Timken Co (TKR) 2008 Q1 法說會逐字稿

Good morning. My name is Christie, and I will be your conference operator today. At this time, I would like to welcome everyone to Timken's first quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Thank you. Mr. Tschiegg, you may begin your conference.

Thank you. Welcome to our first quarter conference call. I'm Steve Tschiegg, Manager of Investor Relations. Thank you for joining us today, and after our call, should have you further questions please feel free to contact me at 330-471-7446. With me today are Jim Griffith, President and CEO, Glenn Eisenberg, Executive Vice President of Finance and Administration, and CFO, Mike Arnold, Executive Vice President and President of Bearings and Power Transmission Group and Sal Miraglia, President of our Steel Group. We have remarks this morning from Jim and Glenn and 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 future financial results, plans and business operations. Actual results may differ materially from those projected or implied due to a variety of factors. These factors are described in greater detail in today's press release and in our reports filed with the SEC, which are available on our website at www.Timken.com. Reconciliations between GAAP and non-GAAP financial information are included as part of the press release. This call is copyrighted by The Timken Company. Any use, recording, or transmission of any portion without the expressed written consent of the company is prohibited. With that, I will turn the call over to Jim.

Thanks, Steve and good morning. I'm pleased to report that Timken began 2008 with record first quarter results. The top line for the quarter was up 12% and our earnings from continuing operations were $84 million. Excluding special items, earnings per diluted share of $0.82 increased 24% over last year, exceeding our earnings estimate for the quarter. The changes we're making to our portfolio are working. We're more industrial, more global, and our portfolio is better aligned for consistent profitable growth. We have made critical changes and investments to improve our ability to execute. Our enterprise strategy is clear, to grow targeted parts of our portfolio, while optimizing the rest.

The first quarter results reflect this progress to structurally transform our business. Beginning this quarter, we are reporting the results of the company under four business segments. Glenn will take you through the details in a moment, but, first, I would like to review the quarter in terms of the progress we have achieved to deliver improved performance.

Sales and earnings for all three bearings and power transmission segments are up. In mobile industries, our results reflect the positive impact of pricing efforts as we discussed last quarter in markets where we are not earning a suitable return. Additionally, we have essentially completed our restructuring and are seeing improved operational performance. The realignment of our bearing and power transmission organization translates into better execution and more effective portfolio decisions. I have been very impressed over the last few weeks at the speed at which our organization has reacted to the customer work stoppage underway in Detroit, reallocating capacity where possible and taking other actions to mitigate the impacts.

Sales and process industries were up 25% this quarter, driven by strong demand, particularly in energy, the metals industry, and distribution sectors. Our investments in capacity to serve these markets are now coming online and have a significant impact on our bottom line, which more than doubled from last year in this segment to $60 million in EBIT.

Two weeks ago, we celebrated the opening of two new plants in Asia, increasing our manufacturing footprint to seven facilities in the region. Timken is very well positioned in Asia to achieve accelerated growth and improved profitability in years ahead. The plant in Chenai India will produce medium-sized bearings to serve industrial customers, providing much needed capacity in market sectors where we've had backlogs. Our new plant in Chengdu China will serve global aerospace customers as well China's rapidly growing commercial aviation industry. Timken sales in Asia grew over 30% in the quarter, further diversifying our portfolio. Nearly 8% of the company's sales now come from this region. Within our aerospace and defense business, we began to see the impact of improved execution, and additional capacity in our core business and the Purdy acquisition has made significant contributions to this business extending our product offering into complete helicopter gearboxes.

In our steel business, we are generating strong results as we continue to grow in differentiated markets. In February, we completed the acquisition of Boring Specialties, further extending our strong position in the growing market for high performance energy products. We continue to experience rapid increases in the price of raw materials in the quarter which resulted in a significant increase in our LIFO reserve.

This month, we successfully implemented the third phase of Project O.N.E., our business process and systems improvement initiative. The company now has most of its bearings and power transmission revenue in North America and Europe flowing through one fully integrated system and we are already seeing improved customer service as a result.

In closing, we expect strong global demand for industrial products to continue. Our results for the quarter illustrate structural transformation and improved execution, driving enhanced performance across the portfolio. Now, I will turn it over to Glenn.

Thanks, Jim. For the first quarter, the company's fully diluted earnings per share from continuing operations were $0.88. Excluding special items, earnings were $0.82. These special items included $6 million of after-tax income, primarily related to a gain on a real estate divestment, which was partially offset by restructuring and rationalization expense. In the first quarter of 2007, special items totaled after-tax income of $12 million, and included a favorable adjustment to our tax reserves which was partially offset by restructuring and rationalization expense. The rest of my comments will exclude the impact of special items.

Sales for first quarter were $1.4 billion, an increase of 12% over 2007. The increase over last year was due to strong demand across the company's broad industrial markets, aided by capacity expansions and the impact of favorable pricing, surcharges and currency. The benefit from the Purdy and BSI acquisitions was offset by the divestiture of the Desford 2 Mill early last year.

Gross profit margin for the quarter was 21.8%, an improvement of 90 basis points from last year, reflecting favorable pricing, currency and strong demand, partially offset by higher LIFO expense reflecting the higher cost of purchased scrap within the steel group. The company was also able to leverage SG&A as the margin improved 40 basis points over last year to 12.3%. As a result, EBIT for the quarter came in at $130 million or 9.1% of sales, 110 basis points better than last year.

Net interest expense for the quarter was $10 million, up $2 million from last year, due to higher debt levels resulting from the company's acquisitions. The tax rate for the quarter was 34.5%, comparable to last year and our prior outlook. As a result, income from continuing operations for the quarter was $78.9 million or $0.82 per diluted share, an increase of 24% compared to $0.66 per diluted share last year, and above our previous earnings estimate for the quarter of $0.70 to $0.80.

As Jim mentioned, the company implemented a change to its management structure. It now operates under two business groups, the steel group and the bearings and power transmission group, which includes three segments, mobile industries, process industries and aerospace and defense. Beginning this quarter, the company will report its segmented financial results under these new segments, which excludes special items and unallocated corporate expenses.

Now, I will review our business segment performance. Mobile industry sales for the quarter were $635 million, up 4% from a year ago. Increased sales in the off highway and heavy truck sectors, as well as pricing and the favorable impact of currency were partially offset by lower demand from the North American light vehicle sector, which included the effect of a strike at one of our automotive customers.

For the quarter, mobile industries' EBIT was $27 million or 4.2% of sales, 80 basis points higher than last year. The benefit of improved pricing, mix, currency, and restructuring were partially offset by higher material costs and the effects of the strike.

We expect to see improved results from this business for 2008, compared to last year, as the company benefits from its restructuring, pricing, and portfolio management initiatives, which are expected to be partially offset by higher raw material costs, and the impact of a strike.

Process industry sales for the quarter were $313 million, up 25% from a year ago, benefiting from pricing, currency and added capacity to serve continued strong demand across our broad industrial markets with the highest growth coming from the metals and energy sectors. The business also benefited from advanced customer purchases ahead of Project O.N.E. implementation that's expected to reduce demand in the second quarter.

For the quarter, process industries' EBIT was $60 million, or 19.2% of sales, 830 basis points higher than last year. The impact of strong volume, added capacity, pricing and currency were partially offset by higher manufacturing, logistics and material costs.

We expect to see continued improvement in our results throughout 2008 compared to last year, however the second quarter performance is expected to be lower than the first quarter due to the timing impact of Project O.N.E. as well as higher raw material costs.

Aerospace and defense sales for the quarter were $102 million, up 39% from a year ago. The increase was primarily driven by the acquisition of Purdy last quarter, as well as volume and pricing. Excluding Purdy, organic growth was approximately 10% for the quarter.

EBIT for the quarter was $7 million or 7% of sales. 180 basis points lower than last year. The favorable impacts of the Purdy acquisition, pricing and volume were offset by higher material costs as well as manufacturing and logistics costs, due to capacity additions, and manufacturing strong demand through constrained facilities.

Looking forward, we expect the aerospace business to improve profitability and margins throughout the year, due to the acquisition of Purdy, strong demand, pricing, and better execution.

Steel group sales for the quarter were $425 million, up 9% from a year ago. The group benefited from strong demand, primarily in the energy sector, which was partially offset by lower automotive related sales. In addition, surcharges and the acquisition of BSI more than offset the decline in volume from the closure of the Desford 2 manufacturing operations. Excluding the impact of acquisitions and divestitures, sales were up approximately 16%.

Steel group EBIT for the quarter was $53 million or 12.6% of sales, 420 basis points lower than last year. The year-over-year change was primarily due to a LIFO accrual, reflecting the higher cost of purchased strap. The benefit of strong demand, favorable mix and surcharges in the quarter were offset by higher material manufacturing and logistics costs. Steel group performance in 2008 is expected to be comparable to the record level achieved last year, despite higher LIFO expense resulting from continued high raw material costs.

Looking at our balance sheet, we ended the quarter with net debt of $805 million, $112 million higher than the end of 2007, due to seasonal working capital requirements and the acquisition of BSI. As a result, the company's leverage of net debt to capital increased to 28%, compared to 26.1% at the end of 2007. We expect to generate strong free cash flow for the remainder of the year, providing financial flexibility to pursue strategic investments.

Capital expenditures for the quarter were $52 million, or 3.7% of sales, comparable to depreciation and amortization of $57 million. This spending level will increase over the course of the year, as we continue to make investments in support of our growth initiatives. We contributed $12 million to our global pension funds during the quarter. Our full year 2008 contributions are expected to be approximately $20 million, down from roughly $100 million last year.

In summary, we expect demand from our global industrial markets to remain strong, especially in key markets where we have invested for growth, and for the North American automotive market to be down. We expect to see higher profitability and margins for the full year compared to last year, benefiting from improved pricing, operating performance, and portfolio management initiatives.

We expect earnings per diluted share for 2008, excluding special items to be in the range of $2.75 to $2.95, a record for the company. And earnings of $0.73 to $0.83 for the second quarter. From a cash flow standpoint, we expect to see higher free cash flow in 2008, benefiting from earnings growth, better working capital management and lower global pension contributions. Capital expenditures should be comparable to last year, as we continue to invest in growth initiatives while cash taxes are expected to increase.

This ends our formal remarks and we'll now answer any questions that you have.

(OPERATOR INSTRUCTIONS). We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Eli Lustgarten of Longbow Securities.

Good morning, Eli.

A nice quarter. Very impressive. A couple of clarifications. One, can you give us the impact of foreign currency, both on top line and bottom line, and the actual numbers for the active contribution of the two acquisitions and the divestiture?

Yes, Eli. Currency for the quarter call it rounded was around $50 million of our revenues. It accounted for roughly one-third of the top line growth. The acquisitions that we had during the quarter of Purdy and BSI, or the full impact during the quarter, was essentially offset by the decline that we had by exiting our Desford operation, so the net between the two was effectively zero, so it no impact year-over-year on the top line. As far as bottom line, we leveraged reasonably well the currency. We don't give out specific levels within the EBIT number.

But the currency clearly contributed to the earnings number?

It did. It did positively help the number.

And you indicated the -- I guess the pull forward of some revenue -- was it the process group in the quarter for Project O.N.E. For the process entity going forward, can you quantify what that might look like and how much do we give back in the next quarter until we can tell how to forecast this stuff?

From a timing standpoint, again, we would say that roughly call it $10 million to $15 million in sales would have been accelerated into the first quarter versus the second. As you may recall, we went through a systems implementation last year as well, but we did it in May. We saw similar events. We prepared for the advance of going live on the systems, but because this is now April 1, the advanced shipments, if you will, went into the first quarter versus the first month of the second quarter.

So that too would have been a couple of pennies a share coming from that.

That's correct.

Do you have any quantification of what the strike might have cost you in the numbers, and whether we see more impact in the second quarter from the automotive strike and the automotive downturn than we saw in the first quarter? It was very impressive what you did given the conditions in the auto industry.

I will give you the dollars and Mike will give you any of the color what's going on. But we are viewing it roughly around $15 million plus or minus, call it a month of the revenue impact from the strike, and with leverage of around 20%. You know, again, similar, a couple of cents a share, if you will, per month of that impact.

Does it get worse in the second quarter since this thing is still going?

Eli, this is Mike. It really doesn't get worse. It stays about the same unless they begin to impact other producers that drives down through the supply chain. So the impact we have seen in the first quarter fundamentally was a March impact. That [continuing] on through April and May is almost a monthly impact that we're looking at.

So we had one month so far in the first quarter and we have one month now in the second quarter (inaudible)?

No, we had about $15 million in the first quarter as Glenn said. If we look at the second quarter going through, if the strike was finalized at the end of the this month, we would probably look at $15 to $20 million. We just have to see how that actually works out. And as Jim said earlier in his comments, our ability to mitigate that from a margin perspective but also try to move some of that product to other markets has been relatively successful.

Okay. I will get back in queue. I don't want to hog it. Thank you.

The next question comes from the line of Martin Pollack of NWQ Management.

Very nice results. If I may, this is the first quarter we are seeing the new recasting of the data, but I'm most curious is within these segments, mobile industries, if you can give us a sense of what the automotive operations did both in the top line and bottom line.

Also, it seems aerospace is a little surprisingly lower than I would have expected, and I'm wondering if could you describe what the mix issue there in terms of the nature of that business. And the process, clearly phenomenal numbers. Can you in a sense give us a little bit more transparency year-over-year as if we had actually maybe seen some of this data without the new recasting of the numbers?

Marty, this is Mike. Let me will walk through all three segments and give you some insight. If we take a look at the mobile as Glen went through the numbers, you will see mobile as a whole is up 4% on sales, about 27% on EBIT. We said in previous quarters that we would try and give you some insight to the automotive piece as if we were still reporting the old automotive group. If we take a look at that sales would have been down, which you would have expected out of what we now consider to be light vehicle systems inside the mobile industries. So sales were down about 3%. The EBIT was actually improved quarter-on-quarter, so year-on-year. So that was good. That was off of a relatively stronger first quarter for the automotive group last year, compared to the remainder of the year. That's actually been very good news on the automotive side inside of the mobile piece. We're making good progress there.

If we go to the process industries just to give you a little bit of insight, you are right. The first quarter was a very strong first quarter, and as Glenn had talked about, some of that is the preshipments that we have made in March versus April, preparing for the implementation of Project O.N.E. and ensuring our customers had the right levels of inventories as we took down some of the operations for the implementation. So there was a combination of some volume that was moved in from April. But we also have very strong pricing that has continued on as we have discussed over the past couple years. That does continue. We have very strong markets and strong demand. Probably just as important is the volume increase that we're getting now from the capacity investments that we have been making over the last several years. So we've talked about those capacity increases as drags on our earnings. Now We are beginning to see the leverage from that investment. And then of course, we've gotten some benefits from currency.

The good news also is in looking at the first quarter, we have been able to mitigate at least year-to-date the material and some of the logistics cost that we have that -- above where we would expect them to be or had expected them to be, but were able to mitigate that through the strength of the business and our pricing. So that looks good. We don't expect that margin in the second quarter, as Glenn already talked about, but in general that business is running very good. And the implementation of Project O.N.E. is not only bringing us improved abilities to serve our customers, but from an on-time delivery perspective, inventory in place for our distribution partners across the world is all working out very well.

A couple of comments on the aerospace because the aerospace does -- this is first time that we have reported that externally. We walked through that a little bit on the analyst day about six weeks ago. But if you go through the walk-on sales, up 39% quarter on quarter. Most of that was from the acquisition of Purdy. If you look at just the organic piece of that, from a growth perspective, they were up about 10% quarter-on-quarter. That 10% breaks down -- because I know your next question, breaks down to about half of that is volume and half of that is price, and there's a little bit of foreign exchange in there.

The difference with regards to the actual margins quarter-on-quarter is, we would look at the first quarter and say, that is going to be our weakest quarter of the year. So we'll continue to see gradual improvement in that business. Fourth quarter was a very, very strong quarter. And if you go back and kind of look at the 2007 quarter-by-quarter results, you will see that the first quarter although fits relatively well in there, would still be considered to be our weakest quarter for the year going forward.

Yes. If I may just to follow up, back to the automotive and I guess I don't have last year's quota but the sale -- I mean, coming off the fourth quarter where profits were significantly down, just give us a little bit of a clarity from there. What kind of loss did we have in Q1 on automotive?

And as far as pricing actions, do you think you've got the kind of tail wind on pricing that suggest things are actually going to get better Q2 and so forth?

And the other question on truck, we are clearly in a down cycle here but should we be expecting any improvement later in the year at least and going into '09 on that piece of the business, and how big is that exposure to you?

Yes. Marty, let me take a little bit of a cut from the automotive numbers, again, relative to prior periods. First thing, and foremost probably is that automotive OEM, which is the way we reported it before, still accounts for around 60% of the segment. So as Mike said, the changes that you see are truly a reflection in part of what's going on within the automotive business.

And as Mike alluded to, that sales were slightly down, but from a mix standpoint, it was attractive. The sales were down because of the strike. They were down in the light vehicle, but we had nice sales improvement on the heavy side. So from a mix and from an earnings standpoint, that was favorable, plus the benefits we continue to get within the pricing as well as the restructuring that we had. And, again, there will continue to be the head winds that we have experienced with regard to material costs and our expectation is that head wind will continue throughout the year. And, again, Mike alluded to the uncertainty of the strike or how long it will last, albeit obviously we are all hopeful that it won't be very long lived.

The other thing, just to say what's different than how we would have reported the numbers before is the unallocated corporate expense which now comes out, which was effectively a little over 1% of sales to 1.4; it varied. That would have been pro rata allocated, if you will, to the businesses. You can come back to try to get to the same kind of number that we had before by looking at our corporate expenses and giving them a pro rata share.

What we would tell you though is as best as we can gauge, that the old auto OEM group would still be at a loss for the quarter, even with the allocated corporate costs, so identical to what we would have reported before the new segmentation. But we would have seen a nice improvement year-over-year in the first quarter and a lot of the improvement within the segment was attributable to the automotive OEM performance. As Mike said, it has improved. We expect it to continue to improve, but realizing that there's still the challenges ahead with material and with the current markets and what's going on with GM and with just the strike that's going on. I hope that gives you some color on it, but, again, it's an improved part of our business.

Okay. Thank you.

Your next question comes from the line of Mark Parr of KeyBanc Capital Markets.

Hey, good morning.

Good morning.

Good morning, Mark.

Hey, great quarter. Holy smokes! The stock is up almost 15% today. Nice work! It's nice to see that something else besides steel is driving the company for a change.

It's one of those overnight success stories that is 20 years in coming.

Mark, I take offense to that.

Sorry, Sal. Is that Mike? Oh, sorry. Mike, great job. Phenomenal results and I just think, we're seeing kind of the initial impact of, you know, a lot of things coming together but at least the early returns on the restructuring appear to be really encouraging. I just wanted to give you that kudo.

I did have a question on the steel business. The LIFO charges did have a negative impact and, one of the things I would point out is that the other steel operations that we've seen report first quarter have been able to overcome the higher raw material costs. I'm wondering if we should see a reversal of the comparisons in the second quarter or how -- you know, given an outlook for flat numbers for the year, again, which is a lot more conservative than the rest of the space I'm looking at, how do you see the quarters unfolding for the balance of the year? Are you really being overly conservative here?

Hi, Mark. It's Sal.

Hi, Sal.

Frankly we are a little concerned. I think it has more to do with exactly how rapidly these raw material prices actually change. Just to give you some quantification, we took over $17.5 million charge for LIFO in the first quarter. So if you look at that, it is by all measures, we had just a bang up first quarter with that one exception in terms of total tons and in terms of the sales dollars. And it is that rapid jump that required that we go through and make a modification for what we believe the full year will be.

If we don't see very radical variations and especially upward variation in raw material from here, if we just go back to even what appeared to be a crazy last year with decline, but something on a bit more controlled way, we expect the year will be very strong. We look to be at least as good as last year, maybe even a little stronger and that is even in the face of relatively weaker automotive markets as it stands right now. But, I mean, you know what happened last month, $150 a ton jump in the cost of our raw materials. That was off everybody's radar screen.

And based on what we are hearing that will be up at least another $50 this month.

We expect that. But $50 doesn't sound so bad anymore.

It is a lot. Based on the way your contracts are structured you are about 70% contract as far as your overall mix at this point?

Yes. That's close.

What sort of lag do you have as far as being able to pass those scrap costs through? Are you on a 30-day or 90-day lags? How is that working?

Our formula is 30 days. It sets the index for the following month based on the prices published in the American Metal Market this month. The beginning of the month, that's what the index will be for the following month. We are on just about a 30-day delay for the change in surcharges.

But we are about -- when it comes to timing, we are 98% covered on this stuff. There's only a few places where we lose a little bit on it, Mark. So it will make its way through. It's just a matter of timing.

All right.

But the LIFO is a real permanent charge until things start coming back down on some other side of the demand scale.

Right. No. Okay. I hear you. Terrific. Thanks for that color, guys and congratulations on a great quarter.

Thanks a lot, Mark.

(OPERATOR INSTRUCTIONS). Your next question comes from the line of Eli Lustgarten of Longbow Securities.

Can you quantify how much incremental capacity you will have available in the second half of the year from the new plants, or the next couple of quarters?

I think we missed the first part of your question, Eli. Would you repeat it?

My first part, I just made a comment that everyone must be so impressed they can't ask questions today.

We actually heard it. We wanted you to repeat it.

You know, we sit there almost in awe of the quarter. Not that we want to pick up (inaudible] it's so conservative for you to beat everybody's estimates by $0.08 -- $0.08 or $0.09. Anyway, but we won't touch that.

Yes, Eli, let me just say your question was basically how much more capacity will be coming online and how that will leverage the remainder of the year?

Yes. What kind of volume increase could we get from the new capacity as we go?

We looked at the beginning of the year at someplace in the neighborhood of about $75 million with regards to increased capacity during this year.

Yes.

So there will be that -- that clearly will be coming on. We will continue to push those new manufacturing facilities for additional product, but we know that we will get to that level. You'll begin to see that as you did in the first quarter with regards to volume. Because if you remember, in process industries, we are still constrained on many of our product lines. So this new capacity goes right to the market and it gets clear leverage.

Okay. And going back for the first time, Sal may have to work for a living and actually perform as opposed to coasting for the last couple of years. Are we going to -- the leverage -- the pass through of the higher material costs that's going to take place, is that going to be offset by the weakness in automotive in the second quarter and you won't see any improvement until the second half of the year?

I don't believe so, Eli. We already saw some weakness in the first half -- in the first quarter, and I -- and it's all-in weakness. We probably would have had 3% higher shipments for the quarter if automotive were anything like normal. So all-in, that was about it and we still had records across the board.

Yes, and I guess I'm looking at the production schedules are weaker in the second quarter and the strike is still going. I mean, it's not going to disappear very quickly.

That's right.

So just looking at the impact, but at this point, we should be able to see some of the improvement in margin beginning in the second quarter and on out?

We believe so, yes.

And the interest charges are going to stay relatively flat at the current level? Is that the expectations?

Yes, the interest rates, obviously we envision generating free cash flow. So the debt balances should come down but the interest rates should remain relatively the same.

All right. Thank you.

Your next question comes from the line of Holden Lewis of BB&T.

Thank you. When you talk about the two items which might be somewhat transient in nature, the pull forward of demand in process and then the automotive strike, you know, one netted you roughly $15 million and one cost you $15 million, so really the impact on revenues from those, it doesn't seem like it was a big deal in the Q1. But how should we look at the impact of those two things from a -- from an EPS or even from a margin standpoint? Because obviously -- it strikes me that the process is very profitable and that no doubt drove some of that, whereas automotive, assuming this is impacting some of your North American guys the most, it's not like you made a lot of money on those clients anyway. So even through it was neutral in revenues, can you give us a sense of what those transient items might have been in terms of margin and EPS effect?

Holden, we would say frankly, it would be relatively neutral for both. We are probably leveraging at around 20%, give or take, but, again, revenues were identical. The bigger impact will be obviously in the second quarter, as the T1 shift obviously will negatively impact the revenues and therefore some earnings in the second quarter, while if the strike continues they will both be moving in the wrong direction. So you will see the bigger impact in the second, but just assume that it was effectively a wash if you're just looking at those two items in the first quarter.

The benefits that came from the pull forward were largely neutralized by losses from the automotive?

Close enough.

Okay. And then can you -- you talked about logistic expenses in at least three of your segments. Are you referring just to energy costs or are there some mismatches in terms of where you have capacity and shipping and that sort of thing? Can you just expand on that a bit?

Yes, there's two things really going on. Clearly the energy costs [inaudible] and surcharges on fuels and the shipping costs, et cetera have gotten quite expensive. The second thing is we still are running our plants, maximized. We are shipping product to customers across the world, and when you are doing that, you are still incurring significant costs, probably above what we would expect long term as we get our manufacturing base very much created across the world, and a better sense that product being produced in Asia is being sold in Asia. Similar currencies, lower logistic costs overall versus moving a lot of product, especially the large product going into the process industries across the world.

Okay. And then lastly, you also sort of referenced better portfolio decisions in auto in particular. Obviously there were no high visibility portfolio decisions that were made. Can you just expand on some of the stuff to which you are referring in that statement?

Well, let me give you a little glimpse of maybe the mobile group and the mix of the sales and the impact and the changes of that mix. If you look at what we call the light vehicle systems, which basically is the passenger car side of the business, first quarter, quarter on quarter comparing back to '07 was down 8%. The heavy truck piece of our business was up 25%. And our after-market piece was up about 14%. So what you begin to see and whether you look at it first quarter of '08 versus fourth quarter of '07, or looking back into quarter one of '07, we are fundamentally driving a mix of our sales much more towards the markets that we believe that we can be the most profitable in. Obviously we get impacted by things like the strike at American Axle and the shutdown of the General Motors plants and that impacts it, but this is a fundamental direction that we are driving our capacity, Holden.

Okay. Thank you.

Your next question comes from the line of Martin Pollack of NWQ Management.

I'm looking at last year's quarter -- fourth quarter you indicated automotive had a LIFO -- I think all the issues of LIFO was the cost. I don't remember what the material amount was, but you mentioned that LIFO was an expense for -- in this release for the steel segment. I'm just wondering if you can effectively describe this. What's your reserve action on the policies on LIFO? Are you effectively doing it on a quarter basis? Do you have an estimate for the year and then you are essentially working with an amount which could change. So essentially is LIFO something that's higher or in line with your original expectations? Maybe by segment, where LIFO seems to -- in your commentary on steel is where you saw the LIFO hit. I don't see that commentary on automotive, which is where the fourth quarter was.

Martin, I guess with regard to LIFO, maybe covering the last part first, which is our expectation, I think Sal may have referenced it. We had no expectation that LIFO expense would be as large as it did, because it's very directly correlated to the high price of the scrap that we are seeing that, again, we didn't envision seeing. Clearly we are managing through an environment of higher LIFO expense than what we would have thought coming into the year or even the quarter.

What we do, though, we look out for the full year and what our expectations will be, and therefore then we bring it back into each of the quarters by building up the reserves. So effectively when you look at the guidance that we have out there, the reaffirmment of the full year, and obviously the first time we have the new guidance or outlook for the second quarter, it reflects now what our current expectation of material costs will be.

LIFO does affect all of our business, but clearly the biggest piece is in the steel business that Sal alluded to. And frankly within the bearing side, the biggest piece would be in the automotive piece of that, to your point earlier. But year-over-year, fourth quarter to first quarter, the number you have quoted for auto would probably be pretty comparable for what they would have had for an expense in the first quarter.

And if I may, on the steel -- just back to the steel. At this point, it is really -- the performance of steel is a little bit unfavorable. Is steel lagging -- are your pricing actions at this point lagging? In terms of those results that affect you, you had not yet fully implemented those price actions.

No Martin, our price actions have been implemented. Our surcharging mechanisms are renewed in our contracts. We have a tiny issue of getting these things through to the market place, but it's probably the quickest of all the timing within any of our businesses. Frankly, it's almost exclusively that LIFO impact from our first quarter.

But that suggests that Q2 could see the bigger benefit then?

Correct.

Okay. And last, CapEx running fairly high, well above depreciation. I mean, are you at a point if you can define whether CapEx is at a level where we're seeing a maximum level for this year? And what would normalized CapEx be? In fact, what would be normalized maintenance, even though I realize there's normalized growth in our expectations so that effectively CapEx will still be fairly high?

Right. Martin, we would say, if you will, that normalized, albeit, that's a tough thing to say, because obviously when you invest in capacity or in continuous improvement initiatives, you are getting good returns on it, so you don't mind allocating your capital that way. But clearly we would target longer term, I think we have said before, around 4% of sales is probably a more normalized level.

We currently have depreciation and amortization of around 230ish to 40ish million a year so clearly we are spending above that level, albeit we spent at that level for the first quarter, but it will grow. We will spend roughly what we did last year. The biggest piece of that spending is on the new capacity additions that we're doing, the Project O.N.E. implementation that we are putting in. So key strategic initiatives of the company is where that capital is going.

From a maintenance standpoint, again, it will fluctuate around a bit, but we think, as it did in the past, that it's around $80 million, give or take of maintenance within the business on that depreciation and amortization level of that call it $235 million. So it's higher than normal, but it's clearly funding key strategies of the company.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). Your next question comes from the line of David Raso of Citigroup.

Quick question. I was trying to back into the non-auto part of mobile. And the way you worded the year-over-year profit improvement in auto, essentially we don't have the exact number year ago first quarter, because of the MRO now included. But essentially if the loss was less in the first quarter just reported than a year ago, trying to back into the non-auto business implies the margins were down year-over-year in the non-auto part of mobile. Is that a correct statement?

Well, David, I think it's close to that. Again, we're not -- we'll not be breaking down the margin side of the various pieces of mobile, but what we set out to do was essentially focus very much on improving those underperforming areas of the business, which was a lot of the old automotive, and that's where we have seen the improvement. And through the period of time now where we're seeing material pricing escalating, logistic costs, et cetera, and we are completing out some of these plants, maintaining those margins in what are actually attractive parts of the mobile industry was really the thrust. So what you are seeing in the first quarter is an example of that.

And, I mean, the delta in auto, given it's the biggest piece of mobile, is obviously the biggest positive swing factor. Better to improve that than show a little improvement in the non-auto.

That's correct.

It was just interesting to see the non-auto was down -- or at least the way I run the numbers down, if not, at best flat. Can you give us some color on going forward how should we think about that or is that a classic volumes are still very good? Because the volumes are up pretty darn big year-over-year if I'm doing it right. For the profits to be flat to down, is that simply an input cost issue, and how are we handling that on price going forward?

Yes. A couple things. I think as we look going forward throughout the year, you are going to see some of that swing back as we see improvements in the other side of the mobile business. But remember, the mobile business is made up of basically the pass car, which this is an area that we have to focus on, but we are doing it both through mix, meaning we are getting out of some business that is, in fact, not attractive, moving prices where it can be. And we are still in the process of doing that. But as I said earlier, our sales quarter on quarter, '07 versus '08 is actually down.

The remainder of that segment, and remember, there's a heavy truck segment that actually was part of automotive. And that has been an area where, in fact, we have decided to continue our participation, certainly in that industry, and it's an area where the sales have been up significantly going into '08. We expect a strong year for that and in addition, pricing has been strong. So that's been a big piece of not only the automotive fix but also how we look at mobile.

Then the other pieces are off highway, which remains strong both from the perspective of sales and margin. Rail, we're seeing some drop from late '07, so that is impacting us on the down side, as that has been a very attractive market for us. So from a mix perspective, actually coming out of '07 into '08 is slightly down. And then the other is our automotive aftermarket which is an area where we do see improvement throughout the year. So I think you will see that mix begin to change in the last three quarters.

And for clarification, the down 8% on passenger vehicle, I will call it generically auto, that includes auto after market but does not include the heavy truck, right? That's total auto OEM and aftermarket.

That down 8% is just sales to original equipment manufacturers.

Okay. That's helpful. And quickly on the aerospace, you mentioned hopefully that's the lowest quarter margin that we will see. How quickly should we expect the margins to get up to where you would have thought of the business as a solid low double digit margin business?

I think you should be looking towards the third and fourth quarter. We will still see some -- a little bit of weakness on those earnings in the second quarter. They're seeing a lot of material impact from the marketplace, et cetera, so I think you will begin to see an interesting jump third quarterrish.

Okay. Thank you very much.

You bet.

Your next question comes from the line of Brian Carlson of Atlantic investment.

Hi, guys. Thank you for taking my call. I wondered if you could just clarify a couple of quick points. Pass car revenue down 8% to OEMs, that's globally, right?

That's correct.

Okay. And then you mentioned that the LIFO charge in steel was $17.5 million, and the LIFO in auto would be similar to Q4; is that correct?

That's right. Figure around 4 millionish with (inaudible).

And embedded in the current guidance would be what kind of expectation? I mean, would the guidance expect scrap steel to rise by another $50, say, and sort of stay at that level? Would it include continued increases of small amounts or is there any moderation expected in it?

We would say at least -- again, we obviously provide guidance with a range and the range is the uncertainty on things that we can't control, which is exactly what scrap prices are. But our general assumption would be that we would expect the price of scrap would come down throughout the year, maybe not significantly but at least the trend shouldn't be as sustained. So it may go up before it goes down, but as it goes through the year, we wouldn't think that it would stay at this high of a level. It may, but again that's our current best guess.

Okay. Is it possible, Mike, for you to give us an update on the sort of negotiations you have had in terms of pricing with the contracts and sort of what percent of the contracts were open and sort of -- I think at the analyst day you were suggesting that things were going a little bit better than you had originally expected. Is that still the case?

I think the progress is going very well. Obviously we have completed all of the '08 contracts and I think they have been good for both us and our customers with regards to certainly the value we provided in the market place. We have opened many of the 2009 contracts from the perspective of those discussions are happening. Clearly we are making sure that as part of those discussions, these significant material price issues are dealt with in those contracts, or, in fact, we will decide that we will exit some of that business.

So I would tell you that compared to a quarter ago, when we talked about this, that this effort is progressing very positively and I think both from the perspective of the mix of our business and how much of that we actually do want to be in the automotive industry, but also with regards to the price levels. And you are already seeing the impact in the first quarter margins for the old automotive group.

It seems to be progressing well.

Yes.

Can you give us any update in terms of Timken's expectations for North American auto production?

Well, we're still sticking with the -- I think the industry number of $14.3 million is what we are still using, however, we talked last quarter about two things that could impact a lot of that. One is just the strength of the recession in North America, but also $4 a gallon gas. And I think at the time we talked about $4 a gallon gas, and kind of chuckled and we're at $3.61 now. So I think that's a concern. We are -- we have modeled that and so we, to the best of our ability are already beginning to manage with regards to that. And I think you have seen the recent announcements from General Motors that is taking their expectations with regards to production down for '08. But probably more importantly, there are bigger percentage drops in the areas such as the light trucks and SUVs, which is an area in which we participate heavily. So the macro number of $14.3 million or $14.2 million isn't as important to us as actually the light truck and SUV numbers, and that's what we watch very, very carefully.

Okay. And then the last question I have was just with regard to steel, I know that the automotive demand was probably a little bit less than perhaps you guys had anticipated, but my impression was if there was any weakness on the auto side, that demand from the energy sector was such that there were clearly customers looking for that steel and net-net you would have a positive mix shift in that you could take a piece of auto steel or take, I don't know some capacity there and reallocate it. Sal, can you just comment on that? I mean, if you would have had more auto sales in the quarter, would EBIT have been higher?

Actually it would have been because we have made shifts where the shifting is appropriate. But then there are some areas and some sizes and ranges and grade where there really isn't an alternative. It's just pretty much automotive related and those weaknesses in shipments are among that category, that which would have been purely automotive. Had there not been a strike, our results for the quarter would have been even better.

Can you give us a sense of the percentage of the steel capacity, which would be solely tied to auto?

No, I really can't give you that number because it may not just be auto. It's areas that use that sort of size range. But for the most part, I can tell you that much of the automotive product is in the smaller size ranges, in the smaller SPQ arenas. So in the -- up to 3 and 4-inch, down to 0.5 inch size ranges in general. That is probably 65% automotive destined throughout the whole of the industry.

Okay.

And that's not the strength of our size range. We are there, but not with extreme capacity quantities.

And just as a general comment, I am very happy to see some of the capacity expansions starting to bear some fruit. Good job. I look forward to seeing more of that.

Thanks, Brian.

Thank you.

Your next question comes from the line of Mark Parr of KeyBanc Capital Markets.

Yes, just I hate to keep pounding on this LIFO thing in steel. But I think I understand now is that the LIFO charge that you took is in excess of what you actually realized in the first quarter because of your full-year expectation for scrap costs. Is that fair, Glenn?

That is.

Okay. That really helps clarify the situation and thanks very much.

Thanks, Mark.

There are no remaining questions at this time. I will now turn the call back over to Jim Griffith for any closing remarks.

Thank you again for your interest in The Timken Company. I'm pleased to see that you all took Eli's challenge and came up with a full hour's worth of questions for us.

To reiterate the message, we are seeing strong global demand, especially from those industrial markets involved in helping build the Asian infrastructure and we are taking advantage of that to improve our portfolio. There are plenty of challenges in the market today, but we're tackling them head on with a goal of driving improved performance for our shareholders. Thank you.

Thank you for participating in today's Timken first quarter 2007 earnings release conference call. You may now disconnect.