And clearly, we're always good market or bad market under competitive pricing situations. But, in a market you have today where consumers or customers are very concerned about inventory levels, volatility in scrap pricing, history would say that domestic mills start taking more market share in weaker markets like this, from a reluctance to make commitments, or long term commitments for overseas product. And we are holding on to the price, and we have wins and losses, but net feel, we are holding on our market share at worse, and history as a guide, would generally say that we have some advantages in gaining that back in the coming months.

Okay, and just more on that. When you look at your revision for Steel from down 7% to 12% to down 15% to 20%, how much of that is surcharge related versus demand? I thought if anything scrap prices may be trending a little bit higher recently. So, I would have thought, maybe, that the surcharges would have had less of an impact than you might have originally anticipated?

The reduction in our guidance would be almost exclusively demand driven. We had an improvement in the second half anticipated for scrap prices. We still have an improvement in the second half anticipated for scrap prices, it's just a little bit less. But, certainly the majority of that would have been demand related. And as you have said, scrap prices have moved up a little bit in the last couple of months, and with the strong automotive market there is certainly some market dynamic to continue that strength.

You addressed this a little bit before, but since it's mostly demand related, are you seeing customers come back to you try to renegotiate annual pricing from earlier in the year, aside from any surcharge activity which is already built into your contracts?

Well, where we do spot business, which would be mostly in the metal service center part of our business, in the industrial distribution side, that business is largely PO to PO and we have agreements, there would be some pricing pressure there. But, we are not seeing anybody push to open up contracts, and, as I said earlier, year-over-year, surcharge aside, year-over-year pricing we do not anticipate to be a material positive or negative impact. It is going to be pretty flat.

And then lastly, guys, could you just touch a little bit more on what you are seeing in the oil and gas drilling markets, and what's going to drive improvement in that business? Are we basically just waiting for, hoping that natural gas prices improve to drive increased drilling activity going forward?

Well, our industry projections would show that rig count bottomed in the second quarter, and is expected to come up in the third and fourth quarter. We have some specific penetration gains of some of the assets that we have invested in, and we think we are making some inroads. So, we have some growth in the second half within the Steel segment that we feel pretty confident upon, that are not necessarily market driven. We are not seeing or anticipating, at this point, earlier in the year customers would have said they would have expected second half to be up significantly from the first half. We're generally not getting that now. It's much more a flat to up modestly in the second half.

Okay. Thanks very much.

Steve Barger with KeyBanc Capital Markets.

First just a modeling question. You talked about revenue increasing sequentially quarter to quarter, and sorry if I missed this. Is that how you expect the earnings to come out as well, or are there mix or seasonal issues that cause that to be more level loaded in the back half?

Yes, Steve, we did address that, but we do again expect sales to increase, again, marginally. Obviously, we took down the full year number, but we will increase sequentially we believe. But from an earnings standpoint, we would expect the third quarter to be down from the second, and then picking up in the fourth quarter. So, despite sales up slightly in the third, earnings down, we talked about the seasonality impact of Mobile where Mobile's revenues will be down, and correspondingly profitability. But also, on the Steel side, where sales, we would expect to see improve, would be down profitability-wise, given the timing of planned maintenance at major facilities that Steel has. But Process and Aero both, again, sequentially up in sales as well as earnings.

Got it. Thank you for that.

The interest rate tail wind, obviously, is providing some cash that you hadn't anticipated. Any immediate thoughts on how you deploy that? Is buy back still highest on the list, or is the board talking about dividend or maybe what is the acquisition channel looking like? How are you thinking about that?

You will notice that in our outlook for cash flow, it's improved on two respects. One, just generating more cash from working capital relative to where we expected because of the lower sales outlook. But, also to your point, given the rise in interest rates, it's now positioned us where we can get our pension plans essentially fully funded without additional contributions that we had envisioned making. So, obviously, we are generating more cash flow from that respect. We have been in the market repurchasing shares. We still have 6 million shares remaining under authorized board program. We continue to look at that as a use of our capital. We continue to look at acquisitions as a use of capital, and so forth. So, that's not changed from that respect, other than we believe we'll have more cash generated this year before those discretionary items, than we had previously.

And you expect that you will be pursuing both those avenues? I know you can't anticipate the timing of acquisitions, but you will be aggressive on both fronts?

We continue to look for strategic acquisitions, repurchase shares, dividends, all the uses of our capital. Again, we are investing fairly heavily in capital expenditures this year. That's already embedded in the forecast, though. But, yes, we do expect to be active on all fronts.

And, obviously it's the top line that's causing the guidance revision. Is it fair to say, though, that your margin profile is outperforming what you would have expected if you had foreseen this revenue decline going back six months? And is there any change to how you are thinking about your ability to hit those longer targets, even if the timing has changed?

I will make a general comment again, and ask Rich and Chris to talk. Again, we believe we are leveraging well. So obviously, the markets are down. We are leveraging well, we will continue to do that. With the expectation of the second half recovery, we did not take as much cost out, arguably, as we could have with the knowledge we have now. So there is additional opportunities there to continue to leverage. From a cash standpoint, while we've taken out working capital, especially within the Steel business in the first half, we have that opportunity on the bearing side in the second half to generate more cash from that as well.

So, we believe we are operating well within the environment, and as far as the long-term outlook, our targets that we've established, again, from our standpoint you got to pick when will the recovery occur. So, if it's just a delay for a short period of time, obviously we would expect to be there. If it's prolonged slow down in the economy, obviously, we will have to revisit that under those circumstances. But Rich or Chris --

I would just add, I see no change in our long-term outlook peak. It's just a matter of when that occurs, and our assets, our investments, our market position, all of those assumptions will not change, unless you make some dramatically different macroeconomic assumptions, there would be no reason to alter that.

Steve, this is Jim.

Let me take it to a little higher level. And I think this is a point that you are asking, that deserves an exclamation point. These are, I will say, almost recessionary times for us in terms of demands in the markets that have been historically our best markets, the oil and gas market, the mining market, rail market, et cetera. These are relatively low levels of demand, and we are earning well north of our cost to capital.

I think that is a pretty powerful statement that says this is a very different company. And this is the point that we have been trying to get across to the investment community, that this is a very different company. So, when you are sitting at recessionary levels of demand with the kind of earnings that we've got, and then you look at the fact that we see the markets improving, you get a sense of what the earnings power of this Company can be in an up market.

Yes, I agree. Thanks for that color.

Last question, and I will get in line. Some of the exposure to the Smith Services and Interlube Systems acquisitions was construction, mining, heavy equipment. How is the integration there, and can you talk about the end market exposure is for Standard Machine?

Yes, well, actually, the three you mentioned, the end market exposure is different across those three. Let me start with that. The second thing is, too, obviously recognize these are relatively small, relative to the bigger picture. So, take them down. Smith Services is really in the power generation, that kind of industry space. Interlube is actually in the after-markets around heavy truck and around some of the industrial applications, if you want to think of it that way.

Standard Machine is directly lined up to mining. Mining in Canada, if you want to get very explicit, and even more explicit than that, heavily aligned to potash and some of the other things going on up in Canada. So, it varies across those three. But all three of them are fundamentally going around the same fundamental premise. We are trying to penetrate the value chain of the diversified industrial end user population. So, all of those businesses are in the after-markets, in the services side, in the industries that we want to increase our exposure to over time. So, I will stop there. I hope that answered it.

No, that's great. Thanks, I will get back in line.

Holden Lewis with BB&T.

Can you just comment a little bit, it's -- obviously, you are going forward with your Steel programs. I think many of your steel peers are going forward with theirs. And we are getting to the point where some of this stuff is beginning to come online, at a time when demand and volumes are relatively soft. I mean, over the next 12 months or so, I mean do you have any concerns about the increase in capacity that the industry might start to have, and that you may hit a tipping point where that is going to begin to adversely impact the margin performance of the business?

Well, certainly, I have concerns about the markets. I mean the market fundamentals that this is based on, strong North American production including localization of transplant supply chains from Asia to the US. No real change in that. That is not where our investments are targeted. But it is where the bulk of what you would read about, from an investment standpoint, is targeted. The other one is a strong North American energy market, fracking, offshore drilling, et cetera. Clearly, we are not seeing that strength that we'd really like today, as oil and gas has continued to increase, the offset in natural gas has nullified a lot of (inaudible). We still fundamentally believe in that. A portion of our investment is certainly targeted at niches of that, a big part of the capacity you would you read about is targeted at that.

Another part of our investment is focused in something that really nobody else is doing, which is our sweet spot of large bar and large tube in North America. And again, our biggest competition there is imports. We feel that this will give us some unique capabilities to pursue products that we have not participated in the past and also push out some imports. Certainly, market strength would help. But, the combination of the cost savings benefit that we get from this, the product capability that we get from this, the markets that we can pursue with this. The short answer to your question in terms of concerns of margin pressure on that, would generally be no, and that is why we are continuing to proceed with those investments.

Okay.

So if overall volumes remain in the same area, you would not expect climbing pressure just from the new capacity?

I'm sorry. Repeat that question.

If volumes and tonnage remained at the same level they are at today, over the next 12 months, you would not expect to see climbing margin pressure just because of new capacity in the market?

Well, there would be some pressure there, but remember a big part of our investment plan is also cost reduction. The net of that, I would certainly still see as margin improvement, not margin erosion.

Okay.

And then you mentioned there is obviously a potential trade case for OCTG. I know you are not in OCTG. But as it relates to the energy side, do you see any potential positive knock-off benefit in terms of imports coming in on the energy side, they need to get more cautious because of the OCTG case, or do you see it as totally unrelated?

There is some small potential impact. We have not seen any impact yet. And, again, the bulk of that is focused on the volume side of OCTG, which as you said, we don't participate. But there is, as you get into some of the more specialty products, there is certainly some possibility that that could reduce the likelihood of customers pursuing imports, and focus more on the domestic mills.

Okay, great, thank you.

(Operator Instructions)

And there are no questions at this time. Gentlemen, I will turn things back over to you for any additional or closing remarks.

All right, again, thank you for your interest and thank you for your questions. I think the questions today were particularly good in reinforcing the fact that Timken is demonstrating value by serving our customers well, and delivering strong financial results in the face of lower demand. We appreciate your interest and your investment in the Timken Company. Thank you.

And that does conclude today's teleconference. Thank you all for joining.