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Edited Transcript of TKR earnings conference call or presentation 31-Jul-18 3:00pm GMT

Q2 2018 Timken Co Earnings Call

CANTON Aug 7, 2018 (Thomson StreetEvents) -- Edited Transcript of Timken Co earnings conference call or presentation Tuesday, July 31, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jason Hershiser

* Philip D. Fracassa

The Timken Company - Executive VP & CFO

* Richard G. Kyle

The Timken Company - President, CEO & Director

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Conference Call Participants

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* Christopher M. Dankert

Longbow Research LLC - Research Analyst

* David Michael Raso

Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team

* George James Godfrey

CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst

* Joseph O'Dea

Vertical Research Partners, LLC - Principal

* Justin Laurence Bergner

G. Research, LLC - VP

* Robert Stephen Barger

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Ross Paul Gilardi

BofA Merrill Lynch, Research Division - Director

* Stephen Edward Volkmann

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good morning. My name is Celestina, and I'll be your conference operator today. As a reminder, this call is being recorded. At this time, I'd like to welcome everyone to the Timken Second Quarter Earnings Release Conference Call. (Operator Instructions) Thank you. Mr. Hershiser, you may not begin.

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Jason Hershiser, [2]

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Thanks, Celestina, and welcome, everyone, to our second quarter 2018 earnings conference call. This is Jason Hershiser, Manager of Investor Relations for The Timken Company. We appreciate you joining us today. If after our call, you should have further questions, please feel free contact me directly at (234) 262-7101.

Before we begin our remarks this morning, I want to point out that we have posted on the company's website the 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 earnings call webcast link.

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

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Richard G. Kyle, The Timken Company - President, CEO & Director [3]

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Thanks, Jason. Good morning, everyone. Thanks for taking their time to join us today.

We reported another excellent quarter, strong financial performance as a result of market demand, our outgrowth initiatives and our operational execution. Revenue was up 21%, with 15% from organic and 5% from acquisitions. Our organic results continue to outperform industry averages as we win in the marketplace with our products, our technical sales model and our service. We are delivering growth across product lines, across markets and across geographies, and we are serving our customers well. On the inorganic, all 3 of the acquisitions we completed in 2017 are contributing at high levels.

We delivered a record $1.11 of adjusted earnings per share, an increase of 63% for the second quarter of last year. The EPS results reflect the benefits of organic growth, price, mix, acquisitions, cost and tax reform. We achieved 14.4% EBIT margins in the quarter, a 320 basis point improvement from the same quarter last year and a 90 basis point improvement sequentially.

Mobile margins improved to 11.2% in the quarter, and the second quarter was our fourth consecutive quarter of sequential margin expansion in Mobile as we recover material costs from pricing as well as leverage volume and improve mix. We remain focused on moving Mobile margins above our 12% target. Process margins improved to 21.8%, up 420 basis points from the second quarter last year. Our focus in Process is to continue to outgrow our end markets at these levels of margins.

Our material costs were up in the quarter, and we expect that trend to continue through the year and into 2019. We more than offset costs with price, and price costs improved in the quarter. Looking forward, we expect price to move up slightly sequentially through the second half of the year and for price costs to remain positive despite tariffs and modestly increasing input costs. We will continue to pursue pricing in the marketplace, and we remain confident in our ability to recover material costs over time. And as we've already demonstrated in 2018, we believe, in the current environment, we can both gain share and move price up.

Margins were also held by our ongoing operational excellence initiatives, including last year's plant closures and this year's plant ramp-ups. Strategically, all 3 of the acquisitions we completed in 2017 are performing very well. They are contributing to our margin improvement, they are growing and their backlogs are up.

We are also successfully generating our planned cost and revenue synergies. We are excited to build upon this successful track record with our recently announced acquisitions of Cone Drive and Rollon. A year from now, we believe these 2 businesses will be contributing at similar levels, and I'll discuss why in just a few moments. Cash flow from Q1, as it usually does -- cash flow improved from Q1, as it usually does seasonally, and was up from prior year. We expect much stronger cash flow in the second half than the first half of the year as our inventory build leveled off in the second quarter. We expect inventory to remain flattish through the second half.

Turning to the outlook. We have seen demand remain strong through the second quarter across nearly all end markets and geographies. And when that market strength is combined with our outgrowth initiatives, we are forecasting second half revenue to be up 19% in total, with 15% from organic and 6% from inorganic, with currency slightly negative. We are planning on the second half to be roughly flat organically with the first half, which bodes well for the start to next year, and we are planning to grown again organically in 2019. In total, we are forecasting revenue to be up 21% for the year, which we are confident will be well above industry averages.

We are revising our EPS guidance to a record $4.15 at the midpoint, up over 55% from 2017. That implies full year margins in the high 13s and up over 250 basis points from last year. The year-on-year EPS increase is primarily driven by growth in volume but also helped by acquisitions, price, mix, tax reform and our operational excellence initiatives.

I'll make a few comments now on the trade front. As it relates to steel tariffs, we expect a negligible direct impact on our business since we only import a small amount of raw steel into the United States. Indirectly, we expect prices from U.S. steel producers to go up again in 2019. It'll be typical in a market like this for us to experience steel cost increases. It is not clear yet if prices will go up more due to the tariffs than they would otherwise would. But if they do, we have 2 primary mitigating options to offset these increases, and those are price increases to our customers and/or shifting our footprint and sourcing strategy. We'll see how steel pricing in the United States develops over time, and we will react accordingly.

On the 301 tariffs, we do import products from China are that now subject to the tariffs. We expect to pay tariffs through the second half of the year, and those incremental costs are reflected in our guidance. We have multiple mitigation possibilities, which include price increases, changing sources and share gains from competitors that are facing tariffs. In summary, from a short-term direct standpoint, the tariffs are currently a manageable situation for us, creating some opportunities as well as some cost challenges. More concerning is the long-term indirect impact on what this means for our customers and our markets. However, I want to emphasize that while our customers are expressing concerns and are developing their own mitigation plans, we are not seeing any negative impact on their outlook for 2018 or '19 at this point.

Finally, let me wrap up with some comments on Cone Drive and Rollon. We're very excited to be adding these 2 brands and businesses to expand our portfolio and strengthen our presence in attractive markets around the world. Both acquisitions are a great strategic fit and they share several commonalities. Both Cone Drive and Rollon provide highly engineered products and like Timken, have leading technical product positions with strong brand recognition. Both are global businesses, they scale us in existing markets with existing customers while also expanding us into new markets with new customers.

Cone Drive and Rollon have a history of growth and serve markets with products that have a strong growth outlook. The businesses are growing in 2018 and have backlogs to support strong revenue growth in the year ahead. Both come in at Timken with higher EBITDA margins than our company average and as before, synergies. And finally, both acquisitions have the scale and technology to compete on their own, and they will be even stronger as a part of the Timken portfolio of products.

Specific to each acquisition and starting with Cone Drive, Cone Drive is based in the United States, is a leader in solar drives globally and a U.S. leader in various applications in end markets such as oil and gas. They also have a growing position in robotic drives and food and beverage. The acquisition give us our first nonbearing manufacturing presence of scale in China, and we look to use that position to accelerate our China power transmission growth initiatives. Cone Drive also has a good position with our existing U.S. distribution customers which further builds our leading position and is critically important and profitable channel.

Switching to Rollon. Rollon serves very diverse markets and customers, with their top 100 customers comprising less than 1/3 of their revenue. Linear motion is a large, growing and profitable industry, and the products serve a similar technical solution to rotational bearings, making Rollon an attractive adjacent product line. Rollon has a strong market position in Europe, with a modest position in the United States. Our primary synergy focus will be to accelerate growth in United States and emerging markets through Timken's channels and Rollon's technical capabilities. Rollon technology is applicable to a sizable unserved market space and has been on a strong revenue growth track for several years. Again, we are excited to have these 2 strong brands and management teams at Timken.

And with that, I will turn it over to Phil.

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [4]

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Thanks, Rich, and good morning, everyone. For the financial review, I'm going to start on Slide 13 of the materials. Timken delivered strong performance in the second quarter, and you can see a summary of our results on this slide. We posted revenue of $906 million, up 21% from last year. Adjusted EBIT came in at $131 million or 14.4% of sales, with margins expanding 320 basis points year-on-year. And adjusted earnings came in at a record $1.11 per share, up 63% from last year.

Turning to Slide 14. Let's take a closer look at our second quarter sales performance. Organically, sales were up around 15%, reflecting continued strength across the industrial end markets plus the benefit of outgrowth initiatives and positive pricing. Acquisitions completed last year added $34 million of revenue in the quarter or about 4.5%, and currency translation contributed just over 1% to the top line. On the right, we show organic growth by region, so excluding both currency and acquisition. You can see that all regions were up in the quarter organically, with sizable gains outside North America.

Let me touch on each region briefly. In Asia and Europe where we were up 25% and 24%, respectively, we saw continued strength across virtually all of the end markets and sectors we serve. In Latin America, we were up 22%, driven mostly by growth in rail and industrial distribution. And in North America, our largest region, we were up 8%, with most industrial sectors up, led by distribution, services and off-highway, while we saw lower shipments in automotive. The automotive issue is timing. We expect to make this up in the third quarter.

Turning to Slide 15. Adjusted EBITDA in the quarter was $131 million, up from $84 million last year. Adjusted EBIT was 14.4% of sales in the quarter, up 320 basis points from a year ago. The increase in EBIT was driven by higher volume, favorable price/mix, manufacturing performance and the benefit of acquisitions, offset partially by higher material, logistics and SG&A costs.

Let me comment further on a few of these items. As I mentioned, price/mix was positive in the quarter. Pricing was positive in both segments but with more coming in Process Industries than Mobile Industries. Mix was also positive, driven by the stronger rail and distribution sales.

Looking at price cost. This, too, was a net positive in the quarter despite higher material costs year-on-year. While we continue to anticipate material cost inflation over the course of the year, we expect the price cost dynamic to continue to be positive and for price cost to be positive in both the third and fourth quarters.

Turning to manufacturing. Our favorable performance was driven by higher production volume and improved operating leverage in the quarter, which more than offset relatively normal inflation. And looking at SG&A, the increase there was driven by higher compensation expense and other spending increases to support our current sales levels.

On Slide 16, you'll see that we posted net income of $91 million or $1.16 per diluted share for the quarter on a GAAP basis. On an adjusted basis, we earned a record $1.11 per share, up 63% from last year. In the second quarter, our GAAP tax rate was 25%. Excluding discrete and other items, our adjusted tax rate in the quarter was 27%, down from 29.5% last year. The tax rate was in line with our expectations for 2018 and reflects the favorable impact of the U.S. Tax Reform. We expect our adjusted tax rate to remain 27% for the balance of the year.

Now let's take a look at our business segment results, starting with Process Industries on Slide 17. Process Industries sales for the second quarter were $417 million, up 22% from last year. Organically, sales were up $65 million or 19%, reflecting strong demand across the distribution, OE and services sectors as well as the impact of positive pricing. Acquisitions and currency were both favorable in the quarter as well, adding roughly 3% combined to the top line.

Looking a bit more closely at the markets. In the distribution channel, the strength was broad based, with all regions up year-on-year. We ended the quarter with our backlog and distribution up sizably versus last year and up sequentially. In the heavy and general industrial OE sectors, we also saw pretty broad growth across end markets and regions. In our services business, we had higher revenue from an improving market for high-speed gearbox repair and other MRO projects. And finally, both military and marine and wind energy were up in the quarter. In wind, we continue to gain market share in an otherwise soft demand environment.

For the quarter, Process Industries EBIT was $91 million. Adjusted EBIT was also $91 million or 21.8% of sales compared to $60 million or 17.6% of sales last year. The increase in earnings was driven by higher volume and favorable price/mix, offset partially by higher material, logistics and SG&A costs. Process Industries adjusted EBIT margins were up 420 basis points year-on-year and up 110 basis points sequentially from the first quarter. Our outlook for Process Industries is for 2018 sales to be up approximately 25%. Organically, we're planning for sales to increase around 19%, driven by broad growth across all of the markets and sectors we serve as well as the impact of share gains and positive pricing. And we expect acquisitions and currency translation to add 6% collectively to the top line for the year.

Now let's turn to Mobile Industries on Slide 18. In the second quarter, Mobile Industries sales were $489 million, up around 20% from last year. Acquisitions added $31 million of revenue in the quarter or 7.5%, while favorable currency translation added around 1% to the top line. Organically, sales were up $47 million or over 11%, reflecting growth in the off-highway, rail and heavy truck sectors. Aerospace revenue was up slightly in the quarter as well, while automotive was roughly flat globally.

Looking a bit more closely at the markets. In off-highway, the construction, mining and agriculture sectors were all up in the quarter. In heavy truck, our growth was driven mainly by higher shipments in Europe and Asia. And in rail, we saw strong growth in Latin America and Europe. Rail fleet car build in North America are improving, and we expect North American rail to be up in the second half of the year.

Mobile Industries EBIT was $55 million in the quarter. Adjusted EBIT was also $55 million or 11.2% of sales compared to $36 million or 8.8% of sales last year. The increase in earnings reflects the impact of higher volume, favorable price/mix, manufacturing performance and the benefit of acquisitions, offset partially by higher material and SG&A costs. Mobile Industries adjusted EBIT margins were up 240 basis points year-on-year and up 60 basis points sequentially from the first quarter. Our outlook for Mobile Industries is for 2018 sales to be up approximately 18%. Organically, we're planning for sales to increase about 12%, led by global growth and outgrowth in the off-highway, heavy truck and rail sectors. And we estimate that acquisitions will add 6% to the top line with currency relatively neutral.

Turning to Slide 19. You'll see that operating cash flow was $102 million in the quarter. After CapEx spending, our second quarter free cash flow was $80 million, up from $47 million last year. The increase in free cash flow was driven primarily by higher earnings in the quarter, offset partially by increased working capital to support our current sales levels. You can see some of the highlights in regards to capital allocation on the bottom of this slide. We spent $22 million on CapEx during the quarter or about 2.5% of sales. We expect CapEx of around 3% to 3.5% of sales for the full year. With respect to our dividend, we increased our quarterly dividend by 4% to $0.28 per share in May, and we paid our 384th consecutive quarterly dividend in June. With this increase, we expect 2018 to be our fifth consecutive year of annual dividend increases.

In regards to M&A, we announced the Cone Drive and Rollon acquisitions that Rich covered earlier. And last but not least, we repurchased about 570,000 shares for $27 million in the second quarter. We still have roughly 8 million shares remaining on our current buyback authorization. However, given the pending acquisitions, we would expect to reduce our share repurchases in the second half of this year. And finally, we ended the quarter with net debt of $900 million or 37% of capital, down slightly from the end of the first quarter, and net debt to adjusted EBITDA was about 1.6x at June 30.

Our strong balance sheet gives us the ability to advance our strategy and acquire great businesses like Cone Drive and Rollon. We expect both acquisitions to close during the third quarter. When both closed, we would expect our net debt to be roughly 50% of capital, dropping in the second half with cash flow. And we expect to maintain a strong investment-grade balance sheet going forward.

Next let me review our outlook on Slide 20. As a result of our second quarter performance and forecast for the rest of the year, we are increasing our outlook for both sales and earnings. We're now planning for 2018 revenue to be up approximately 21% in total versus 2017. Organically, we expect sales to increase about 15%, driven by broad growth across most of our end markets and sectors as well as the impact of outgrowth initiatives and positive pricing. Acquisitions should add 5.5% to the top line in 2018, with currency translation also contributing slightly. Our outlook includes the ABC Bearings, Cone Drive and Rollon acquisitions as of their expected closing dates later in the third quarter. And currency reflects exchange rates as of June 30 for the remainder of the year.

On the bottom line, we now estimate that earnings will be in the range of $3.90 to $4 per diluted share on a GAAP basis. Excluding anticipated special items totaling a net $0.20 per share of expense for the year, we expect record adjusted earnings per share in the range of $4.10 to $4.20 per share, which at the midpoint of our guidance is up 58% from 2017. The midpoint of our 2018 outlook implies that our adjusted EBIT margin will expand by over 250 basis points. This would put us in the high 13s percent margins for the full year at the corporate level, a great accomplishment, and we believe we still have room to go from here. And finally, we estimate that we'll generate free cash flow of around $250 million in 2018 or over 75% of adjusted net income.

So to conclude, we continue to generate strong financial performance with record adjusted earnings per share in the second quarter, and we continue to advance our strategy with the announced acquisitions of Cone Drive and Rollon. Most importantly, we remain excited about the company's future and look forward to the opportunities that lie ahead.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Steve Volkmann from Jefferies.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [2]

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Sorry, my head's spinning a little bit. You guys are ganging up on us today. Rich, did you say that you would expect the organic revenue to be up again in 2019?

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Richard G. Kyle, The Timken Company - President, CEO & Director [3]

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Yes, we're planning for that, yes.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [4]

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And so a couple questions on the back of that. Would you also expect that margins would be up in that scenario as well? And obviously, I'm sort of thinking about how price cost sort of continues to move forward here.

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Richard G. Kyle, The Timken Company - President, CEO & Director [5]

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Yes.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [6]

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All right, good. We'll keep this short and sweet. The other question I was going to ask you is just about the margins on the segments. You sort of talked about Mobile having a target to get above 12%. Do you have a similar target for Process? And how much progress can we make next year?

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Richard G. Kyle, The Timken Company - President, CEO & Director [7]

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Yes, I'll comment on that. So on Mobile, we've been making good progress for several quarters in a row. And I think we largely need -- from what we control, we need to do more of what we've been doing, which is recovering material costs, moving price up. We do expect help from volume. We've been sequentially improving our operational performance as the volumes come up, and we would expect to continue to do that. Last year's acquisitions mixed us up a little bit there as well. The new acquisitions are more Process, so we don't get much there. And then we also -- as we look forward, rail has been a headwind on the mix for some time and believe that's in a good position to help us improve there. So keep tracking where we've been on Mobile and making good progress and certainly think we can get up there and out, ready to put a time line on when you'd see that but would expect to continue to improve margins there. On the Process side, certainly, organically, we believe we can hold and still move up from where the margins just were in the second quarter. But as we stated, our real objective is to outgrow the business both organically and inorganically. So just using the 2 acquisitions as an example, while they are right in line or accretive to Process, EBITDA margins, they will mix us down after we put the depreciation and amortization on a little bit but not so much that we wouldn't expect to be able to continue to hold the 20%-plus margins. So we are -- implied in our guide is 20% Process plus 20% margins in Process for the full year and every quarter of the year and believe we can continue to do that.

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Operator [8]

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And we'll take our next question from Ross Gilardi from Bank of America.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [9]

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Yes. I just want to ask you about -- a little bit more about the acquisitions. You guys didn't disclose the purchase price of either one of them, but you did just give some information on what you think. Net debt to capital is going to be, by the end of the year -- I mean, it looks you're implying you paid like 13, 14x EBITDA for these 2 businesses. Am I wildly off on that? I'm just taking the margins that you gave on the revenue. For both of them combined, it looks like it's about $60 million to $65 million on EBITDA, and just looking what the implied net debt is by the end of the year.

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Richard G. Kyle, The Timken Company - President, CEO & Director [10]

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Say, you're not wildly off, but you're a little high. I would say sub-13 as you blend the 2 of them. And similar to The Timken Company, although maybe a little less though in some cases, but it's a big delta if you look at trailing 12 months of EBITDA versus forward 12 months of EBITDA.

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [11]

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Yes. And the comment around the 50%, Ross, was at closing. And then with cash flow in the second half, we'd expect that net debt to capital will come down closer to our -- the high end of our target of 45%, again, as we generate cash flow in the second half. But as Rich said, pretty close, I think they're pretty close on the purchase price, probably a little bit high.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [12]

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How would you guys look at it on a forward EBITDA multiple basis? What would it be closer to ex synergies?

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Richard G. Kyle, The Timken Company - President, CEO & Director [13]

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I would say last year, on the 3 deals we did last year, we were a little north of 12x. And as you look at those today on a trailing basis, they're all sub-10.

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [14]

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Yes, and I think on both businesses, Ross, I think we're seeing backlog building at both Rollon and Cone, so I think markets are good and markets look to continue to be good for both businesses. And then you mentioned ex synergies, but we do see some significant run rate synergies in both. And if you put it on the current EBITDA levels, probably brings you down 3 turns or so. With run rate synergies, again, we won't get to that level in a year, but we do see some really nice opportunities for both.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [15]

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Are they mostly revenue synergy sale because these businesses already have got very, very high, margins, and I think both have been owned by private equity? So is this mostly like a cross-selling opportunity into the mechanical power transmission markets that you've been talking about for years?

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [16]

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I would say some revenue, but more cost than revenue. But certainly some revenue with the cross-selling, as you mentioned, and cost synergies around purchasing and back office leverage that we can get, et cetera. And then in the case of Rollon, as Rich mentioned, it's a European-based acquisition, so we're actually going to get some tax synergies as well as we're able to leverage our international structure and reduce taxes at Rollon from where they were pre-acquisition.

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Richard G. Kyle, The Timken Company - President, CEO & Director [17]

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We've been looking at making an organic move in power transmission into China for some time and believe that Cone Drive, having a sizable facility in China, with the talent that goes along with that, combined with what we have in bearings, will significantly accelerate that. I would say it's a combination cost and revenue benefit, but that's a sizable part of it. The tax benefit is also sizable. We have -- as you look at Cone, we have an existing gear drive business that we believe we can also drive some synergies with that as well.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [18]

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And how are you guys feeling about, like, your margins targets right now? I mean, you're at the higher end of them right now. You just acquired 2 pretty big businesses that have got very robust margins. So why not raise the target margin ranges at this point given your confidence and the growth outlook into 2019?

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Richard G. Kyle, The Timken Company - President, CEO & Director [19]

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I think that's a good question. And I would tell you right now, we're focused on operating above them and expanding them. So I guess, maybe I just raised the target.

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Operator [20]

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And we'll take our next question from Joe O'Dea from Vertical Research Partners.

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Joseph O'Dea, Vertical Research Partners, LLC - Principal [21]

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On the Process organic growth, can you talk about -- break that down at all in terms of what you see as outgrowth when we look at organic in the high teens over the past couple of quarters? Just trying to appreciate where the outgrowth is coming from, how much of that could be related to distributor stocking and really just by kind of the channels and end markets that you're serving there.

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [22]

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Yes, Joe, let me start first on the inventory. As we've talked about before, we do have reasonably good visibility into our larger distributors, both in North America and Western Europe. And we would say, North America inventory at the large distributors, it looks to be relatively flat net-net from end of the year, relatively flat to maybe up a little bit year-on-year, but not a big restock certainly at all so far this year. And our outlook would assume inventory remains relatively in line with current levels, maybe a little bit more but nothing material. From a market standpoint within Process, strong quarter, as you saw. Distribution was up globally. And I would say, we probably saw it kind of mid-teens year-on-year kind of growth there, saw significant growth in the general and heavy industrial OE sectors, and that would be markets like metals, aggregates, cement, industrial gearbox bearings, the machine tool and the like. And that would be where we deal with a lot of new products, new bearing offerings that we're taking into those markets and seeing some nice share gains there. Our gears business with military and marine was up with just normal activity. And then the services business was up really more with an improved market demand. But in wind, as we've talked about, we have been gaining share in that market for several years now with our technology and our products. And even though the market, if you look globally in wind, relatively flat, pretty soft actually, we're continuing to gain share. And while we weren't -- we were probably up north of 10% in the second quarter year-on-year just given some of the gains we've been achieving in both Europe and Asia. So I would say, outgrowing in spots across Process, but looking more at the general and heavy industrial OE and wind are probably the 2 spots where we're seeing most of it.

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Joseph O'Dea, Vertical Research Partners, LLC - Principal [23]

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Okay, I appreciate the details. And then just thinking about cost inflation as we move forward into next year. I mean, any visibility that you have at this point when you look at scrap prices based on conversations you're having with suppliers, the -- just kind of ballparking or bracketing the kind of cost inflation you're looking at related to steel.

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Richard G. Kyle, The Timken Company - President, CEO & Director [24]

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No, I think that'd probably be getting ahead of ourselves a little bit. A lot of our steel in the U.S. is purchased on annual agreement with a surcharge mechanism. So to -- for us to be forecasting where the surcharge mechanism is going to be for next year, I think, would be premature. And in regards to base price, we have not locked into base prices next year, but we also haven't locked into a lot of our commercial agreements with our customers as well. So I think our focus would be to see how the trade situation evolves, see where U.S. steel pricing goes and where we have to go with pricing and other mitigating tactics as we go forward. But I would wrap that up that we, I think, have demonstrated not only in recent times, but prior to this that we can recover material costs in the marketplace. And I think we can, whether it's by supply and demand or by tariffs.

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Joseph O'Dea, Vertical Research Partners, LLC - Principal [25]

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And so just your earlier comments about margins being up, that's kind of related to confidence and ability to recover, not only against the cost inflation but recover it with margin moving forward.

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [26]

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Yes. I think it's -- get some -- if we grow organically next year, certainly leverage that volume very well. And as Rich said, in this market environment, as we sit here today, demand is good. The supply, if you will, is a little bit tighter, so it's a good environment. From a pricing standpoint, we would expect positive pricing again next year. As we look at 2018, we would see pricing for the year -- price cost to be positive, so we're pricing above the material cost inflation that we're seeing. And as Rich said, a little bit too early to make that call on '19, but that would certainly be the objective.

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Operator [27]

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And we'll take our next question from Chris Dankert from Longbow Research.

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Christopher M. Dankert, Longbow Research LLC - Research Analyst [28]

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I guess, first off, and we've seen some more concerning headlines from macro growth out of Asia and Europe. You guys are obviously pacing well ahead of that. So can you break down what's helping drive some of that? I mean, obviously, cross-selling is a part of it, but just what is the internal initiatives versus market growth in those regions?

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [29]

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Yes. I'll start first with, I would say that the theme for Timken this year, from a growth standpoint, has been really the breadth of what we're seeing. So virtually -- as I said, virtually all of the sectors that we serve in both Europe and Asia are up. And again, a lot of that is market growth, but a lot of that is targeted growth initiatives in areas like wind, in areas like rail, in some of the industrial applications with some of our new bearing products and our bearing solutions continuing to look to emphasize outgrowing the China market where we're up significantly, outgrowing the India market in the targeted sectors. So for us, as we've talked about many times, being a large North American player, it's critical for us to win outside of our home market in North America and it's where we focus. And you saw it with the double-digit growth. I think you are hearing some things in China, certainly in the consumer side of things. But the markets we serve, the industrial markets, heavy industries, off-highway, heavy truck, rail, wind, et cetera, all continue to grow nicely. And as we sit here today, looking at them, they continue to grow.

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Christopher M. Dankert, Longbow Research LLC - Research Analyst [30]

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Got it, got it. Good to hear. And then any comment as far as like Romania? Is that fully ramped now? Just kind of what the loading looks like there today?

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Richard G. Kyle, The Timken Company - President, CEO & Director [31]

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Well, certainly not fully ramped and there would be -- from the initial capital investment, there's still lines going in. It's performing well. It's performing in line with expectations. It's coming up in a market where demand is significant. I'd say we're somewhere between, call it, 40-ish percent of where the initial capital investment would be.

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Operator [32]

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(Operator Instructions) And we'll take our next question from Justin Bergner from Gabelli & Co.

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Justin Laurence Bergner, G. Research, LLC - VP [33]

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The first question I have would just be on sort of the acquisitions. I guess, I understand very well the strategic rationale for the Cone Drive. I'm a little bit less clear on the Rollon deal. Would you be able to sort of take us through why you think Timken is the rightful owner of this business? And does this represent sort of a new platform for the business beyond bearings and power transmission that you would look to grow both organically and inorganically in the coming years?

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Richard G. Kyle, The Timken Company - President, CEO & Director [34]

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Okay. So first, I would start with the close adjacency of the technology. A linear motion product is very similar to a rotational bearing, and it's generally managing a load and friction. And in some cases, in a lot of cases, shares the same rolling elements as well and is managing motion and linear direction versus a rotational direction. So technology-wise, very close. Some of our global bearing peers are in the space, some of us have historically not been. Obviously, we have been one of the ones that have not been but are in it now. So there's certainly some shared technology in that regard. It's a growing market. It's very fragmented, so it fits a lot of what we call the Timken business model characteristics for what we look at from an attractiveness standpoint. And in some cases, it goes through the same channels as bearings. In other cases, it goes through different channels, and that would be depending on markets and geographies around the world. Rollon tends to be, I would say, on the nichier, more fragmented, more engineered to order side of the business or the industry, of the linear industry, which is similar to where Timken is and where we focus. And then as you look across the market mix from the slide deck we put out last week, 26% of it is through distributors, again, some of which are the same, some of which are new. General industrial bucket, logistics and packaging, passenger rail, which as you know, rail is a focus market for us, and we're stronger in freight but have a good passenger rail bearing offering as well that we're working to expand. Machine tool and automation, aerospace, medical, so again, markets that we participate in some cases and in other cases, are lighter in. To your point on the fit, we do see it as a separate business, so there'd be some -- certainly some focuses -- Phil talked about on costs as well as revenue, but we intend to retain the management team, run the business as a separate entity. And we believe the growth potential and profit potential is extremely attractive.

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Justin Laurence Bergner, G. Research, LLC - VP [35]

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Great. That's very helpful. I appreciate the long discussion. Would you intend maybe not immediately but over time to use this as a platform for more inorganic activity?

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Richard G. Kyle, The Timken Company - President, CEO & Director [36]

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I think I would -- it's -- certainly, that possibility exists, but I wouldn't want to get ahead of myself right now. So right now, we're focused on getting a good return on the investment we just made in the business and being successful in the marketplace. But certainly, there are both larger as well as smaller players around the world in this space.

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Justin Laurence Bergner, G. Research, LLC - VP [37]

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Okay, great. And then just one separate question, I'll get back in the queue. The free cash flow guide is sort of not moving up further and sort of ending the year potentially around 75% of adjusted net income. Is that lack of positive revision there in sort of the 75% conversion almost entirely working capital related or are there other factors we should think about?

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [38]

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I would say it's -- working capital would be a piece of it, probably most of it. The other piece would be we do have higher tax payments this year, just a timing issue where we're -- some taxes we were anticipating paying next year and in subsequent years, we're paying this year, and that was a piece of it as well.

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Justin Laurence Bergner, G. Research, LLC - VP [39]

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Okay. The tax side was -- the fact that you're anticipating paying them now versus next year, was that consistent with sort of your prior view? Or did that shift into this year, sort of become more recent?

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [40]

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No. Yes, that was a recent development versus -- from what we would have guided last quarter.

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Operator [41]

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And we'll take our next question from Steve Barger from KeyBanc Capital Markets.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [42]

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I'm going to stick with the acquisitions. I see both Rollon and Cone have some distribution exposure. Are there more opportunities there? And then just more broadly speaking about the acquisition strategy, is that primarily built around market orientation or return metrics, just finding individual targets? Or how much thought goes into buying assets to make a more complete distribution package?

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Richard G. Kyle, The Timken Company - President, CEO & Director [43]

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Well, I think the answer is probably all of the above. Certainly, a complete distribution package is part of the focus. And in Cone, Cone in the U.S. goes through the -- our existing customer base, so that 16% on their distribution pie chart is essentially our existing customers. And within time, we'll be able to provide customers consolidated shipments, consolidated order inquiries for stock products and leverage that as we've done with others. And as the world digitizes and more of distribution work is done as drop shipments and things online, et cetera, I think the per scale there and breadth is of much value and it's -- it will continue to be of focus to us. Also, there's a significant focus paid on markets. And we like Timken's market mix very much. We are successful in the markets we're in. We like automotive. We like heavy truck. We like mining. We would also like to build some positions in markets like solar. We think the solar business will complement with the success we've had over the last several years organically with wind. We also like some of the lighter duty markets, particularly in North America, where you look at what's happened with the manufacturing base over 20 or 30 years, and the increase in logistics and packaging, aerospace and automation versus the heavier industries markets. So again, don't want disparate those markets. Those are important markets for us. We focus on them very heavily. It's a big part of our growth today as we sit here in China, but we'd also like to get more diverse. And as you look at Rollon, that was a much more of a focus on the product category and the end markets and the potential for growth and standalone versus, I would say, the distribution channel. And then if you take it back through the previous acquisitions we've done, you get a little bit of mix of markets of distribution of where we just think the -- in the case of lubrication systems, where we think automatic lubrication systems have a lot of complement with bearings as well as our product line that is generally going to outgrow the market because of the amount of unserved market space that's out there. So a little bit different synergy cases for each.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [44]

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That is really great detail. I'm just thinking about the Cone manufacturing base in China you'll use to expand there. Do you have to make a lot of investment to build that process equipment? Or is that more turnkey for the products or markets that you want to pursue there?

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Richard G. Kyle, The Timken Company - President, CEO & Director [45]

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We would be looking at incremental investment, but it's a fairly sizable building. So it's a reduced investment. And I would say, quite a few of the products that we move beyond bearings generally require a lower CapEx per dollar than bearings. That's not the case in all of them, but I would say, with a modest CapEx investment for what we'd be looking to generating sales.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [46]

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And realistically, how quickly can you start to leverage that or take advantage of those opportunities? I know you got to get into the plan to do all the things. But is that a back half or is that more a 2019 and beyond?

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Richard G. Kyle, The Timken Company - President, CEO & Director [47]

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I would say, it was definitely -- the work will kick off in 2019. I would say before you're getting benefits, it would kick off in 2018. But the -- before you're getting benefits, probably the end of 2019 or 2020. And it varies, some of the PTs. I said that's the only place we have a scale. So we do have a small PT presence there, and we do have a few products that have -- that we are importing into there that would be better off localized. So we have a hub of business to begin with. And then from there, we'd be looking to where do we go next and where can we profitably go.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [48]

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Got it. And last one for me. 2Q had the best railcar industry order number since mid-2014. Is the increase in the back half guidance for you, for that market more OEM production picking up? Or are you going to get more benefit from increased aftermarket activity because of increases in railcar traffic?

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [49]

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Yes. I'd say it's a little bit of both, Steve. Certainly, we'll benefit from the newbuilds, but also as the economy continues to hum along, see some increased aftermarket revenue. I would point out when we talked about rail in the second quarter, North America was up slightly, probably not worth mentioning. But in Latin America, a lot of the growth we saw was in Mexico, and a lot of that revenue actually supports the U.S. market. So we are starting to see it. We saw it in Mexico, as I said, in the second quarter, and we'd look to see it more in our U.S. business in the second half of the year.\

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Operator [50]

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(Operator Instructions) And we'll take Ross Gilardi from Bank of America.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [51]

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Rich, I missed the obvious follow-up. I mean, since you're raising the mid-cycle margin targets, what are you raising them to? I mean, can you commit to 20% margins -- 20%-plus margins in Process? Can you do 12% plus in Mobile through the cycle?

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Richard G. Kyle, The Timken Company - President, CEO & Director [52]

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So we're targeting -- yes, glad you got back on, Ross, because I definitely didn't add enough color. So when we put those margin targets out there, it was a 300 basis point improvement from where we're operating at the time, which we thought was an aggressive enough opportunity. And those target ranges have always been directional. We have operated over 20% in Process Industries for well over a year at a time. We've operated below the low end of the range in both of them as well, but it's been intended to be more directional than when we're above it. Like in the case of the acquisitions, it tends to -- it can bring it back down a little bit. Also internal investment, et cetera, would tend to put some pressure on them. But our target would very much be to continue to operate Process Industries above 20%, and that's what's bringing the acquisitions in. And right now, we're targeting getting Mobile to 12%. I wouldn't say over a cycle, but I'd say for a full year is what we're targeting right now. And we still got -- while we've moved above the range in Process, we haven't gotten even at the top end of the range yet in Mobile, and we're very focused on that.

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Operator [53]

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And we'll take our next question from David Raso from Evercore ISI.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [54]

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Just a quick question. Your comment about '19. The back half of the year, organically, you have Process guided to grow nearly 20% in Mobile, slows a little bit, but still 11.7%. When you mentioned '19 and the visibility you have, what are you thinking about mix in '19 based on the order book and what you're seeing, just given obviously Process is a lot higher margins? I'm just trying to make sure, is that how you're seeing '19 base case on your order book, that Process is outgrowing Mobile in maybe some order of magnitude?

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Richard G. Kyle, The Timken Company - President, CEO & Director [55]

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Yes. And I assume your question is organic there. So I'll...

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [56]

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Yes, all organic.

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Richard G. Kyle, The Timken Company - President, CEO & Director [57]

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Yes, the inorganic is coming into Process for the most part. But I would say we have seen our mix shift organically heavier to Process, which is obviously good for the profitability of the company. And I would expect us to not only, as you just said, finish this year strong, but expect to finish the year with a strong backlog in Process Industries. And so I think the answer to your question would largely be yes. But I wouldn't say it's huge. We would see a little bit more mixing organically to Process Industries versus Mobile because also, as we talked earlier, I think rail is still early too, and that's got some upside for Mobile as well. But I would say mix is in our favor right now, both for the second half and heading into 2019.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [58]

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And within that Mobile comment, just curious, so obviously rail is a nice piece of Mobile. But the off-highway piece, the -- maybe if you can give a little split of bag, CE and mining. Just curious, the early read from your big customers on '19 production schedules that gives you that confidence on Mobile broadly.

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Richard G. Kyle, The Timken Company - President, CEO & Director [59]

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Yes, I wouldn't want to go so far as to say full '19, but certainly, I think everybody were getting indications that the year is going to finish strong and start off positively as well. And that in total, many of these markets, to your point on off-highway, are not where they were in 2014 or 2012, and they're still coming back to some previous levels and that they don't see the momentum changing. I'd throw heavy truck probably into that as well where I think the heavy truck OEM build around the world is pretty optimistic about 2019 right now as well.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [60]

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That would include a Europe truck comment as well? Or is that...

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Richard G. Kyle, The Timken Company - President, CEO & Director [61]

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No, that would definitely be more U.S. and some other parts of the world than Europe.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [62]

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No. I'm just curious of growth in Europe or not -- or I mean, we just have an early indications of '19.

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Richard G. Kyle, The Timken Company - President, CEO & Director [63]

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You're talking Europe in total?

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [64]

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Europe truck for '19. I'm just curious...

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Richard G. Kyle, The Timken Company - President, CEO & Director [65]

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Europe truck for '19. You're probably getting a little more specific now than where I wanted to go.

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Operator [66]

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And we'll take our next question from George Godfrey from CL King.

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George James Godfrey, CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst [67]

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I just wanted to ask, if -- I know you didn't disclose the purchase prices on the acquisitions, but you did give us some revenue metrics and comments on earnings accretion. I'm just curious, what would be the argument against levering up to buy back stock at current multiples versus buying these acquisitions?

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Richard G. Kyle, The Timken Company - President, CEO & Director [68]

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I think it's probably a time frame horizon and value creation opportunities. So certainly, I think short term, the EPS accretion is better from share buyback. And if you'll back the last few years, we have certainly not been shy about using that lever and buying back a lot of shares. So we agree with your point of the value creation opportunity. On the flip side, I think when you look out a few years, the upside to the synergies, the growth is there on the inorganic side. And we've taken a pretty balanced capital allocation approach over the last 4 or 5 years of paying a healthy dividend, looking for good, immediately accretive and long-term good IRRs and ROIC acquisitions. And then where we're not finding those and find a valuation appealing, buying back shares.

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George James Godfrey, CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst [69]

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Understood, okay. And the bidding or the buying process, was it a competitive situation such that if you didn't act now, the asset may not be there in 3 or 6 months?

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Richard G. Kyle, The Timken Company - President, CEO & Director [70]

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In these 2, yes.

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Operator [71]

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And we'll take our next question from Justin Bergner from Gabelli & Co.

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Justin Laurence Bergner, G. Research, LLC - VP [72]

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Just 2 quick ones. On steel input costs looking into '19, I just wanted to sort of verify that the entire effect of the higher scrap prices is coming through as a surcharge in '18. So it'd just be sort of the spread as it gets renegotiating contracts going into '19, that would be a headwind?

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [73]

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Yes. I think the way -- I think that's right, Justin, the way to look at it is -- so the scrap price surcharge does get adjusted quarterly on a lag, so we do feel that. And then the other element is the base prices, which get renegotiated as contracts renew annually. So we do have the surcharges in the guidance, if you will, and then really, the -- what Rich was talking about earlier was more the base prices. And then keep in mind, outside the U.S., we typically negotiate prices quarterly that take into account inflation, but it's more of a negotiation than it is a mechanism, if you will.

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Justin Laurence Bergner, G. Research, LLC - VP [74]

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Okay, got you. And then on the wind side, is the increase in your view on wind attributable to the market or more just sort of larger outgrowth than you were even seen a couple quarters ago?

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [75]

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No. Yes, we said kind of coming into the year that the wind market looked a little soft, a little flat coming into the year. We felt like we had an opportunity to continue to gain share in that market that's happening with some big customers in Europe and some customers in Asia. So my comments around wind were really Timken specific. I think if you poll the market, you'd probably get a sense that the market is flat to even maybe slightly down globally, but we continue to -- as we've done for the last several years, continue to gain share in that market.

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Operator [76]

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And we'll take our follow-up from Chris Dankert from Longbow Research.

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Christopher M. Dankert, Longbow Research LLC - Research Analyst [77]

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Just one real quick housekeeping thing. On ABC, that's still expected to close in the third quarter, I assume. And then as far as the acquisition of Rollon, I mean, you guys did disclose, it was, what, $545 million, look at the EBITDA you threw out there, I mean, we're at 13x forward before any kind of synergies. Is that the right way to look -- I mean, to me, this is a screaming deal, but maybe I'm wrong.

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Philip D. Fracassa, The Timken Company - Executive VP & CFO [78]

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Yes. No, I think, Chris, I think you've got it. So yes, we did put an 8-K out relative to Rollon. But I think, as Rich said, if you take Rollon and come together, you blend them, you're just sub-13x. On 2018 EBITDA from a closing standpoint, we expect ABC to close at the end of August. We expect Cone to close hopefully at the end of August. We expect Rollon will close hopefully before the end of September, and that would have been roughly what we included in our guidance for the year.

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Richard G. Kyle, The Timken Company - President, CEO & Director [79]

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And to one other piece color on it, the question earlier about the timing and the sale process and the need to act now. That being said, we -- these have both been targets for us for several years. We've met with the management and the ownership of these businesses years ago and have been in touch with them, so they've been targeted. And they, certainly, were not reactionary to just the fact that they on the market and available.

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Operator [80]

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And there are no further questions. I would now like to turn it over to Mr. Hershiser.

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Jason Hershiser, [81]

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Thanks, Celestina, and thank you, everyone, for joining us today. If you have further questions after today's call, please contact me. Again, my name is Jason Hershiser, and my number is (234) 262-7101. Thank you, and this concludes our call.