Shelly M. Chadwick - Treasury & Vice President-Investor Relations Richard G. Kyle - President and Chief Executive Officer Philip D. Fracassa - Executive Vice President and Chief Financial Officer.

Ross P. Gilardi - Bank of America Merrill Lynch Samuel H. Eisner - Goldman Sachs & Co. David Michael Raso - Evercore ISI Institutional Equities Steve Barger - KeyBanc Capital Markets, Inc. Eli S. Lustgarten - Longbow Research LLC Justin Laurence Bergner - Gabelli & Company.

Good morning. My name is Aaron, 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 Release Conference Call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session. And thank you, everyone. At this time, Miss Chadwick, you may begin your conference..

Thank you, Aaron, and welcome to our second quarter 2015 earnings conference call. This is Shelly Chadwick, Vice President of Treasury and Investor Relations for the Timken Company. We appreciate you joining us today. If, after our call, you should have further questions, please feel free to contact me directly at 234-262-3223.

Before we begin our opening remarks this morning, I want to point out that we have posted on the company's website presentation materials that we will reference as part of today's review of the quarterly results. You can also access this material through the download feature on the earnings call webcast link.

With me today are the Timken Company's President and CEO, Rich Kyle; and Phil Fracassa, our Chief Financial Officer. We will have opening comments this morning from Rich and Phil, before we open the call up for your questions.

During the Q&A, I would ask that you please limit your questions to one question and one follow-up at a time to allow everyone an opportunity to participate. During today's call, you may hear forward-looking statements related to our future financial results, plans and business operations.

Our actual results may differ materially from those projected or implied due to a variety of factors which we describe in greater detail in today's press release and in our reports filed with the SEC which are available on the timken.com website.

We have included reconciliations between non-GAAP financial information and its GAAP equivalent in the press release and presentation materials. Today's call is copyrighted by the Timken Company. Without express written consent, we prohibit any use, recording, or transmission of any portion of the call.

With that, I would like to thank you for your interest in the Timken Company, and I will now turn the call over to Rich..

Thanks, Shelly. Good morning, everyone, and thanks for joining us for our quarterly update. I'll provide color on the quarter and the outlook, and then turn it to Phil to review in more detail. The quarter came in close to our expectations for revenue and earnings.

As expected, the strong dollar continued to affect the year-over-year comparisons, impacting the top line by $39 million or 5%. Putting currency aside, demand was slightly better compared to the first quarter.

While we experienced lower Mobile Industries demand, which reduced sales in that segment by 8% year-on-year, we're pleased by the fact that we continued to grow and Process Industries, and that's despite some very difficult heavy industries' end markets, posting a 4% increase in sales excluding currency.

We're capturing new business within specific areas, places like wind energy, industrial services, and marine, and that is offsetting general market weakness. Our adjusted earnings per share were $0.57. While this was off compared to the same quarter last year, EPS was up sequentially from the first quarter and basically in line with our expectations.

We made progress sequentially on margins with both segments showing improvement from the first quarter, but both segments remained below the low end of our margin targets, and we have more work to do to overcome the impact of currency and lower volumes to get the margins in the target ranges, and we're committed to doing so.

We also generated strong free cash flow in the quarter and expect to continue to generate solid cash flow through the course of the year. Our ongoing efforts to improve our SG&A cost structure continues to show results with costs down $11 million in total, and $6 million excluding the impact of currency from the second quarter of 2014.

We're also delivering significant cost savings in manufacturing and purchasing. But, when compared to prior year, these savings are largely being offset by currency and the reduction of volume in our plants.

We returned substantial capital to our shareholders in the quarter, purchasing 2 million shares of stock and increasing our quarterly dividend by 4%. While the second quarter came in close to expectations for revenue and earnings, it came up short on expectations for incoming orders, backlog and customer outlook.

As a result, we are taking a more cautious view of the rest of the year. Unlike last year, we did not see our backlog and order patterns build in the second quarter to the degree we needed to support a second half recovery in our markets. There remains much uncertainty in our end markets.

And while we'll be well positioned to respond to any upturns, we are preparing for a modest sequential second half softening from a combination of markets and normal seasonality. Mining, agriculture, rotorcraft, and oil and gas markets, all remained weak.

Oil and gas was not a big direct market for us, but we are now seeing an indirect effect on other North American markets, including metals and industrial distribution. This softness is expected to offset strength in automotive, rail and wind, as well as penetration gains.

While we came into the year with expectations for moderate growth, we're also committed to drive cost reduction. We're seeing the results of these efforts and are now working to accelerate our cost reduction initiatives across the enterprise to further offset the volume decline and the impact of currency.

We expect to continue to gain momentum on these initiatives in the second half of the year, which along with the share buyback will contribute to flattish EPS from the first half despite the softening markets.

In addition to cost reduction, we remain focused on developing innovative product solutions to satisfy our customers' bearing and power transmission challenges, delivering the highest levels of service and engineering support in our industry and expanding globally.

We continue to invest in our DeltaX growth initiative, accelerating our speed in product development and driving for growth in our core product lines. In products, new engineering and selling tools, geographic penetration, innovation, they all come together under the DeltaX umbrella to move our organic efforts forward.

Our development and application pipelines are building, which gives us confidence in our long-term penetration and success in the marketplace. I'll now turn it over to Phil..

Okay. Thanks, Rich, and good morning, everyone. I'll take you through a more detailed review of the numbers. At a high level, you'll see that Timken generated solid operating performance in the quarter, despite a challenging market and currency environment.

I'm going to reference the slides from the quarterly earnings presentation as I go, starting on slide 10. For the second quarter, Timken posted sales of $728 million, down 8% from last year, with currency negatively impacting our sales by $39 million or about 5%.

Excluding currency, sales were off roughly 3% as we experienced lower demand in many of our end markets, including aerospace, agriculture, automotive and industrial distribution. On the positive side, we saw year-on-year gains in wind energy, industrial services, military marine, and rail.

Regionally, excluding currency, our sales were up 7% in Europe and 4% in Latin America. While our European results were coming off a relatively low comp last year, we saw solid growth in wind energy and industrial distribution, and also had a nice contribution from the Revolvo acquisition.

Markets were relatively stable in Latin America, with modest gains posted in the industrial end markets. On the other hand, sales were off 5% in North America and down 7% in Asia Pacific. Several end markets in Mobile Industries contributed to the decline in North America. In addition, we saw further softening in our industrial distribution business.

In Asia, sales were down in China, as we are feeling the effects of the economic slowdown there, the main exception to that being wind energy where we continue to see good growth. In the rest of Asia, sales were up in India, and flat to down across the rest of the region.

You can see on slide 11 that gross profit in the second quarter was $205 million or 28% of sales, down about 140 basis points from last year. This was driven by currency and lower volume and mix, offset partially by favorable material and logistics costs.

SG&A expense in the quarter came in at $126 million, down about $11 million from last year, driven by lower incentive compensation, positive currency and the benefit of cost reductions, offset partially by higher employee benefit expenses. In the quarter, SG&A was 17.3% of sales, unchanged from last year.

Our second quarter EBIT was $74 million on a GAAP basis. On slide 12, when you back out pension settlement and other restructuring charges, adjusted EBIT in the quarter was $80 million or 11% of sales, compared to $96 million or 12.2% of sales last year. Currency impacted our margins by just over 100 basis points in the quarter.

On slide 13, you can see in summary that adjusted EBIT was negatively impacted by currency and lower volume and mix, offset partially by lower material costs and the impact of our cost reduction efforts in both manufacturing and SG&A.

As outlined on slide 14, we posted net income of $37 million in the quarter, or $0.43 per diluted share on a GAAP basis. On an adjusted basis, our EPS came in at $0.57, compared to $0.65 last year. Note that earnings per share benefited from a favorable tax rate and share buybacks, including 2 million shares repurchased during the second quarter.

Our GAAP tax rate in the second quarter was 43%. Our GAAP tax rate will be particularly volatile this year, due primarily to the large pension settlement charge we took back in the first quarter. On an adjusted basis, our tax rate was 31% in the quarter compared to 34% a year ago.

We expect to maintain our year-to-date adjusted rate of 31.5% for the remainder of 2015. This rate reflects our geographic mix of earnings and greater utilization of foreign tax credits. Now, turning to slide 15, let's take a look at our business segments, starting with Mobile Industries.

In the second quarter, Mobile Industries sales were $389 million, down 13% from last year, including 5% attributable to currency. The remainder was driven by lower aerospace, agriculture and automotive demand, offset partially by continued growth in the rail sector. For the second quarter, Mobile Industries EBIT was $36 million.

Adjusted EBIT was $37 million or 9.5% of sales, compared to $47 million or 10.4% of sales last year. The decline in earnings was driven by lower volume and negative currency, offset partially by lower operating costs and favorable SG&A expense.

We now expect Mobile Industries sales for 2015 to be down roughly 8% to 9%, driven in part by negative currency of approximately 5%. Excluding currency, sales are expected to be down 3% to 4% based on lower demand in aerospace and agriculture, offset partially by growth in automotive OE and rail.

EBIT margins are expected to be slightly below the low end of our targeted range of 10% to 13%, due in large part to currency. Slide 16 shows that Process Industries sales for the second quarter were $339 million, down 1% from last year.

Excluding negative currency, sales were up almost 4%, due mostly to continued strength in wind energy, military marine, industrial services and the benefit of acquisitions, which more than offset weaker industrial distribution demand. For the quarter, Process Industries EBIT was $57 million.

Adjusted EBIT was $58 million or 16.9% of sales, compared to $67 million or 19.5% of sales last year. The decrease in earnings was the result of negative currency and mix and unfavorable manufacturing utilization, as we did not build inventory like we did last year. Offsetting this was the benefit of higher sales volume and lower logistics costs.

We now expect Process Industries sales for 2015 to be down about 6% to 7%, including a negative currency impact of approximately 5%.

Excluding currency, sales are expected to be down 1% to 2%, reflecting weaker industrial after-market and heavy industries demand, including both direct and ripple effects from the downturn in oil and gas, offset by growth in wind energy and military marine and the benefit of acquisitions.

EBIT margins are expected to be slightly below the low end of our targeted range of 17% to 20%, due primarily to currency. Turning to slide 17. Free cash flow for the quarter was $65 million or 132% of adjusted net income, compared to $54 million during the same period a year ago, an increase of $11 million on lower earnings.

The improvement in free cash flow is driven in large part by favorable working capital and lower CapEx year-on-year. Looking at our balance sheet and capital allocation on slide 18. We ended the quarter with net debt of $382 million or 22% of capital, compared to net debt to capital of 13% at the end of 2014.

During the quarter, we continued putting our balance sheet to work and executing on our capital allocation plan. We invested $24 million in CapEx, supporting growth and margin improvement. We increased our quarterly dividend by 4% in May to $0.26 per share, paying out $22 million in the quarter.

And we bought back around 2 million shares at a cost of $80 million. Year-to-date, we've repurchased 4.3 million shares. As of the end of the second quarter, we have around 4.6 million shares remaining under our buyback authorization, which expires at the end of 2015.

We'll continue to march toward our 30% to 40% leverage target and expect to continue to be in the market buying back shares. We'll continue to report our progress on a quarterly basis. Shifting for a moment to our outlook on slide 19.

We now anticipate consolidated sales for the year to be down around 7% to 8% compared to last year, including 5% negative currency. We expect GAAP earnings per diluted share to be in the range of $0.30 to $0.40 per share. Included in our GAAP earnings outlook are three unusual items.

Non-cash pension settlement charges of $1.80, impairment and restructuring charges of $0.20, offset by $0.20 of income related to discrete tax accrual adjustments. Excluding these unusual items, which net to $1.80 per share of expense, we expect adjusted earnings per share to range from $2.10 to $2.20 per share.

We expect adjusted EBIT margins in the range of 11% at the corporate level, including a negative currency impact of around 100 basis points. Note that our EPS guidance includes share buybacks through the end of the second quarter. Any additional buybacks would further increase our EPS.

We'll adjust our guidance for share buybacks, as necessary, each quarter. For 2015, we expect strong free cash flow of roughly $190 million, after CapEx spending at around 4% of sales. This represents over 100% of estimated adjusted net income for the year.

While the year is shaping up to be more challenging than originally anticipated, we remain focused on driving our strategy and continuing to improve our financial performance. We are well positioned to capitalize on market upturns, should they materialize faster than our outlook would imply.

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

Operator?.

Thank you. And we'll take our first question from Ross Gilardi with Bank of America Merrill Lynch..

Hey. Good morning, guys. Thank you..

Morning, Ross..

Hey, Ross..

I first want to ask you about North America and the volume decline there. It seems to be pretty consistent across a lot of companies similar to yours, where the U.S. actually feels like it's one of the tougher markets right now. And obviously you've got oil and gas, but you've got a lot of other end markets, too.

But maybe you can just flush that out a little bit more about what you're seeing in the U.S.? And many of those indirect impacts that you've referenced before?.

Yeah. I'll start with that, Ross. We came into the year with an outlook for North America that we categorized as neutral. And you go back to January, we had a slide where we had markets that were positive, neutral and negative. And North America has definitely moved through the first six months, just for this year, from a neutral to a negative.

And with two other markets in that neutral category that industrial machinery, which would include industrial distribution, which serves a wide variety of small OEMs, end users, after-market, steel mills, et cetera; and then the heavy industry side, mining, metals.

And those areas have – through the second quarter, we did not see any strengthening in order book for that and expect some sequential softening in those markets.

So last year, during the course of the second quarter, we would have saw order book improving for the most part in those areas, which led to sequential improvement in the third quarter and year-over-year, and we did not see that through the second quarter. I would categorize that though that it's not a massive move.

It's not a massive de-stocking and it's more a flattish to a gradual decline across a broad swath of markets. And we're getting feedback from customers that they see more impact from the oil and gas effect than what maybe they would have anticipated.

So, the example, industrial distribution, the two big bearing distributors in North America are Applied Industrial Technology – Applied Industrial Technologies I don't believe has reported yet. And motion industry is a part of Genuine Parts, and Genuine Parts certainly referenced oil and gas in the slower North American industrial market..

Got it. Thanks, Rich. That's helpful. And then, can you talk about your latest thoughts on restructuring? And what, if any, hesitation do you have to embark on a much more substantial restructuring? I would imagine Timken's got a fair amount of excess capacity right now. I mean, demand for – it's not just Timken, it's just across this base.

Demand just isn't there and you're trying to sustain margins.

And what else can you do? And any thoughts on timing on when you might move forward on a bigger initiative?.

Yeah. I'll take that, Ross. So, first, on the non-manufacturing side, we've been steadily working at that for close to two years now and see a continued steady working of that going forward. Making good progress on that and expect to continue to make good progress on that.

On the manufacturing side, which is certainly the bigger piece, we do have excess capacity. We have been guiding to $15 million to $25 million of annual restructuring. We've guided to $20 million this year.

Don't have it in front of me, but I believe our spend rate for the first half was around 6% or 7%, which clearly implies that we would have an acceleration of spending in the second half.

And as we made comment in my prepared comments that we're looking to generally accelerate that work, I would not expect something to be significantly outside the range for 2016. We're not really here to guide to 2016, but I would not expect a massive move. With that sort of guidance range, we can continue to make significant headway on that.

And our restructuring is more around repositioning our footprint, investing additional capacity in lower cost regions and shuttering less competitive capacity or reducing less competitive capacity. And I think you'll continue to see that moving forward.

So, some increase in the second half from the first half, and then I would certainly expect 2016 to be on the high end of where we've been the last couple of years but not significantly over that. And with that, and volumes where they're at, currency where it's at, we can get ourselves back into our targeted margin ranges going forward..

Okay. Thank you. And then, just lastly, your thoughts on your year-end debt-to-capital targets and M&A versus buybacks? And should we – what can we think about for M&A? Should we be thinking more of like small- to mid-size deals or – a lot of the larger deals have clearly gone at very competitive multiples..

Sure. I'll take that one, Ross. This is Phil. Good morning. On the capital allocation, as you know, we continue to be in the market buying back shares. We bought back two million shares in the second quarter. We would expect, given where the price is, that we will be buying back shares in the second half. We'll update you every quarter as we go.

On the M&A front, we continue to work a pipeline of candidates in that small- to medium-sized range, nothing in the large category at the present time, and are actively working the pipeline and would be hopeful to complete some M&A this year..

But are you wed to that year-end debt-to-capital target? Or do you feel like that could just get pushed out a bit just because these things are very difficult to time?.

Well, things aren't difficult to time. I'll jump in on this one, Ross. If we completed the entire share buyback, no M&A, it would probably still leave us a little bit light of the target. If we completed some sizable M&A, it would put us in the middle. So, again, we've been moving forward towards that.

So I think, with confidence, as Phil already said, we will be in the market in the third quarter and with confidence we can say we will move materially toward the low end of that even without M&A, and with even some modest M&A, that would put us in the low end of the range..

Okay. Got it. Thanks very much..

Thanks, Ross..

And we'll go next to Samuel Eisner with Goldman Sachs..

Yeah. Good morning, everyone..

Morning, Sam..

Morning, Sam..

So can you talk a little bit about the competitive environment? In particular, have you seen any competitive dynamics from some of your competitors internationally with regards to using FX as a tailwind to their business? Any update that you can give there would be great..

I would say, Sam, very clearly, we are not seeing any competitive effects of currency with the exception of that it has impacted our margins by the tune of 100 basis points, and we have not made up for that in pricing. So, that obviously gives us some reluctance to move pricing. But beyond that, there has been no real competitive dynamic on that.

Certainly, we track our market share very closely as we're going forward and try to track it, looking at what we're winning, what we're losing, and then are able fairly well, with industry data other competitors reporting, to track it from a historical standpoint.

And we look back on the first quarter and think we stacked up pretty well and are quite confident that we are not losing share in the environment that we're in and are not seeing any real changes in dynamics of pricing..

Got it. Perhaps switching gears a little bit. Can you talk a bit – you were answering the prior question. Can you talk a bit about what your current utilization is, say, in the second quarter? What was it in the first quarter? And if you can give some information in regards to the two operating segments, that'd be great..

Yeah. Sam, this is Phil. I'll take it. I would say utilization is actually down slightly in the second quarter versus the first. We have been working to keep inventory under control and, in fact, generated some cash from inventory in the second quarter.

The absolute numbers are a little bit misleading, just given the various markets and places where we participate. But I would say, in areas like wind and rail, we continue to run at very good capacity levels. On the other hand, in heavy industries and agriculture, et cetera, utilization would have been fairly light.

But, by and large, I would have said slightly down from the first quarter and then down from the same period a year ago where we were actually building inventory..

And taking that same question and looking at your guidance for the back half of the year, are you implying kind of flat utilization levels from what you currently are or are you planning for any acceleration? Any help there would be helpful..

Yeah. I would say, in the back half, we're going to continue to work on the inventory. But I would anticipate utilization would stay relatively – sales will be down slightly, utilization to be relatively flat to down slightly..

Great. And then, I guess just lastly, any update on the aerospace restructuring and the plans to I guess try to monetize the PMA portion, that'd be great..

At this point, we've announced that we are looking at strategic alternatives for the PMA parts business and we don't have any updates on that. We'd expect to conclude that process certainly before the end of the year..

Great. I'll hop back in queue. Thanks..

Thanks, Sam..

And we'll go next to David Raso with Evercore ISI..

Hi. Thank you..

Morning, David..

The growth from rail and wind have been pretty important to keeping the numbers afloat a bit.

So can you give us a little bit of color on the visibility you have for both businesses, particularly if those are extending beyond this year?.

Yeah. I'll start, David, and Rich can jump in. The rail and wind, you're exactly right, I mean they've been running very strong for the last – over 18 months frankly, both up in the first half nicely.

I would say we're continuing to see good growth in both of those segments, albeit as we've grown so rapidly, obviously the comps get a little bit tougher. So the year-on-year increases will begin to moderate from a percentage standpoint. But continuing to see good growth in wind for the rest of the year and also continuing to see good growth in rail.

And that's both domestically with some of the share gains and penetration that we've achieved as well as, probably more importantly, internationally as we've moved into Eastern Europe and more heavily into Asia..

How large is the wind business going to be this year?.

We haven't really commented on it. We've said – last year we were north of $100 million, close to $120 million, and again, anticipating solid growth this year. We don't really comment on what it'll be at the end of the year. We'll get into that probably in the first quarter of next year..

And just the nature of the business, is there any visibility on rail beyond this year? Or is that mostly a kind of six-month, three-month turn type business?.

I would say that's a four-month to six-month type visibility business now for us with firm orders. But I would also say the customer pulse on it is still relatively bullish for both the after-market as well as the new equipment build..

All right. That's helpful. I appreciate it. Thank you..

Thanks, David..

Thanks, David..

And we'll go next to Steve Barger with KeyBanc Capital Markets..

Hi. Good morning..

Morning..

Morning, Steve..

I wanted to go back to the Process segment. You had organic growth of better than 6% in the first half. Now you're looking at a decline of 1%, 2%. So, a big step down in 2Q.

Is that just a continuation of current trends against tougher comps? Or is there something really specific in there that's driving that decline?.

Tougher comps is certainly a big part of it and then we are looking sequentially for a softening in industrial distribution..

Okay. So, well, I guess two questions there.

As you look at the distribution channel, is it the heavy equipment guys where you're going to see continued de-stocking? Is that kind of the concern that you have around that?.

Yeah. Heavy equipment and industrial distribution. And the heavy equipment side has an element of agriculture which is immobile and has a element in Process Industries.

But, yes, even when you look at industrial distribution, which is serving all markets, our customers are pointing to the heavy equipment side of their business, oil and gas and the industries that serve that market, mining, agriculture as leading reasons for their decline in the second half that they're forecasting..

But, again, this is probably just a continuation of the trends that are already in place? Or is that accelerating?.

I would say that's an accurate statement, is a continuation of the trends that were in place, not an acceleration. And the real point would be last year we saw the trend reverse in the second quarter and this year we are not anticipating that reversing in the second half of this year..

Got you. Okay.

And sorry if I missed this, but any unusual impact in either segment in one quarter or another? Or are you expecting the back half guidance of $1, plus or minus, to kind of be equally weighted between the quarters?.

Yeah. I would say, nothing jumping out that would – normally seasonality for us would be that big OEs would tend to slow down in the fourth quarter. Having said that, our services business, its seasonality would generally tend to pick up in the fourth quarter.

So, from a quarter-to-quarter standpoint over the rest of the year, we would say not a big difference between the quarters..

Thanks. One more and I'll get back in line.

Thinking about some of the outgrowth initiatives that you've been working on, are you seeing customers with those tougher end markets get more cautious on wanting to engage in new product development, or in spending the engineering dollars for redesign? Or are they accelerating that process to help their own results?.

No. And it's a good question. I tried to allude to that, but I'm glad you asked that. We are not seeing that at all. We're seeing a lot of focus in the OEM customers and the customers that we partner with on design to continue a focus on new models, new equipment, energy efficiency, power density and other technical streams.

So, no slowdown at all in focus on innovation and new designs..

Very good. Thanks. I'll get back in line..

And we'll go next to Eli Lustgarten with Longbow Securities..

Good morning, everyone..

Morning, Eli..

Morning, Eli..

Just a clarification.

One, is there any change in the original plan of completing the share repurchase that expires by the end of the year? I mean, that's still the goal, isn't it?.

Yeah. Eli, as we've talked about, our goal is to get at the low end of that range by the end of the year. And as we said, if we were to complete the program and do no M&A, we'd still be below. So we're going to continue to be in the market in the third quarter.

But it is still the target to get to the low end of that range using the buyback and M&A that we continue to work on as the primary means to get there..

We've hedged the answer to say that we will definitively do it for the purpose of that if some M&A came in there, Eli. But, obviously, the window is getting shorter and shorter to do that. And Phil just alluded that what we have in our pipeline is more smaller and mid.

So, obviously, the likelihood of the full 10 million shares is increasing as the year goes on and we, through the first half of the year, have been holding roughly that pace..

Yeah. Right. I don't want to bring up a sore point, but the stock is getting cheaper and cheaper, too, making it less money to do it..

Thanks for that sore point, Eli..

Inventory levels, I mean are you comfortable – where were inventory levels around the corporation, and at the distributors, and versus competition? Is the whole industry going to go through an inventory liquidation in the second half of the year or....

Well, the numbers that – going back to previous question, is this an acceleration of a trend or a continuation of a trend, and in pricing, it's more of a continuation. The numbers we're seeing from distribution are a gradual softening, not a dramatic one.

So, outside of agriculture, which probably still hasn't seen bottom and has a lot of inventory to flush through channels, we have in the revenue guidance a gradual de-stocking to match the decline in revenue, but nothing that would anticipate a significant push-out of inventory in the fourth quarter.

And I think that's based on history and all the indicators we have at this point..

And you talked about rail being an improving market. We know wind is about $120 million and growing.

How big is rail for you at this point? And with these new regulations that may or may not happen, what have you, are you seeing any movement or any indication that that could stimulate the rail business as we get past the next year and beyond?.

Yeah. Rail business is north of $300 million, Eli, and obviously grew a lot last year, continues to grow this year. As far as the regulations, we do see opportunity for us to gain some business and participate in the conversions that are going on not only in the U.S. but also around the world.

And that does continue to present some nice opportunities for us..

And can we talk a little bit about oil and gas and how big it is? And you reported in both sides of the business, it was Mobile and in Process, and what's your experience? Are you down to the same 25% that everybody else is, more or less?.

Our intent will be to capture all of that, also all the direct oil and gas business and Process Industries to a degree. There's an indirect effect on rail and trucking and that sort of thing would obviously fall into Mobile Industries. It's, as I said, for direct, a relatively small market for us, 3%-ish.

That's down a lot, I would say at least the 25% number that you referenced. But we're seeing more – other customers point to it as a reason for their decline, and again, industrial distribution probably being the easiest one to point to where they're pointing to softness in their metals customers in the U.S.

and believing that that has some trickle effect from oil and gas as well..

And just one clarification, one more. You mentioned that the Ag business has not seen bottom yet? I mean, we've been hearing some conflicting stuff from other companies.

You're saying there's still lot of inventory, so Ag still has more downside to go at least on the bearing side?.

Well, yeah. Internally, Eli, we've obviously worked very hard to take some inventory out at the end of last year, kind of manage the seasonal build we would normally expect in the first half. Inventory has been a positive. And when we look back to year-end, look back year-on-year, inventory has been a positive contributor from a cash standpoint.

We'd expect to continue to manage it very tightly, obviously balancing it with the need to make sure we maintain high service levels because our customers, they depend on high service levels in the channel. So we're going to balance both of those, but I would expect us to continue to manage inventory very tightly for the rest of the year..

And Eli, we would be looking sequentially second half our off-highway equipment, which Ag would be a big part of that, construction would be a part of that – rail is not, rail is a service sector – but to be down sequentially in the second half versus the first half and 10%-ish type number, so still on a declining path for us..

Okay. All right. Thank you very much..

Thanks, Eli..

And we'll go next to Justin Bergner with Gabelli & Company..

Good morning, everyone..

Morning, Justin..

First, I want to ask about the margin headwind associated with currency, the 100 basis points or so?.

Yeah..

And how that sort of factors into the role that FX is playing.

How exactly do you measure the margin headwind associated with currency?.

Sure, Justin. I'll take that. I mean, for us, as we've talked about, currency really takes a couple of forms here. There's normal translation, which would typically – our foreign earnings translating back to U.S.

dollars – would normally translate at around, call it the corporate EBIT margin, maybe a little bit higher because we have a lot more administrative expenses here in the U.S. But in addition to that, we have a lot of cross-border activity where we serve, for example, Canada out of the U.S.

or serve Latin America out of the U.S., et cetera, where those cross-border shipments coming out of the U.S., coming out of China, into lower currency countries can actually create a larger net impact on our margins.

So, when we sort of combine the two, we're seeing currency – so the top line in the quarter would have impacted us by around $39 million. On the bottom line, you saw in one of the charts the impact was around $13 million. So it actually blends to around a 33% impact, a pull-through, if you will, on the quarter.

So, to really estimate the impact of the margins, we just typically would add back the sales impact to currency, add back the earnings impact to currency, and then recompute. And it's coming through – in the first quarter, it was a little bit under 100 bps. In the second quarter, it was right around 100 bps.

And then, we'd expect around that number for the full year..

Okay. But when you do that margin comparison, are you actually thinking about product that's priced in foreign currency versus the U.S.

dollar-denominated costs?.

Exactly. That's exactly right. So we make it in the U.S. All the costs are in dollars. For example, ship it to Canada, it's priced in Canadian dollars. And that translation or that transaction creates a loss for us this year year-on-year relative to the Canadian dollar and how it's declined..

Okay. Got it. So you're not increasing your prices for goods that are denominated in foreign currency due to the FX exchange rate. You're keeping the Canadian dollar price unchanged, while you experience perhaps more cost pressure given U.S. dollar-denominated costs..

I'd say pricing decisions are kind of made independently. Obviously, we're cognizant of the currency when we look at setting prices and, for example, we have put through a price increase up in Canada this year, normal price increase.

So we do make the pricing decisions, call it, generally independent of currency but obviously mindful of what the currencies are doing in the various regions around the world..

Okay. Great. Thanks for that discussion.

With respect to mix and volume and sort of the EBIT bridge, that negative $14 million of volume mix, is it like half-and-half volume mix or any sort of detail you can provide there?.

I'd say it's primarily volume but there is a negative mix element and it's primarily coming through, at least in the second quarter, primarily coming through Process Industries, as we talked about the industrial distribution being down. We've talked about after-market being our highest margin business within Process Industries.

So, with after-market being down and the OE business being up within Process, that's produced a little bit of negative mix. Mobile was on the mix line I would say relatively flat in the quarter..

Okay. But I guess across Process and Mobile, the higher growth of Process relative to Mobile would have a slight benefit to mix, offsetting some of those headwinds within Process, is that....

That's generally how to look at it. I mean, growing in Process generally mixes us up at the corporate level. In this case, because of the negative mix within Process, it mitigated it to a great degree..

Okay. And then, just more of a big picture question, I mean it's been sort of over a year now that Timken's been on the hunt for M&A properties. And you haven't really closed anything major or announced anything major.

Could you maybe just talk about what is unique in your process that may make it more conservative or perhaps give some detail behind situations where deals didn't come together that looked like they were going to come together? I guess what's making it so hard to sort of get to the finish line?.

Well, I think a couple things. As we look at M&A, it really all starts – first of all, we have a robust process and I think we've made really good strides in improving the process over the last many years. It starts with a strategic fit, so looking for companies that have that strategic fit and that's kind of filter one.

Next, obviously we have – very disciplined in our approach from a financial standpoint. We want the target to be accretive to earnings in year one and earn the cost of capital by year three, have an attractive IRR. Obviously that's the other filter. But I would say, M&A doesn't come steadily. It doesn't come quarterly.

It kind of comes in chunks, if you will. So we just keep working at it. And as we've talked about over the last quarter, we're pretty encouraged by the pipeline as we see it today and, again, hopeful we'll be able to be successful on some front this year.

Rich, anything to add here?.

No. I don't think so. I think Phil hit it. We try to maintain – we do maintain a disciplined process. And then, obviously, from a capital-allocation standpoint, the share buyback is also an attractive option for us that we've obviously been executing on considerably..

Great. Thank you for taking all my questions this morning..

Thanks, Justin..

Thanks, Justin..

And that does conclude the Q&A portion of today's conference call. We'd like to thank you all for joining today's conference, and we thank you for your participation, everybody. You may now disconnect..