Timken Co (TKR) 2008 Q2 法說會逐字稿

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

Thank you. Welcome to our second quarter conference call. I'm Steve Tschiegg, Manager of Investor Relations. Thank you for joining us today, and if after our call should you have 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, Bearings and Power Transmission Group; and Sal Miraglia, President of our Steel Group. We have remarks this morning from Jim and Glenn and then will 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 relating 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 on today's press release and in our report filed with the SEC which are available on our website 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. Timken achieved another solid quarter of profitable growth. Sales and earnings were both records and exceeded our previous estimate for the quarter. Sales were up 14% from last year while earnings were up more than 30%. Glenn will take you through the numbers in a moment, but first I would like to provide some insight into the strategies that are driving our improved performance and give us confidence that we will achieve our long range targets.

The bottom line is these results demonstrate that the strategic actions we have been taking are working. We have a very clear enterprise strategy to grow in targeted geographies and channels where Timken can generate significant values, and optimize the rest of our business, shifting the portfolio toward global industrial sectors while continuously improving our execution. We are growing globally. Half of our bearing and power transmission sales are now outside the US. Our most rapid growth is taking place in Asia and especially in process industries, where we are capitalizing on the hot infrastructure related demand. As a result, nearly 20% of our process industry sales now come from Asia, providing important market diversity.

We are beginning to leverage our recent capacity investments and expect that strong demand will continue to fuel our growth in process industries where we have some of the best opportunities to capture the full life cycle of profits. Sales in our aerospace and defense business grew over 40% this quarter with double digit margins. The Purdy acquisition has served as a catalyst to the strong growth in aerospace as we continue to build our strategic position in the helicopter and defense sectors.

At the same time that we are growing in targeted areas, we are also optimizing our portfolio and driving better execution. At an enterprise level, we implemented the third phase of Project One in early April. This project is streamlining our global business processes and significantly enhancing our systems capabilities. We now have roughly two-thirds of the bearing and power transmission business operating on one platform.

In steel, we are relentlessly focusing on execution. A current example is our effectiveness at recovering rapidly increasing costs and related LIFO charges with price increases and surcharges. Our mobile industries business is clearly benefiting from the realignment announced last fall. We are simply better managing across shared capacities across multiple industries.

While the North American light vehicle market has weakened, the outlook for our overall enterprise has improved to more than offset this impact. Accordingly, we have increased our full year earnings expectations. We certainly were not surprised by the improvement of our earnings for the quarter, as the strategy really is beginning to take hold. But the magnitude of the earnings improvement and the quality of our results exceeded even our own expectations. The first half results illustrate the combined power of profitable growth, structural transformation, and improved execution. Going forward, we expect strong global demand for industrial products to continue and that we will deliver record results for the full year. Now, I will turn it over to Glenn for a more detailed review of Timken's performance and results.

Thanks, Jim. For the second quarter, the company's fully diluted earnings per share from continuing operations were $0.92. Excluding special items, earnings were $0.96. Special items consisted of primarily of manufacturing rationalization and restructuring costs. The rest of my comments will exclude the impacts of special items.

Sales for the second quarter were $1.5 billion, an increase of 14% over 2007. Strong demand across the company's broad industrial markets was offset by weaker North American automotive demand. Increased sales resulted from pricing, surcharges, currency, and acquisitions. Gross profit margin for the quarter was 22.4%, an improvement of 30 basis points from last year. Favorable pricing, surcharges, and mix were partially offset by higher raw material costs, related LIFO charges and manufacturing costs.

The company was also able to better leverage SG&A as the margin improved 60 basis points over last year to 12.7%. During the quarter the company increased its reserve for automotive credit industry exposure by $7 million. While our current customer account balances are within normal levels, we felt it prudent to increase our reserve given the uncertainties in this industry. As a result, EBITDA for the quarter came at $147 million or 9.6% of sales, 110 basis points better than last year. Net interest expense for the quarter was $10 million, up $1 million from last year due to higher debt levels resulting from the company's acquisitions. The tax rate for the quarter was 32.7%, bringing our year to date effective tax rate to 33.5%, reflecting increased earnings from lower tax rate foreign jurisdictions. We expect to maintain the 33.5% tax rate going forward. As a result, income from continuing operations for the quarter was $92.4 million or $0.96 per diluted share, an increase of 32% compared to $0.73 per diluted share last year.

Now I will review our business segment performance. Mobile industry sales for the quarter were $628 million, down 1% from a year ago. Increased sales in the heavy truck and off highway markets were more than offset by lower demand from the North America light vehicle market, which included the effects of a strike at one of our automotive customers. The company benefited from improved pricing and currency. For the quarter, mobile industries' EBIT was $12 million or 1.9% of sales, 200 basis points lower than last year. The benefit of improved pricing, mix, and currency were more than off set by higher material costs and related LIFO charges, an increase in our reserve for automotive industry credit exposure, and the effect of lower light vehicle demand. For the second half of 2008, we expect strength in the heavy truck and off highways markets to be more than offset by lower light vehicle and rail demand. While second half results should be lower than the first half, we expect full year results to be comparable to last year. The company continues to actively address the impact of the weakening North American automotive market through adjustments in manufacturing capacity and costs.

Process industry sales for the quarter were $328 million, up 23% from a year ago. The company benefited from strong industrial markets as new capacity continues to come online as well as favorable pricing and currency. For the quarter, process industries' EBIT was $64 million or 19.4% of sales, 500 basis points higher than last year. The benefit of strong volume and pricing were partially offset by higher material and manufacturing costs. Second half performance is expected to be lower than the first half, primarily due to anticipated higher raw material costs, but well above prior year levels.

Aerospace and defense sales for the quarter were $106 million, up 42% from a year ago. The increase was primarily driven by the acquisition of Purdy at the end of last year. Excluding Purdy, sales were up approximately for the quarter. The company benefited from favorable pricing and volume. EBIT for the quarter was $12 million or 11.5% of sales, 590 basis points higher than last year. The favorable impacts of the Purdy acquisition and pricing were partially offset by higher materials and manufacturing costs, including the startup of the company's new facility in Chengdu, China. Results for the second half should be slightly improved over the first half as the company continues to benefit from strong end market demand and added capacity.

Steel group sales for the quarter were $520 million, up 26% from a year ago. The group benefited from strong demand across all market sectors with the exception of automotive. The group was also able to recover higher raw material costs through its surcharge mechanism. The increase in sales from the BSI acquisition was offset by the closure of the Desford tube manufacturing operation last year. Steel group EBIT for the quarter was $80 million or 15.5% of sales, 50 basis points lower than last year. Improved earnings resulted from strong demand, favorable mix, and surcharges which were partially offset by higher material costs and related LIFO expenses as well as higher manufacturing costs. Steel group performance in the second half is expected to be lower than the first half of the year due to seasonality and expected higher material costs, but well above prior year levels.

Looking at our balance sheet, we ended the quarter with net debt of $787 million, $18 million lower than the end of the first quarter due to strong cash generation from operations which was partially offset by seasonal working capital requirements and capital investments in support of our growth initiatives. As a result, the company's leverage of net debt to capital decreased to 26.5% from 28% at the end of the first quarter. The company expects to generate strong free cash flow for the remainder of the year, driven by record earnings and improved working capital management. Capital expenditures for the quarter were $75 million, or 4.9% of sales above depreciation and amortization of $60 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 $3 million to our global pension plans during the quarter, bringing our year to date contributions to $15 million. Our full year 2008 contributions are expected to be approximately $20 million, down roughly from $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, with light vehicle production expected to be approximately 13.4 million vehicles for the year. 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, though constrained due to weaker automotive demand and expected higher raw material costs. We recently increased our earnings per share estimate excluding special items to be in the range of $2.95 to $3.10 for the year, a record for the company. For the third quarter, we anticipate earnings per share excluding special items to be $0.65 to $0.75 compared to $0.51 for the same period last year. 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 cable 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 will now be happy to answer any questions you may have.

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

Good morning, gentlemen.

Morning.

Couple of quick questions, one how much was foreign currency in the quarter? You get top line and bottom line impact?

Eli, we will provide the top line. We normally don't comment on the bottom. For the company, currency impacted us by around $45 million, or around 3% of the 14% growth we had.

I assume it helps earnings to some degree -- is that a fair statement?

Yes, it is a fair statement. It does help earnings.

And the tax rate looks like it added about $0.03 to the quarter and to get to 33.5% first half -- is that tax rate going to the second half of this year [but] into next year?

Yes, at least at this stage of the game it is fair to use that for the remainder of this year and our current outlook of what next year would be.

In your guidance segment, you have a reasonable third quarter but it looks like an exceptionally weak fourth quarter shaping up versus what we have been seeing in the comparisons. Is there anything going on other than conservatism or so? With your guidance of $2.95 to $3.10 and a $0.70 implied third quarter, something in that range -- that fourth quarter drops off an awful lot just to get to the upper end of your guidance, let alone if you don't get to the upper end of your guidance. Is there anything going on in your outlook that is causing that big of a drop?

Clearly the uncertainties that are out there. But our fourth quarter, while being low for the full year, is still expected to be higher than the same period a year ago. We do expect that within at least the different groups, mobile should be down in the second half given what is going on within the auto industry, albeit we are leveraging well on the declining volumes. Similarly from a more macro level we expected to see higher material costs negatively impacting or constraining the margins across all the rest of the businesses. The only segment that we really see the positive second half versus first is within the aero group, but all the groups should be better second half versus the same period a year ago. We view it pretty positively. To your point given the uncertainty on what is out there, we feel good about where we are right now, and we'll wait to see as we progress through the year and see if that will change our outlook from where we currently are.

Do you have an estimate of how much material cost impact will be for the second half, either across the company or by sector if you want to be insane and give it to us?

I don't think we will be insane and give it to you other than its direction. We, like I'm sure the consensus out there -- that material costs are expected to increase. To some extent it is a variable that we don't control. But clearly we believe we can absorb those costs.

Do you have any measure of the impact of it on the second half of the year and any ballpark estimate of what the magnitude of what we are looking at?

Not an a magnitude other than directionally. We expect it to be higher than what we experienced in the first half, which again is constraining to some extent some of the margins and profitability in the second half.

Do you expect mobile to stay profitable for the next two quarters? Is that a possibility to go into the red. I know the third quarter is ugly -- I'm not sure what the fourth quarter is like with heavy truck going down both quarters, so.

This is Mike. We expect it to stay profitable for the next two quarters, again, very much driven by still downside on this whole light vehicle side from the North American perspective. We've still got very strong markets in the remainder of the mobile side of the business.

Can you give us one indication of how much incremental capacity do you expect to have available in 2009 in bearing versus 2008 ?

We have on on a clip of about $75 million a year or so, Eli. So that is has been been pretty consistent. Actually our ramp up of the manufacturing facilities are going very well. We are actually trying to accelerate those ramp ups through the remainder of the year, which will probably put a little more cost into our business, but it will pay off both in revenue and profitability because most of that capacity is directed at constrained markets and yet very strong markets. It is lining up very well.

Okay. And one final question, Project One costs, should we expect more material charge in the second half of the year and into ' 09 in the Project One area?

No, as we have talked about before, given where we are with the project, the cost associated with P1 has peaked. For this year, it should be -- call it comparable to maybe last and then we would expect those costs to go down into ' 09 and beyond.

I will let somebody else ask some questions.

Thanks, Eli. I think that was more than the one question and one follow-up.

Okay. Your next question will be from the line of Bob Schenosky from Jefferies.

Good morning. Two questions. First one is given the capacity additions in non automotive, how small, especially with the drop in volume, how small is auto now as a percent of the total business, overall company?

Well, we don't talk in terms of auto anymore. If you want to look at light vehicle systems, light vehicle systems now would be less than 20% of the total company.

Great.

From a bearing perspective.

The steel business is about 23% of total sales. So we are about in that range, 23% and 25%.

And the other one is a lot of the other reporting companies have not shown the same type of strength in aerospace that you have. Even excluding Purdy, can you highlight some of the areas of strength that you're seeing.

This is Mike. As you know all the aerospace businesses are different in the types of applications they serve, et cetera. We are focused on the defense industry, certainly the aftermarket from the growth perspective and not as much on commercial aircraft. We are seeing the strength certainly from our acquisitions and in particular Purdy, and also we have volume gains and still strength in the defense market. Overall, it is hanging in there very well and our order books are extremely strong. We are still constrained on the capacity of the products that we produce to go into that market.

So for the back half of the year, is it fair to assume that you anticipate that defense will be the key?

Yes, and we project at this point that it will remain strong.

Terrific, thanks.

Your next question will come from Mark Parr of KeyBanc Capital.

Thanks very much. That was really a surprise on the quarter. I'm kidding. Very strong results. One thing I wanted to ask as far as a nuance. Did you use in the April call an '08 auto build assumption of somewhere around 14 million to 14.2 million vehicles?

From an auto build perspective?

Yes, your assumption when you were giving full year guidance for '08 at the end of the first quarter -- I thought your imbedded production assumption was 14 million to 14.2 million -- is that right?

That's correct.

The conclusion I'm coming here is that you have increased your full year earnings outlook despite a reduction in your automotive -- your North American or US automotive production outlook; is that correct fair?

That's correct, Mark.

That's very encouraging, I guess. One other question I had on the steel sector. We have been seeing a lot of other steel companies work aggressively to get all the raw material cost pressures pass through. It looks like your commentary would suggest that you might still have a little more work to do in that regard. Can you give a sense of where you are in that process or how you would be grading yourself and what potential upside opportunity there might be for steel profitability over the next several quarters?

Morning Mark, this is Sal.

Great quarter.

Thank you very much. We appreciate that. I don't know where you got the impression that we weren't passing most raw material costs increases through. We are. In fact, we probably got close to that earliest because of the profile of our contracts back several years ago. And that has continued today. In fact, you may recall, you and I had a question at the end of the first quarter where you were pushing me on don't you think scrap prices are going to be higher at the end of the year and you should be up at LIFO? We've capitulated and we did, and we've take a bigger LIFO hit too. All of the value that has been caused by that we are passing right through with our surcharging mechanisms and also taken some strong inflationary costs into account and getting returns on that too.

Was the change in the year-over-year margin more than explained by the change in LIFO charges?

The margin I think is -- the answer is yes but also because of the general inflating value of the sales while we are making very good but same profits. So we are seeing -- you are seeing the margin dilution because of the sales inflation more than anything. In fact, if you look at --

You mean it is a pure passthrough as opposed to having a markup on the surcharge; is that fair?

At this stage, it is a pure passthrough as opposed to having a markup on the surcharge. Right.

I appreciate the extra color and congratulations on all the progress. One other question, if I could, on the aerospace business, it seems -- if you look at -- Glenn, I think I heard you said that the aerospace business, ex Purdy is up 14%; is that right?

That's right.

Most of the aerospace commentary we have been getting from the other companies has been relatively subdued. It is flattish or up a couple of points or down a couple points. What is driving the growth in your aerospace business so aggressively in the current marketplace?

Mark, this is Mike. Remember where we have focused much of our growth. We had a historical aerospace business that was supplying antifriction products into original equipment manufacturers and we have expanded that business significantly into the aftermarket. We are making a much broader range of products we hadn't produced in the past, and that came through some inorganic growth, so we made several acquisitions in addition to Purdy. To a certain extent, we are getting a lot of growth because of the expansion of our product line in the markets we serve.

If I wanted to summarize it succinctly, could I say you are having success with internal organic growth initiatives?

Yes.

Is that something that we are on the front end of or something that you would see persisting for an extended period of time? Are we are basically seeing the completion or the tail end of these programs?

We have a strategy to continue to grow in those selected markets, especially with regards to our MRO expansion. And so we are in the market both from a organic growth perspective, leveraging the investments we have made in the acquisitions, but also looking at other opportunities to acquire the capabilities.

Mark, this is Jim, just to tie back to a previous comment to Mike made. The comment he made is that our markets focus more heavily on defense than commercial. If you look at the relative strength of the two markets, the defense market's held up a whole lot more than the commercial markets. That explains part of it and I think gives us more opportunity to grow. I think it is also important to note that our aerospace business is a relatively small business to be broken out separately. Part of the reason we broke it out --

That's fair.

-- is because of the strategy of growth. That's a business we intend to grow.

Okay. All right. If there is -- Mike, while I have got you here and I have got your attention, can you give us an update on the contract pricing momentum that you are seeing in the mobile industries and just how that whole accelerated focus on loss reduction in some of the old automotive contracts is progressing?

It is actually progressing very well, Mark. I appreciate you asking about it. We have been very aggressive in the marketplace across the mobile industries. We would have seen that in our bottom line performance, had we not seen such a significant reduction. I think we were down around 19% on our light vehicle volume. So that took a significant amount of volume out of the business. That is progressing very well. As you know, there is an opportunity to only renegotiate a certain percentage of our contracts on an annual basis. Some of those -- that were not open for re-negotiation, we have had the ability to open those up on discussions to make sure we are getting recovery on material costs, increases, surcharges, et cetera. Overall, I would say that is progressing very well. In fact, probably ahead of our plans.

Terrific. Thanks again for all the color and look forward to talking with you again next quarter.

Your next question comes from Marty Pollack of NWQ Investment Management.

Hi guys. Nice quarter. Two questions. One on mobile, I know you promised us more transparency as far as auto business even after the new restructuring. But when I look at last year's fourth quarter, it was a pretty tough quarter for auto as you reported $35 million loss for that single quarter. Obviously when you are saying this year's numbers will be better than last year's, it does seem to be in context to a very weak automotive number. Can you give us some idea, again with that transparency, what automotive would look like this year -- could look like this year in that fourth quarter? Would it be much better or much improved from that number?

This is Mike. Let me give you some insight on that. We expect year on year -- if you take a look at the old auto, which of course we don't talk about any longer -- there would be an improvement year on year. That means there would be an improvement year on year in the second half of that year. Now, the interesting thing is because the way we have restructured and refocused our business and the strategies as to the markets we will serve, what you won't see in the mobile side of the business is the impact of our ability to shift capacity that traditionally had served the automotive industry and is now actually serving the process industry. Some of the upside that we are seeing on process industries' performance is as a result of the movement of that capacity directed to those growth markets where we are obviously more profitable in what we sell. So you are going to see a combination of a couple things. One, we are offsetting the reduction in volume in the light vehicle side of the North American industry, right, which is significant. We have good growth in our heavy truck, our off highway, our rail and our automotive aftermarket businesses. That is all attractive. And we also have this additional piece that we have actually moved capacity to other markets, which is helping the overall corporate results.

Actually, that led to my second question because the process margins were spectacular. You were around 19%. When you look at incremental Q1 [and] first half, your incremental margins look to be around 40%. So presumably you are saying even if auto looks weaker, the reality is if you were to look at the impact of the shift, you are saying you are seeing that now in those margins. The question is -- are process margins at these levels temporarily spiked by this shift? Because 19% is well above anything you have produced historically. I would imagine that maybe it is a temporary benefit while automotive is temporarily stifled by the problems it has.

Marty, what I would tell you is if you look at the first half of 2008, clearly, when we went through the reorganization last year, the comments that we made in the previous calls was that we would begin to shift very aggressively that capacity that we could from one market to another and that would fit with the strategies. That has been successful, and so in the first half you have seen the efforts of that capacity that's easily changed and refocused on other industries. Now we get into the point where we start looking at the rest of our fixed assets to what else can we move, what will be the effort to do so and what will be the demand from those light vehicle system markets that will allow us to make those moves even more aggressively. There was certainly some benefits in the first half of that initial move.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from Melissa Cook of Calyon Securities.

Good morning. I wanted to see if you can give us an update on your capacity rollout in China and India -- how is that going? And can you talk about customer orders, end market demands, and give us color in what you are seeing in those markets? Thanks.

This is Mike again. Actually the capacity rampups in our new Asian facilities are going very well. I think we have been relatively public with regards to those investments over the last several years. The three newest facilities we have is a facility in Chennai, which is focused on industrial markets, that's in Chennai, India. That rampup has gone very well. In fact, we will accelerate that rampup over the next six months. We think we will see more benefit for it. The Chengdu facility, which is an aerospace products based facility in China -- the rampup there was slow -- as many of you know the earthquake situation in China, and that was very close to the epicenter of that. The overall infrastructure around there to be able to continue on got slowed down. Other than that, the rampup will go very well and will be on target for there and of course our large bore manufacturing facility, which is targeted right at the growth markets across the world, the infrastructure build in Asia, wind energy markets and other energy markets has gone very well. We think that rampup will exceed expectations the remainder of the year. So we're accelerating that. I have to tell you overall, it has been a very good experience for us.

How about end market demand in those markets -- are you seeing any slowdown?

Very strong. We are not seeing any slowdown at this point. Those end market demands are very much focused around energy, the infrastructure build throughout Asia, and everything to do with mining and these sorts of things. We have got them -- those investments pegged very closely to high growth markets, of which at this point we have not seen any degradation in demand and the geographic focus of it being Asia, obviously we haven't seen any degradation of demand there either.

Your next question comes from Holden Lewis with BBT.

Good morning. Can you comment on your distribution business? I know you send a fair amount of your product through distribution and we have had some companies report that the distribution side of things tends to be a little more general, as industrial has weakened somewhat. Can you talk about setting aside the infrastructure and getting into general industrial piece of distribution and what you are seeing in that channel?

We won't give you specifics, but let me see if I can give you enough color to give you some insight what is going on there. Our growth in the distribution markets, especially on the industrial side, has been double digits in 2008. That has been very strong for us. There have been a combination of things that have helped. The demand across the world has been strong in distribution. Secondly, this shift in capacity away from the old automotive industries into industrial markets has specifically benefited our ability to serve the distribution markets and there was some pent up demand in those. The concerns going forward that you hear from the marketplace primarily are North American based and they continue to be based on the general economy and the overall construction industry, again of which is not that big of an industry for us. It is important for some of our distributors, but for our products and our growth and where it is targeted, it is not that critical of a piece. Overall, our distribution sales have been strong. They have been positively impacted with regards to the mix changes that we are making from a strategic perspective across the business and it continues to look that way throughout 2008.

And then trying to get a little bit more of color in terms of what is going on in steel. Primarily because if you read your description of what is going right and what is going wrong in this quarter, it looks a lot like the description you got this quarter. Yet rates of growth obviously got better. The margins got substantially better. You are kind of talking about price being mostly a passthrough, actually pressing down on the margin to some extent in terms of how that math works. It seems like from Q1 to Q2 you flipped a switch and went from doing okay to doing great. I'm curious what was the cause of that flip switching?

This is Sal Miraglia. Good morning. I mentioned last quarter you were going to have to take a look at the first half as a [hold]. As you will recall, as we were getting into the first quarter, we saw some spiking -- really extreme spiking going on in the raw material costs and as I made the point I said well, we have direct passthrough. There is a timing issue. The reality of it is that the timing issue is we collected for that in the second quarter. So if you take a look and average the first and second quarter of this year instead of looking at them individually, you will see we are just slightly ahead of, a little better than last year, which were two record quarters that we had last year. We're just a hair better than that on average. It is just a timing issue more so than anything else. The only other thing I would say is that it is a slight better result from last year with the substantial LIFO reserve that is required because of the value increase in the raw materials. Does that make any sense?

Yes, you just were behind in Q1 and you caught up in Q2?

That's exactly, right. Timing.

So since we are not taking the one question and one followup that seriously, can you comment on working capital as well? Q1 to Q2, it looks like working capital is significantly increased on the asset side and wanted to get a little bit of color as to what was driving that?

Obviously from a seasonality standpoint we tend as a company to build up working capital and obviously we have seen good top line growth in the company as well as over that period of time. As we look to the second half of the year, we expect to see those levels to come down due to seasonality, but also just very active working capital management within the plants with the benefit of P1 going through, dealing with the fact that we have lower volumes now coming from our light vehicle plants and so forth. As we track the metric on days and percent of sales, we are tracking where we expect to be but to see improved performance in the second half.

And those working capital initiatives are there anything new in there? Have you put new things in place to try to capture that that you can put some color to?

Just part of the reorganization -- but just relentless focus we know we have high levels of working capital in the company. We realize we need to take them out and we have a lot of programs both discrete and broad that are geared towards taking down our working capital levels.

Were any of those put in place or hustled in place in or around Q2? Or is it just the same stuff you have been working on all along?

Again, there were things in the second quarter, but it is a continuation of what we are doing. We benefited in the second quarter. We will continue to benefit through the second half of the year. Again, you have to look at it as a relative basis of the seasonality and look at it on a percentages or days basis, and we are continuing to see some progress. We are ramping up in certain parts of the world. You have to to look at each thing pretty discretely -- where we want to take it out and where we're aggressively trying to take it out, we are being successful. At the same points, there may be places where we are actually adding inventory because we want to build up the availability of product in the markets we want to grow where we're ramping up capacity.

Thanks, guys.

Your next question comes from Brian Carlson with Atlantic Investments.

Thanks for taking my call. A couple of points I wanted to ask about that were commented on in the last quarter. Mike, I think you said last quarter pass car was down 8% globally. Can you tell us what that would have been this quarter?

Down 19% in North America.

He said globally.

That's our overall light vehicle sales.

Can you clarify that? Globally pass car is down 19%?

That's correct.

Okay. And I think that there was mention of $7 million auto credit reserve. Do you anticipate needing to take more as a reserve? Because clearly the margins and the mobile division would have been 3% if we take that $7 million out. I'm wondering if -- the continued weak profitability in that division has any impact from auto credit reserves going forward?

The $7 million build up in the reserves was for the whole company, so we obviously have auto exposure within the steel group as well as with the bearing and power transmission. But the bulk or majority of it would have been in the mobile group. It is our best assessment of the marketplace. We have tried to look at all of our accounts. We are not seeing any deterioration in it. It was purposely meant to say that the markets are are coming down. There are risks out there and we thought it would be prudent to reserve against it. We look at different metrics such as insurance and being able to sell those receivables and what it would take to do that. We believe we are as current as we could be relative to what reserves were needed. If there is a further deterioration, that could mean we build it up further or it could mean that at some point we free them up as the market will change. It is as of today our best assessment.

And then Sal, just within the steel segment, as we talked about margins -- first half margins for last year I believe were 16.4% if I do the EBIT in sales for the first two quarters together and this year would be 14.8%. Is that a step down? Is that just higher raw material costs?

That is the inflating passthrough of raw materials at the equivalent profitability levels, as we are weighting the sales figure without pumping the bottom line, although we did better as we did last year as we attempt to recover inflationary costs too. So we did very comparable to last year first half, little bit better, matter of fact.

Just on a total EBIT dollar basis, you mean?

Correct, and close -- in terms of if you look at it on a return on invested capital basis, it is still very, very positive.

Would you expect -- taking into account the guidance that you've given for profitability is better than last year but not as strong as the first half I believe. We should see a nice step up in EBIT dollars in the second half versus the first half for steel?

We agree with that. That is what our projection is. We will do better than last. We will do better than than 2007, but not as good as the first half of 2008. And we have structurally things going on in the second half. We will, for example, take a relatively large shutdown as we install, connect and start up the new small bar mill which will position us for better and more sales next year.

Can you talk to us for a little bit about sort of what the revenue impact would be from that shutdown?

It is in our forecast. The numbers are there. We are not breaking these numbers out but our forecast --

I am just trying to get a sense of what I could add to 2009 to normalize for that.

I'm afraid we wouldn't want to break it out to that level.

Okay. Finally, Jim, I will -- you sort of alluded to this in your first comments with regard to feeling comfortable with the long-term outlook. I want to give you a chance to concretely comment that you still feel comfortable with the 15% to 20% EPS growth outlook you guys have for the next couple of years?

Yes, Brian, we are comfortable as we look forward that we have a continuing program that is shifting the company to focus on markets that are driven by global demand and that allows us to continue to implement a strategy that will improve our earnings going forward.

Okay. The very last thing, Mike, if I could just ask, within process, I believe that if we have $75 million of capacity coming online on on annual basis, and assume that also happens in 2009, and we have price increases for several of the particularly larger end bearings going through at high single digit rates, if I understand correctly from the channel. That would suggest that 2009 growth could be double digit in that business. Is that crazy?

Well, we certainly haven't forecasted 2009 yet publicly. If you just take a look at the first half of 2008 versus 2007, yes, we would be well in excess of that, right?

Okay.

We expect that these are our highest growth markets and we are absolutely strategically aligned to those markets and this is where we have been putting our capacity in. Most of this will be very good news from a growth perspective.

I absolutely agree. Thanks very much guys.

Your next question comes from Marty Pollack of NWQ Investment Management.

Just a couple items, normally these would suggest very high improvement in quality of earnings on those claims of numbers. But when you look at impairments and restructuring, those numbers -- that number comes down very significantly for the first half and first quarter, and down sequentially now for three quarters. Similarly also the restructuring charges, I'm wondering whether the second half will be more of the same and what is accountable to what looks like this much cleaner numbers?

Obviously when we provide the outlook for the year, we exclude special items, so from a forecasting standpoint we don't speak to it other than just to recognize that comment that we have seen that number come down because of the restructuring primarily related to the reorganization that we went through and the shoring up of our capacity relative to demand that we saw within the mobile or least the auto industry in particular and some industrial moved that we had made. It's fair to say that it has come down, and barring other moves, or gain/loss, those type of things, we don't forecast it. But from the restructuring of rightsizing the operations, clearly it is going now to a very small level and hopefully at some point obviously even soon will be going away.

On the impairment and restructuring itself, you would think certainly even within the mobile and auto area, there would be some impairment of assets despite shifting some of that capacity. So that number, $1.8 million, was very low. Basically second half should more or less be more in the same type of trend line?

Again, I think it is fair to say if there is a new initiative, we would comment on it. We are saying there is not. So we are managing through the business without additional restructuring. Again, a distinction between a special item of restructuring versus managing through lower volumes and what actions you would take from taking out costs and so forth.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from Holden Lewis with BBT.

Some things you have commented on last quarter which you haven't done so far -- how much were the LIFO charges this quarter and can you split that between automotive and steel?

We can. The LIFO charges for the quarter were around $45 million for the company. And the biggest piece as you would expect would be to be in steel. I will give you rounded numbers. Call it around $25 million of it within the steel group and call it around $10 million of it within mobile, and the rest spread between process and aerospace.

I think the comparable number was $17 million in Q1; is that right?

That's right -- for the steel numbers I believe is what we had provided -- or at least the question had come up in the first quarter.

What was the mobile number in Q1?

The mobile number -- well, in total we had around -- call it around $30 million in the first quarter as a company. Again, the bulk of that, the number you quoted coming from steel, the other biggest piece would then come from mobile.

Can you talk about what assumption you are making in terms of scrap in the steel side with these new charges?

Well, I think it is fair to say our expectation that material costs will continue to rise over the second half of the year. So we have effectively charged from a LIFO basis what we expect the full year to be and then obviously we are accruing to that on a quarterly basis and the increase over the first quarter reflecting the fact that we had higher material costs in the second quarter and again at this stage we don't see that abating right now. Obviously it could go up or down. But at this stage we expect it to be at relatively high levels.

That's a little different than Q1, where if I remember correctly, you set the LIFO charge to assume that scrap was at the May level, which was when you did your conference call. This time you built in a little more flex for the second half?

That's fair.

You can call it flex or recognizing the fact it is going to be higher value than what we thought it was going to be.

I guess that is rapidly becoming a fact.

Every time I turn around I'm surprised at how the big the number gets.

Can you talk about the impact as well of the strike in the quarter on the mobile business?

I would say just a couple things in general. Clearly it had a big impact on revenue line. Sales came down, but we were able to leverage that very well as Mike said, taking advantage of being able to reallocate that product to the process side of the business. It did have a negative impact overall, but not a meaningful number frankly to have even brought it out in our explanation of our results.

In Q1 you were saying you were expecting $15 million to $20 million per month and it was down for two months and then you thought that 20% leverage off of that. The revenue happened but the leverage was not that bad? Is that a good way to look at it?

The revenue turned out to be to be between $30 million and $35 million total impact on second quarter.

And last corporate wide pricing impact? I know you talked about ForEx, but price impact corporatewise?

Again, we don't break out the level of pricing other than to say that a lot of the driver of the improved performance in margins has been on putting price across the board, across the different segments.

And then I know you gave the revenues contribution from Purdy. What was the revenue contribution from boring specialties in the quarter?

We talked to the fact that it was offset by the decline from the sales from our exiting Desford. But both rounded would be around $15 million in revenues.

So you had $15 million -- when does Desford anniversary?

Well, at the end of this year, because it was end of last year that it was gone. To your point, we will start to see a build up towards the latter part of the year with boring contributing more than Desford would have come off.

Thank you guys.

Your next question comes from Brian Carlson of Atlantic Investments.

Getting tired of hearing my questions, I suppose. I wanted one more clarifying point. One might have the assumption that the strike reduced light vehicle demand and that allowed more capacity to be available to process in the quarter, and that maybe with the strike ending that that might not be true going forward. My impression would be that continued weakness in particularly larger vehicles, like SUVs and trucks, will continue to make the larger end of the machinery you have available for production in automotive more or less available for other end markets ala process. Is that the right way to think about it, Mike?

Yes, we have not reversed any mix change moves we have made as a result of any reductions in that marketplace.

The other thing was that in Q1 there was some commentary about the potential impact of a prebuy relative of people for staying ahead of SAP implementation. Can you talk to us about what impact that had or ended up not having in Q2?

Most of that worked its way throughout the quarter. We talked about prebuy in the first quarter and we have seen sales remain very strong in the second quarter. I didn't see it come out which meant that the market is probably a little stronger than we had forecasted originally and our sales remain strong. Again, speaks to our position in the marketplace -- if we can continue to put additional product in there for the capacity increases we are making, we will continue to garner the sales.

Super. Thank you very much.

There are no remaining questions at this time. Do you have any final comments or remarks?

Thank you for your interest. Obviously we had a good quarter but underneath the covers of the good quarter we continue to pursue a strategy that is showing success in shifting the company to markets with strong demand and investing in the ability to achieve profitable growth in those markets. We look to bringing you another good quarter in in the third quarter.

Thank you.

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