Timken Co (TKR) 2005 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the Timken fourth-quarter and full-year 2005 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. (OPERATOR INSTRUCTIONS) Thank you, Mr. Tschiegg, you may begin your conference.

Thank you and welcome to our fourth-quarter conference call. I'm Steve Tschiegg, Manager Investor Relations. With me today are Jim Griffith, President and CEO; Glenn Eisenberg, Executive Vice President of Finance and Administration and CFO; Mike Arnold, President of our Industrial Group; Jacqui Dedo, President of our Automotive Group; and Sal Miraglia, President of our Steel Group.

We have remarks this morning from Jim and Glenn, and we will then all be available for Q&A. At that time, I would ask that you please limit your questions to one question and one follow-up at a time to allow an opportunity for everyone to participate.

Before we begin I would like to remind you that during our conversation today you may hear forward-looking statements related to the future financial results, plans, and business operations. Actual results may differ materially from those projected or implied due to a variety of factors. These factors are described in greater detail in today's press release and in our reports filed with the SEC, which are available on our website, www.Timken.com.

Reconciliations between GAAP and non-GAAP financial information are included as a part of the press release. This call is copyrighted by the Timken Company. Any use, recording, or transmission of any portion without the express written consent of the Company is prohibited. With that, I will turn the call over to Jim.

Thanks, Steve. Before I discuss our fourth-quarter performance, I would first like to review the accomplishments of 2005 and summarize the opportunities that will propel the Timken Company forward, generating improvements in the year ahead. My comments will exclude the impacts of special items.

2005 was a strong year for the Timken Company. Our top line grew 15%, driving our sales to a record $5.2 billion. Earnings per share at $2.53 were up sharply from the $1.35 we earned in 2004.

We generated $93 million of cash from operating activities, after a strong capital investment program and contributions of $226 million to our pension fund. We strengthened our balance sheet, lowering net debt over $70 million. We continued to invest in structural changes to increase profitability in the future.

We achieved a labor contract that facilitates continued rationalization of the industrial bearing manufacturing operations in Canton, Ohio, and initiated a restructuring of our Automotive business.

These results represent strong structural performance, represented in the fact that our associates achieved record results in productivity and safety, improving sales per associate 12% over last year, while lost-time accidents were reduced to an all-time low.

The high level of global industrial market demand that we're experiencing and a number of actions taken in 2005 will create even greater opportunities for Timken going forward. To leverage these, we will focus on a few key initiatives in 2006.

First, we are investing in Asia to create the foundation required to substantially grow our business in that region, improving our profitability and diversifying our geographic footprint.

Second, we are investing in our bearing capacity for targeted markets around the world, to improve our responsiveness to customer demand for our products and services.

Third, through strategic portfolio management, we are investing in areas where we can grow profitably, with a particular emphasis on industrial markets. The acquisition of Bearing Inspection, Inc., and our alliance with Rolls-Royce are examples of investments that continue to strengthen our strategic position in the growing aerospace industry.

In contrast, portions of our business that cannot meet our financial or strategic requirements are being addressed aggressively, either by fixing them or exiting them. On that note, we pruned our portfolio this year with the divestment of Linear Motion Systems and NRB Bearings, two non-strategic businesses, redirecting the resources to our core business opportunities.

The restructuring underway within both our Automotive and Industrial businesses will continue to improve financial performance. Finally, we are investing in business infrastructure, an initiative called Project ONE, to improve our business processes and systems to deliver enhanced customer service and financial performance.

These actions, together with the continued strength of key market areas, combine to give us confidence in our ability to achieve even better performance in 2006.

While we had a very good year in 2005, our fourth-quarter results fell short of our expectations. The principal reason for the weaker than expected results was higher manufacturing costs in our Automotive and Industrial businesses, as well as a write-off of obsolete inventory.

We experienced higher than anticipated costs as we ramped up plants to add capacity to meet increased demand in certain product lines. And in the fourth quarter, we temporarily lowered operating levels to reduce inventory in other product lines. These manufacturing cost increases and inventory write-offs impacted our performance at the EBIT level by about $13 million in the fourth quarter.

In addition, when we compare to a year ago, EBIT for the quarter was impacted by incremental investments in Project ONE and in Asia growth initiatives totaling about $6 million. We will continue to experience these costs well into 2006, but expect a combination of continued strong industrial demand and our own tactical improvements to deliver increased earnings per share of between 5% and 11%.

Now I would like to review the performance of our individual business units in the fourth quarter. Industrial Group sales for the quarter were $492 million, up 10% from last year. We experienced strong demand in all key industrial segments, particularly mining, metals, rail, aerospace, and oil and gas markets.

Sales were up in most geographic regions, Asia being the strongest with roughly a 30% increase. We have made significant progress in reallocating capacity to serve these markets, but still have a significant backlog of demand in many areas.

Industrial Group EBIT was $42 million or 8.5% of sales. Performance continues to be favorably impacted by volume and pricing. However, compared to a year ago, margins were negatively impacted by the higher manufacturing costs discussed earlier. In addition, we incurred a $5 million charge for obsolete and slow-moving inventory.

Strong Industrial markets are expected through 2006. While higher manufacturing costs associated with the ramp up of capacity and the Canton, Ohio, bearing plant rationalization will constrain margins in the near term, we expect to see continued profitability for the year, even with our growth investments.

Automotive Group sales for the quarter were $407 million, up 4% from last year, driven primarily by our ability to capture price increases and a strong market for medium and heavy trucks. Despite our expectation that the Automotive Group would return to profitability this quarter, we incurred a loss before interest and taxes of $8 million, compared with a loss of $2 million in the fourth quarter last year.

Our results were impacted by the continued weakness in the North American light vehicle market. We incurred higher manufacturing costs in some facilities due to reduced unit volumes from light vehicle customers and our efforts to reduce inventory. In addition, our Automotive Group's performance has been impacted by the cost of ramping up some plants to serve industrial markets.

We anticipate Automotive [profits] will generally be weaker in 2006, except for medium and heavy trucks. Performance of the Automotive Group will benefit, however, from the gradual improvement in the balancing of our operating levels with the demand, and from actions to strategically reposition our portfolio, and from pricing.

The structural performance of our Automotive business has improved during 2005, and barring unexpected events we expect the business to return to profitability in 2006.

Steel Group sales for the quarter were $420 million, up 8% from last year. The group benefited from strong industrial, aerospace, and energy market demand, as well as pricing and surcharges. Steel Group EBIT in the quarter was $50 million, compared to $32 million last year as the group leveraged stronger market demand with high plant utilization and record labor productivity. Price increases and surcharges along with continued strong volume were the main drivers of increased earnings.

Looking forward we expect the cost of scrap will continue to decline; however alloy and energy costs should remain at historically high levels. Automotive demand for steel is anticipated to be slightly weaker than last year, but broadbased industrial market strength should continue, especially in the markets related to aerospace and energy. We expect Steel's results in 2006 to be lower than they were in 2005 due to the expected lower surcharge premium for material costs.

In summary, we had a strong year in 2005 and, despite a fourth quarter that fell short of expectations, we anticipate even better performance in 2006. Now I would like to turn it over to Glenn for a more detailed review of Timken's financial performance.

For the fourth quarter we reported fully diluted earnings per share of $1.01. Excluding special items, earnings per share came in at $0.54. These special items, totaling pretax income of $75 million, included income from CDO receipts and the sale of assets, partially offset by expenses relating to the rationalization of the Canton bearing operation.

In the same period last year, earnings included $21 million of pretax income, primarily relating to income from CDO receipts, partially offset by expenses related to the integration of Torrington and asset disposition. The rest of my comments, consistent with those by Jim, will exclude the impact of these special items.

Sales for the fourth quarter were $1.3 billion, 8% over 2004, with improvement across all three business groups. Gross profit margin for the quarter of 20.4%, a decline of 40 basis points from last year, primarily reflecting the impact of higher manufacturing costs as we ramped up capacity to meet strong customer demand, and a $5 million write-off of obsolete and slow-moving inventory.

SG&A margin of 13.4% was 20 basis points higher than last year, due to the Company's investment in Project ONE and Asia growth initiatives. We expensed approximately $6 million during the quarter on these initiatives, impacting margins by over 40 basis points.

Partially offsetting the margin decline in gross profit and SG&A was other expense, which improved 60 basis points, primarily due to favorable impacts from currency and improved performance from joint ventures. As a result, EBIT for the quarter came in at $85 million or 6.6% of sales, unchanged from last year's margin.

Interest expense of $11 million was $3 million less than last year due to lower debt levels. With a tax rate of 32%, net income for the quarter was $51 million or $0.54 per diluted share. While EPS was up 23% over last year, we fell short of our estimate for the quarter of $0.56 to $0.66.

While we're disappointed with the fourth quarter ending the way it did, we feel very good about the full-year accomplishments, highlighted by record sales of $5.2 billion, up 15%, and earnings per share of $2.53, up 87%.

Similarly, we had a good year in cash generation. Net debt ended the year at $656 million, $73 million lower than last year, after contributing $226 million to our domestic pension plan.

Cash from earnings was partially offset by working capital requirements to support sales growth, and higher capital expenditures required for an increase in capacity.

The Company's leverage of net debt to capital of 30.5% was 6 percentage points lower than the end of last year. It is now at the low end of our targeted range, providing the Company with financial flexibility to pursue strategic investments.

Our outlook for 2006 is for continued improvement in our business. We expect earnings per share excluding special items to be $2.65 to $2.80 for the year, and $0.55 to $0.60 for the first quarter.

Our Industrial and Automotive Groups are expected to see improved results, Industrial benefiting from strong markets and additional capacity, while Automotive benefiting from pricing and improved manufacturing performance. Our Steel Group results, coming off record performance in 2005, are projected to be lower in 2006 due to expected lower surcharges.

The Company's earnings will be constrained by additional investments in our Project ONE and Asia growth initiatives, expected to increase about $20 million in 2006, as well as an estimated $7 million cost of implementing FAS 123, which requires the expensing of stock options, effective January 1, 2006.

From a cash flow standpoint, we expect to see higher free cash flow in 2006, benefiting from earnings growth, better working capital management, and pension contributions of approximately $150 million, which would be about $50 million lower than in 2005. However, we expect to have higher capital expenditures targeted around 5% of sales to support our growth initiatives.

We look forward to a good year in 2006 with the potential to reach record sales, record earnings, and record cash flow. This ends our formal remarks, and now we would be happy to answer any questions. Operator?

(OPERATOR INSTRUCTIONS) Wendy Caplan with Wachovia.

A couple Auto questions if I might. Could you discuss the 4% in the quarter, or perhaps the 5% sales increase for the year? Obviously, the volume is down. How much of that is pricing?

What were you expecting in terms of volume in Q4 versus what actually came in? Because it sounds like there was a misstep in terms of expectation.

And can you tell us what this increase in accounts receivable reserves is about?

Yes. Good morning, Wendy. Jacqui. Starting with your question on sales, the 5% growth in sales year-over-year is all due to price. We had some increased products; but that was offset by products that we intentionally lost. So the entire 5% is due to price.

On the expectation with regard to volume in the fourth quarter, we had [missed]. We had additional decreases from both our General Motors slowing down on our engine and transmission products, as well as some decreases in our heavy truck customers due to inventory issues that they were trying to deal with at the end of the year.

The last one I think related to the increase in reserves. Wendy, we took around a $3 million increase in our reserves relative to the potential exposure within the industry, even though we are current on all our receivables.

One last question. I am a little confused about the changeover from auto to industrial plants. I know that is part of the strategy, but can you address how much capacity we are moving over, and what are the issues? Is that the only manufacturing issue in terms of those plants? Or are we adding additional capacity? I am a little confused about that. Thanks.

This is Jim. Let me take that. Just as background, depending on where we are in the market cycle, roughly 30% of the sales of the Industrial business are actually produced in automotive plants. Obviously, where we are in the cycle right now, that number is going up. But we are working to help that number go up.

The way we separate the businesses, the cost of ramping up that capacity is -- disproportionally [land] in the automotive business. So that is sort of one piece.

The second piece, which is about adding capacity, when you have significant investments going on around the world, [part of it] is increasing capacity specifically in products for industrial markets.

Thanks, I will get back in queue.

Mark Parr with KeyBanc Capital Markets. We will move on to the next question. [Vincent Bircher] with Goldman Sachs. Gary McManus, JPMorgan Chase.

I was worried with the prior two calls. I just want some clarification. I think, Jim, in your prepared remarks you talked about $13 million EBIT impact. Was that just the write-off of the slow-moving absolute obsolete inventory? Or was that -- what is that amount?

You had $6 million I think with Project ONE in Asia; and then Glenn talked about $3 million reserves in auto. I was just trying to get a sense on each one of these buckets individually.

Gary, of the $13 million, again we talked about, I guess, inventory impact would be around $5 million. You've got around $8 relative to the manufacturing cost.

Okay, and the $6 million is the Project ONE in Asia, right?

That is correct, that would be on top of that.

The $3 million reserves in Auto is within this [$19] million, or is that additional?

That would be additional to it.

So the total -- I don't if I would call it nonrecurring or unusual non-manufacturing would be $22 million in the fourth quarter?

Again I wouldn't necessarily call the investments we're making in Project ONE in Asia nonrecurring, because it is going to be a part of the Company going forward for some time. Actually we would expect to see increased expenses or investments in those two.

But the others that you would characterize as clearly the write-off of inventory or the increase in the bad debt potential, we view that way, as one-time.

And the manufacturing costs we expect to go away, albeit we expect that to diminish over time; but we still have some issues relative to ramping up capacity. So we will have a part of it. But overall that will go away over the next few quarters.

Okay; that's what I was going to -- in the first-quarter guidance, how much of that $22 million is still with us?

Well, maybe take a tact of if you look at just from the first quarter, what has changed? Or why would we expect the first quarter to be low relative to the first quarter a year ago, while we are expecting the full year to be higher?

If you looked at our Steel business, firstly, just as an example, we have had obviously very strong performance throughout the whole year. But in particular, you noticed that the first half of last year we had significant margins, well above normal. It's our expectation a little bit, as we saw in the second half of the year with Steel, but we would continue to see that decline.

So while we will have some costs associated with the manufacturing as we are ramping up costs, that pales really in comparison to coming off of the record levels that we had in Steel. In fact, we expect to see improved results out of the other two businesses in the first quarter next year, even absorbing some of that manufacturing cost.

But we do not expect recurring inventory write-off or the recurring bad debt exposure. But that obviously is subject to change in the marketplace.

I guess, what I am a little bit confused on, maybe you can clarify it; but if I add back the $22 million that you reference in the fourth quarter, you had very strong EBIT growth year-over-year. Now you are suggesting an EBIT that is down in the first quarter year-over-year.

I can recognize some of that is in Steel, but if I give it -- like it's been running $50 million a quarter for the last two quarters. If [I say it's there], you still would see very little growth in the other two segments.

Again, if you look at the earnings guidance we gave, again, for the full year, we expect to see improvement in earnings and we expect to see an improvement in margins as well. So it's as much just the timing of it.

So again, overall, we will trend much better in the second half than the first; in part again because of the Steel business performance in the first half of last year, as well as we've burn through some of those inefficiencies on the manufacturing costs as we get into the second. So it's more of a timing issue.

But again, margin improvement year-over-year within our Auto and Industrial Groups. We would expect margins to come down to more normal levels of peak performances, if that is such a word within the Steel Group. So still very strong performance; but we will make up that margin decline within the other two groups.

One last question and I'll get back. Do you expect Auto to be profitable in the first quarter?

As we look to the year, again, we expect to see improved performance. We are looking to be call it breakeven-ish in the first quarter and then picking up each quarter thereafter.

Okay, thank you.

(OPERATOR INSTRUCTIONS) Holden Lewis with BB&T.

Just sort of curious about the progression. Because I mean the Project ONE, the new capacity, all these things -- it's not like they are new. You have kind of been working on them, and presumably would have had plans in place going into Q4 when you provided the guidance at that time. So I guess I'm kind of curious about why the costs have sort of come as a surprise.

What is sort of the catalyst to having missed the bottom end of your own range in the quarter? It seems to me that most of these things would have factored into your thinking with the guidance; and clearly something didn't.

Holden, this is Jim. If you come back to my prepared remarks, I started off by saying the miss from our forecast in the fourth quarter was based on manufacturing costs. A combination of the capacity ramp up costs, the absorption costs of taking inventory out, inventory write-offs, and then you add to that the increase in reserves in Automotive. That is what caused the miss.

The other discussion, the discussion about Project ONE and about Asia, is an ongoing expense that in fact is ramping up. When we say investment, understand that this is expenses that we are incurring as we add infrastructure to be able to do those things.

So we're trying to deal with two different time frames. One is to explain '06 versus '05 and what that progression is going to be. The other is to explain what happened in Q4 that surprised us.

Okay. Of the $6 million for the Asian investment in Project ONE, what do you expect that to be in 2006? What is going to be the expense there?

We commented that we're going to be up around $20 million year-over-year in the two initiatives, with Project ONE and Asia. So both comparable around $10 million. Again, as Jim commented, we are ramping up, frankly, on the Project ONE which was initiated this year. So to really put in new business processes, but as much to put in global ERP/SAP systems to support our growth, the Company that we are today frankly, as well as the growth going forward. So we will see a lot of the costs as we go through that longer-term program.

Asia is a little different animal, because that is a lot top-line growth driven. It's part of the world where we clearly have a big focus of growth to sell our products in. We are already established there.

So to your point, Asia growth as we would define it is on top of what we are normally or had been normally doing in Asia. But we've been a big player there, so we have made a conscious decision to build up the infrastructure, sales engineers, to put in a senior management team over there to really coordinate our activities. We are saying that is the additional investment or the additional focus that we expect to realize good returns from that.

But Mike, you may want to comment given a lot of that focus is within our Industrial Group.

Yes, this is Mike Arnold. Essentially the investments that we are making in Asia are predominantly along the lines of the industrial markets that expand over there. So we have been ramping up since 2003 quite aggressively our cost structure and building the infrastructure, not only with regards to S&A as Glenn talked about, management structure, and salespeople, technical people, etc., but also our manufacturing as we go through that.

We're doing it obviously specifically because that market continues to grow for us. Our sales on an annual basis over the last three years have averaged about 35%, 40% per year growth. So it's a very exciting market. It's a market that we continue to invest in. We will continue to invest in that as we go forward.

Just so I get the numbers right, Asia and Project ONE was $6 million in the quarter; how much was it for the full year of '05?

We spent -- the total was around $12 million within our Project ONE group. What we would say is the incremental spending for the Asia growth initiative would have been around 8 for the year, so 20 in total for the year, 6 of it in the fourth quarter. And again that 20 going up to around 40 next year combined.

Okay, and then the last thing is you noted that you had reduced operating levels, I think to deal with inventories. Is that kind of a onetime thing? Do you anticipate operating levels moving back up, just because you're dealing with inventories? Or how should we view the impact of that and the impact of it going forward?

Again, when you say the operating, if you are talking relative to the margins and the performance of the Company, we do expect to see improved performance. Working capital management obviously is a focus; we used a lot of cash during the year.

We continue to focus on it, although in the fourth quarter we would only seasonally expect that to be the big contributor of cash, which it did to the tune of around $80 million. But given the seasonal nature of our business, we would expect to see that ramp up in working capital again in the first half and then following a similar pattern. But clearly it had an impact on the performance in the fourth quarter.

Yes, my impression is that in order to deal with working capital you made a deliberate effort to reduce operating levels below the seasonal norm. I mean, that is kind of how I read your comments. Is that correct or not correct?

That's correct. Again we have an active program on it. Let's just say in the fourth quarter there was heightened focus relative to the demand in the market, especially within certain products. So we would always expect to be aggressive on managing that and balancing the performance of the Company, as you can expect or appreciate the challenges, especially in certain constrained areas. So obviously the focus was on areas especially within the Automotive Group that is focusing on lower light vehicle production, so where we put more emphasis taking out inventory.

Okay, but is it a one quarter issue and you get back to more normalized rates of production? Or is the market such that we are probably stuck at these kind of levels going forward?

Again, I am a little hard pressed on your question. We would say that as we look going forward there is nothing unusual. We will continue to try to take working capital out of the system, but clearly we are expecting continued top-line growth, especially within our industrial markets. So we will see that inventory ramp up a little bit, if you will, for meeting those needs.

But overall, I think we made the comment earlier that we expect working capital to be a positive this year relative to the significant ramp up we had last year. And we saw the start of that in the fourth quarter, wo we would expect that to continue during the year, with the expectation -- depending on how strong the market is -- that we can continue to take inventory levels out of the system.

Holden, this is Mike Arnold. Maybe just one comment that might help tie together a couple of your questions. In the fourth quarter, in addition to the questions that you have asked, we have accelerated the ramp-up of capacity to serve industrial-only markets. So this is capacity that would not be shared capacity between our Auto Group and our Industrial Group, where we might move the mix of where that capacity goes to.

But this is looking at a very strong '06 that continues to grow. As you look at some of the industries like mining that you could even argue is continuing to accelerate across the world, especially with oil, we made a fundamental decision in the fourth quarter to spend some money to ramp up that capacity and get (inaudible) strong markets in '06.

So that is a little of what you have seen in the fourth quarter. You will continue to see some of that in the first quarter, and then obviously the sales will be coming as a result of that capacity.

Right, and that is the $8 million you're referring to. Okay, all right. Thank you.

Mark Parr with KeyBanc Capital Markets.

I am glad it worked this time. I have been trying -- I didn't -- for some reason, we were having some technical difficulties, and I was not able to get all of the nuances related to the fourth quarter. What I have gotten so far is a $3 million discretionary increase in receivable reserves; a $5 million charge to inventories for obsolescence that was unusual but operating. Of the $6 million that you spent on Project ONE in the quarter, what is the -- was there anything that was unexpected there relative to where you were in October?

No. Mark, where we came lower than the guidance that we provided was not within the Project ONE and Asia spend. That is more of highlighting the initiative now, because it's ramping up. As we look to '06, it will clearly have a constraint upon what our growth would have been other.

But the other ones that you've mentioned, the receivables and the inventory, clearly were onetime, not expected. On top of that, we did not perform as well as we were expecting on the manufacturing side as we were ramping up that capacity.

Okay. So you have seen a lag in the benefit of the ramp-up in capacity; is that fair? Is that more the issue? Or is it the end markets not performing as well, or you walked away from more business than you had thought in October?

I am trying to get more if this is an internal event that you kind of -- that maybe there was a little delay, or maybe it's an end market issue.

No, as a matter of fact, we would characterize that the end markets for us right now are very strong, and that the costs, what we did -- frankly, we didn't leverage that stronger market as we were ramping up our capacity.

Again, we're getting that through the system. We expect that to obviously go away where it is an unusual item. But it will trend favorably, even though it won't all be away, because we still are facing that same strong demand within certain markets.

Mark, this is Jim. The only market where we are seeing weakness is pretty obvious. It is out of Detroit into our Automotive, particularly the pass-car side of the Automotive market. So that is -- a little bit of this inventory adjustment happens to be in that area.

But in the core markets, particularly industrial markets, heavy truck, this is, as Mike said, a conscious inside decision to spend more money to be able to turn in better performance as the markets develop.

Okay, so that is something that you -- that was a decision that you made in the fourth quarter; and you have got spending in place now that impacted the fourth quarter. Did you quantify at all the magnitude of those new more recent decisions to accelerate your growth in those areas?

Within the Industrial Group, we impacted the results probably around $5 million in total, from ramping up capacity and moving equipment around and people around during the year. So all of the, if you will, the surprise that we had with margins in Industrial, if you will, not at the same level as they were a year ago, was really attributable to the manufacturing costs of around $5 million. And the inventory was there, around another $5 million.

So this is new investments that you chose to make for new growth that you're seeing in '06 and beyond, Industrial arena, right? Okay, terrific.

I had another question if I could digress just a little bit. The Steel side of the business, you had talked about margins in the first half being perhaps unsustainable. I'm just looking here; those margins were perhaps a bit higher in the first half of '05 than the second half, but not an enormous amount higher.

I guess I would really like to get some more color on where you're seeing your lower surcharges impacting margins, and how that works, especially given the fact that we've seen scrap move back up, $35 or $40 a ton here in February?

Absolutely, Mark. This is Sal Miraglia. We have seen a lot of activity in that area. You're absolutely right, over the course -- in fact if you looked at the last three months, we saw sort of a fall of about $35 a ton; and then more recently with the Ford and the DaimlerChrysler bundle options, virtually a recovery of that.

We had expected to see a steady decline in those bundled prices over the course of the latter part of the fourth quarter and continuing on into 2006. We still believe that will decline to a great degree for a variety of different reasons, but it's sort of stayed as it was and where it was.

You talked about our EBIT margin performance, and you are right. We were up pushing the 12% to 13% EBIT margin range in the first half of the year. We were in the sort of 11%, 12% in the latter half of the year. We expect it to go a little bit lower than that. We expect it to go back down to what we have seen as -- in our better performance times, somewhere around the 10% range.

It is just a question of how quickly we see that fall, and that is where the uncertainty in prediction may be, and has a great deal to do with this issue associated with the erratic behavior of the scrap number one bundled prices. That's, of course, as I am sure you are aware of, what our index is based on, metal market posting of number one bundled prices. Does that give you some color on what you are looking for?

Yes, I guess perhaps it does. But I think the guidance, given what has happened with February, you have seen the number bounce right back up again. That would seem to be helping you guys.

The other thing, I guess the other thing that you haven't really addressed on Steel is with the continued momentum in energy and aerospace markets, that would imply an improvement in mix for you guys in '06. It would also imply perhaps enhancement in margin as Latrobe continues to fully commission the recent upgrade that you made there.

We have also been getting a fair amount of evidence to suggest that base prices for SBQ material in '06 has actually been stable to higher in some cases. I guess, given some of the other things that I am hearing, I guess your guidance for Steel seems a little bit on the conservative side. Just help me here; what am I missing?

I think you have got it exactly right, Mark. I mean, our mix has improved, particularly regarding what we consider to be higher-value products within our business; that is, industrial, aerospace, and energy, at the expense of some of our auto participation, which is fine in our book at this stage in time.

The biggest issue with our guidance is we continue to expect to see the price of the number one bundles, that is, the surcharge, fall. Now frankly we haven't seen it. So you are right, we're going to have a bit better than what we thought would happen in the first part of the year. But I think that is built into Glenn's upside earnings estimates, as we have looked at this, given the total package that we are trying to deal with at this stage in time.

As a matter of fact, Mark, I'd even just add to what Sal is saying, is that part of the volatility -- and obviously too the benefit that we had in '05 -- is very difficult to forecast. So as you come into a year and you're projecting out now a full year's worth, do you project the benefit that we did receive last year that was unusual into a forecast this year, even though again it is very volatile?

And we have seen -- your point -- some positive events, at least into January. But again you could argue there's upside there; but arguably downside too, depending on what the scrap levels go to.

At this point, can you tell us how much of your Steel business is on 12-month contract?

About 60% of our products is on annual contracts.

Okay, terrific. Thanks for the color.

Vincent Bircher with Goldman Sachs.

It's actually [Ben Bernstein] at Goldman Sachs London. Just one very quick question for you. Would you to be able to detail the organic growth rate for each division this quarter?

Looking at -- the question was for the fourth-quarter organic growth?

Yes, please.

I believe all of the growth -- at least of any significance -- would have been organically. We had the one acquisition during the year of Bii, which again would have been relatively small to the total.

Okay, thanks very much.

Andrew Obin with Merrill Lynch.

The question I have about the costs in the fourth quarter, could you comment what trends are you seeing in your labor cost? Is that a component of the shortfall?

It is not a cause for the shortfall. Labor costs right now are kind of as we would have expected with really no changes.

Okay, the second question I have, looking at my machinery universe, pretty much every company that I cover missed numbers. And every company had a host of onetime items that pretty much seemed to explain all of underperformance.

Are we missing collectively as analysts? Are we missing something happening in broader markets that is causing this sector to have sort of these earnings issues? You guys are right in the thick of it. What are you hearing from your customers?

Let me start and then I'll pass it on to our business presidents, but you have to temper the issue in the fourth quarter and step back and look at the year that we had. It's hard to say that the 15% top-line growth doesn't do anything other than reflect very strong markets that we have; and that is even constrained given where the automotive industry is.

The fact that we were able to see our earnings grow close to 90%, albeit coming off of a low period, but we had an equally doubling of earnings the prior year.

So as we look at the fourth quarter, again we're disappointed because we missed the expectations that we had set for ourselves. But where we missed clearly was in a few onetime items of inventory, of bad debt expense increasing, as well as on some operating issues that we had obviously with the capacity that we have spoken about.

So we don't see a fundamental shift in the end markets or in our performance. We reflected that by the guidance that we had of improved results next year, even tempering it with the investments that we're planning on making, which are really long-term initiatives, as well as if you will an outlook within the Steel Group that would say we are coming off of record levels. Even though at lower than record levels would still be a tremendous performance within the Steel Group and probably a record for any other year other than this past year.

So we can only speak to what we are seeing, but it's nothing that would give us reasons for concern based upon what happened in the fourth quarter. But I would ask maybe Mike, Jacqui, and Sal just from an end-market perspective what you are seeing.

I am more interested in sort of I guess costs, because the revenues are clearly doing very well.

From a cost standpoint? From that respect, again, we are looking for margin improvement next year, not counting on the recurring issues that we had in the fourth quarter; and again tempering the steel issues that we talked about.

Just a follow-up question on CapEx. Where are we spending the CapEx? Are we spending it proportionately to where the sales are? Or there is some sort of disproportionate spending into growth areas? I'm talking geography.

We would say at least the increased spending, and we are increasing our CapEx spending, is to support the growth initiatives that we have, principally focused within the Industrial Group. If you go geographically, principally focused over in Asia. So it's very targeted to where we see long-term opportunities.

So I would say it's fair to say if I take the Delta in your CapEx I should assume that you're spending it in Asia?

You are looking at call it 50 million-ish if you target our 5% of sales. That is probably an appropriate amount of capital that we're putting into Asia.

Thank you very much.

Steve Volkmann with Morgan Stanley.

Just a couple of quick follow-ups. Glenn, I think you made the comment that debt levels were down to the bottom of your target range, which would give you some flexibility to make some investments. I am just a little bit intrigued by that. Should we be thinking about acquisition activity or more along the lines of what we have already discussed this morning? Or what about some other potential uses of the cash, share buybacks, etc.?

Let me take at least the first (indiscernible), Steve. The comment was really to say that the balance sheet obviously is always important to us. We believe in a very strong balance sheet. Coming off of call it 50% leverage levels at the time we did our Torrington acquisition, we feel very good about bringing it back to within our targeted leverage.

You'll notice that we have made increased contributions to our pension plans this year, well above the minimum, probably an extra $100 million; and our balance sheet is still there. So it gives us the flexibility.

We always look for strategic acquisitions. We did some the past couple of years, albeit smaller ones; and we are continuing to pursue that. So we have the ability to, if the right opportunities come up, and you get into all the valuations and so forth. But we do look for that.

But having said that, the clear focus within the Company is much more within the initiatives that we have talked about and that we are throwing investments in. Project ONE, the Asian growth, the capacity adds that we're doing, the restructuring programs that we have announced within our Automotive and Industrial Group.

So that is, if you will, the focus; and if the strategic acquisitions come, we are in a financial position to take advantage of it.

Great, thanks very much.

Eli Lustgarten with Longbow Research.

It's Eli Lustgarten. I have a couple of clean-up questions. I really don't understand some of the things you said. In the fourth quarter, $5 million inventory charge was Industrial, $3 million was a reserved in Auto. I assume they are in the EBIT numbers. Of the $8 million manufacturing cost, is that split between Automotive and Industrial? And where is the $6 million Asian (technical difficulty)?

The last $6 million? (multiple speakers) In Asia, okay, the Asia. Right, we would say, at least trying to hit some of the numbers you had commented on, the Auto reserve was the $3 million. We've had the inventory of $5 million, which was within the Industrial Group. Then from a manufacturing standpoint, we talked about $5 million of manufacturing cost within the Industrial Group, ramping up capacity and so forth. But we also had slightly higher manufacturing costs within the Automotive Group due to, again, the producing (multiple speakers) .

(multiple speakers) between the Auto Group?

Eli, you are really breaking up. Can you please say that again?

In your comments you said $8 million was higher manufacturing. (technical difficulty) and 4 Automotive?

That's correct. $5 million Industrial, $3 Automotive.

And the $6 million Asian stuff is Industrial?

The $6 million was both our Project ONE and our Asia growth initiative. Most of the Asia costs, which would have been around $2 million of that, would have been focused within the Industrial Group. Of the $4 million with our Project ONE initiative, would have been equally split between those two groups primarily.

Now you talked about $90 million for Project ONE over the next five years. That includes the SAP development, of which that -- the incremental 20 is in '06; is that correct?

Yes, the $90 million for Project ONE would include the SAP implementation; and the $20 million increase -- well, it is $20 million in total, I'm sorry. For Project ONE the absolute spending will be around 20, but that would be roughly a $10 million increase over what we had spent this year.

So you spent $12 million -- sort of [indicated] $12 million is for Project ONE in '05; you're saying $22 million in '06 or something like that. But we still have almost $60 million to go in '07, '08, '09. Is that going to be evenly split between (technical difficulty) ?

The dollars that we quoted was expensed primarily. We will have some capital that will go through that. But a lot of the cost, if you will, is going to be the people, the outside advisers that we're using.

We have a five-year product, so if you look at the bulk of your cost, the people cost, it is going to take, call it, the four-year, five-year time frame. Those people costs more tend to go into, call it, years two, three, and maybe a little bit into four. So the least amount of spending is kind of the front-end (multiple speakers).

(multiple speakers) '07 going to be another incremental 10, (technical difficulty) ?

I'm sorry (technical difficulty). That's right, we would probably see another incremental spend, because we are ramping up at that point in the second half of '06, first half of '07. Then you will start to see it wean down as a lot of the people that are being utilized on the project now start to go elsewhere.

Do you have anything built in here now just for the disruption that SAP tends to do to the whole manufacturing process? (technical difficulty) Go back in history what has happened in the last couple years, and people who have implemented, it has played much more havoc with operating results than anybody ever wanted to admit.

That -- obviously we have benchmarked a lot, we have taken our time on building this up. We have spent over a full year working on our design phase of the project before we started doing any implementation in order to make sure that we are as best positioned. We have ramped up the people and put the right people, the resources that are required. So we are making a significant investment, and we're trying to mitigate the potential disruptions.

We're doing a pilot program right now in one of our locations, as far as the first wave, to make sure that everything goes through smoothly, as smoothly as a systems implementation can go, before we spread it out through the rest of the organization.

So do we expect that there are going to be hiccups along the way and some disruptions? Yes. I think we have done everything that we can to mitigate it as much as any company can.

(technical difficulty) I just couldn't hear the answer whether you expected to be profitable in Automotive in the first quarter.

Right, we said given the trends that we have, our expectation if we look at least for the year -- you hate to just focus quarterly, but we will -- for the year we expect to see improved results for all the initiatives, the pricing, the reduction in the costs that we have had, getting our capacity right, and the restructuring program being implemented.

As we look at the trend and what we did factor into our guidance, it was a basically breakeven-ish type of quarter for Auto, and then progressively improving throughout the year.

Thank you.

Robert Schenosky with Jefferies & Company.

Actually this is [Steven Weiss] with [Luxo] Group. A couple of questions. What would you guys say are the risks moving forward for some of your major raw materials for the remainder of the year?

I believe -- let me just repeat the question to make sure we got it. That the risks of higher material cost to the Company?

Yes, what are the risks moving forward that you see that are challenges for your major raw materials?

Let me take the first stab at that; this is Sal Miraglia. Clearly, we have some sort of insight with respect to that, because you have to acquire real raw material to produce some of our products. What we have seen so far and what we expect to be the case is that the raw materials will be available, but there will be costs associated with them.

There is a spectrum of issues with regard to costs that include not only the basic scrap, but there is an alloy problem in certain areas, and it's ameliorating in some other areas. We have seen a similar condition on a global scale, where my colleagues in the parts fabrication businesses have to source locally. That is, that it's been available but we have had to pay prices for it.

Now in terms of the steel business, we manage to be able to cover most of our contracts with surcharges that are consistent with what we think to be the cost increases covering scrap, covering alloy, and in fact more recently even incorporating fuel surcharges, which we thought we would be a little less successful at than we have been; but we have been fairly successful.

That has been compensated to some degree by the fact that these costs for natural gas in particular have not gone nearly as erratically high as we anticipated just six short weeks ago. So in North America, that problem looks like it is relatively in hand, with the exception of the need for being sensitive to the pricing associated with somewhat close supply conditions, but not negative supply conditions.

Globally, that picture is relatively a mirror of what we have seen here. As a consequence, it is simply a matter of making sure that we are covering ourselves in many of those cases. But our inside view from the Steel business's point of view is that it is available. Pricing may be affected.

We actually expected to see the supply loosen a bit, meaning that the pricing would start to come down, or the surcharges would come down. That has been a bit more erratic than we thought. At this stage in time we are continuing to believe that will be the case, that it will be available.

To combat these challenges, what proactive supply-side initiatives are you guys putting in place? What are you guys doing proactively?

I'm sorry, could you slow down a little bit and repeat the question?

You mentioned the risk a few minutes ago and that [was great]. To combat a lot of these challenges that you guys are facing, what are you guys doing proactively in terms of supply-side initiatives?

This is Steve? Is that who you said it was?

Yes.

Steve, I think as a general statement, the point Sal was making is we don't see major supply-side risks. So when you talk about the proactive initiatives, they are our normal risks, to manage our supply chain, to diversify our supply chain, and to drive cost out.

Your suppliers have been working real well with you? They think it is a win-win situation for both parties?

Right.

Final question is, for the remainder of '06 what would you say is your top raw material that is concerning you?

A month ago, my top concern would have been energy. That is not so much a problem anymore. Probably in the Steel business's arena, our biggest concern is a general inflationary pressure across a number of consumables that frankly we haven't got built into surcharging, and that we have to rely on pricing mechanisms in one fashion or another to deal with.

Everything from, in our case, electrodes, which have seen a huge increase because they are also energy based or carbon based; to other consumables, including refractories. But again much more manageable risk than it is a supply shortfall risk. Mostly price based.

Okay, thank you very much. Continued success down the road.

Wendy Caplan with Wachovia.

I just want to just confirm, because I am still a little confused on the numbers. You knew when you told us in October that, when you gave earnings guidance in October, you knew about the Project ONE cost, in terms of the $2 million for Auto and the $4 million Industrial.

You did not know at that time about the $3 million in reserves, the $3 million in manufacturing in Auto, and the $5 million in inventory write-down, and the $5 million in manufacturing cost for Industrial. Is that correct?

Clearly as we said, the Project ONE in Asia costs, as you talked about, was known. Again, we are highlighting it now just because of the increase as we go forward. What was unknown at the time that we provided our guidance -- which again, you hate to miss, and this was the first time during this year that we have missed the estimates that we had; but we were $0.02 short at the low end of it -- but we did not know what we were going to reserve relative to the Automotive.

You will recall that in the third quarter we did take a write-off relative to one of our old customers going into bankruptcy. As a result, it gave us a heightened focus on looking at all of our exposure within that industry by customer. Then we determined late in the year that we would increase the reserve, again, even though everything is current, in order to be prudent relative to the potential exposure that is out there.

Relative to be inventory write-down that we took, again, that was another year-end activity, if you will, as part of our process of moving a lot of things around with the restructurings and so forth. We made an assessment based upon our policy that it was appropriate to write-off that $5 million.

So you take the two that we did not know about, the two that were clearly one-time, if you will, that caused us to miss what we had expected to achieve during the quarter.

This is Jim. Just to put those two numbers, the Industrial and Automotive manufacturing issues, into perspective. That is kind of 1% variance for the quarter in terms of their total manufacturing cost. So it says that we knew the things that were going on; we underestimated the cost.

Thank you very much.

Gary McManus with JPMorgan.

Just a couple of mop-up questions. I noticed the average share count in the fourth quarter went up to 93.6; it was like 91.7 in the third quarter. So what share count should we use both for the first-quarter and full-year 2006?

We would use the ending average for the fourth quarter, call it the 93.6 as a good proxy.

Even though -- I mean, that is an average share count. I assume the number was moving up as the quarter progressed. Is that -- no?

Again, it's going to fluctuate around it. As you know those are numbers on a fully diluted basis, so it involves looking at options, looking at the share price. There are no shares that have been issued, option exercises, a lot of things come into play. So we would just say that that is a good proxy. You may want to round up, use 94.

Okay, pension and healthcare cost, directionally in 2006 versus where it came in, in 2005.

Those were kind of flattish year-over-year; and our expectation for '06 is for that to be flat as well.

Do you need to make additional -- are you expecting to make an additional cash contribution in the pension as you have done in the past?

Yes, We have targeted around $150 million of contributions in '06. So down from the $226 million in our domestic pension plans that we did in '05. That is a target for right now; and again we will assess it as we did the pensions this year as we go throughout the year, whether or not we would even considering contributing more to that.

Okay, just the last question. Part of your Automotive business is serving the North American heavy truck market. I think it is, what, 15%, 20% of your sales? (indiscernible) give it a number. But obviously, most people expect that to drop fairly significantly in 2007 with the new EPA emission standards. How much will that impact Auto performance coming in 2007?

In 2007, we're predicting the softening. The good news is, the manufacturing capacity that we use for heavy trucks can be used by Industrial. So we are balancing out the outlook for our Industrial customers for that capacity.

But presumably it's a higher margin business than the light vehicles business, so won't that play a part in your margin in your Automotive performance?

Also, can you just give me -- was it 15 -- am I right it's about 15%, 20% of sales, or am I kind of off on that?

Yes, it's about 15% of sales, and there is higher margin in some of our portfolio in Automotive, but it's lower margin in a lot of the portfolio in Industrial where the capacity would be directed.

Okay, all right. Thanks.

Holden Lewis with BB&T.

Can you just comment what your expectations are for CDSOA going forward?

Yes, it would be the same estimates that we have each year coming into a year. We don't plan on it to occur. We don't put it in our guidance. In fact, when it even does occur we treat that as an unusual item. So we won't have any view to that unless there is a change in this legislation or until the end of the year when we find out whether or not there are any payments coming.

Right, I guess I was curious about your view on the legislation side. Do the risks look to you greater this year that that legislation, to sort of roll that back, would go through relative to prior years? Or you don't see any difference in the environment than what you have seen every year?

Holden, we have sat and tried to predict commodity markets, the industrial economy. I don't think it's appropriate for us to try to predict what's going to happen in Washington.

Okay, thanks.

Mark Parr with KeyBanc Capital Markets.

I just wanted to thank you for the level of disclosure that you gave. Really, it really helps when we really understand what your thought process was, how things have changed over the course of the quarter. I just want to wish you good success on achieving your operational objectives into '06. Thank you very much.

Thank you, Mark. Appreciate those comments.

Andrew Obin with Merrill Lynch.

I had a question on CDSOA, but it was answered. Thank you very much, guys.

At this time there are no further questions, sir.

All right, thank you very much. As Glenn reiterated about halfway through the Q&A session, we had a significant improvement in performance in 2005. We remain confident that the strengthened industrial markets in 2006 and our own efforts should continue to fuel our performance throughout the year 2006. Thank you again for your interest in Timken and your investment.

This concludes today's conference call. You may now disconnect.