Timken Co (TKR) 2008 Q3 法說會逐字稿

Good morning, Ladies and Gentlemen. My name is Tina and I'll be your conference operator today. At this time, I would like to welcome everyone to the Timken's third quarter earnings release conference call. (OPERATOR INSTRUCTIONS). After the speakers' remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). Thank you. Mr. Tschiegg, you may begin your conference.

Thank you and welcome to our third quarter conference call. I'm Steve Tschiegg, Director of Capital Markets and Investor Relations. Thank you for joining us today and, if after our call should you have any 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. Then we'll 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'd 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 web site, www.timken.com. Reconciliations between GAAP and non-GAAP financial information are included as a part of the press release.

This call is copyrighted by the Timken Company. Any use, recording or transmission of any portion without the express written consent of the Company is prohibited. With that, I'll turn the call over to Jim.

Thanks, Steve, and good morning. Timken delivered another solid quarter of profitable growth. Sales and earnings were both records, and exceeded our estimate for the quarter. Having said that, we are navigating through one of the most unpredictable times in history. As one small indicator, at the beginning of the year, scrap prices were about $370 a ton. When we talked to you last quarter, they hit an all-time high of $870 a ton. In September, the price was $550, all the way down to the current price of $290 per ton.

As Glenn walks you through the results for the quarter, he will take you through the details of how these scrap price fluctuations and the impact on our LIFO charges affected our numbers in the third quarter as well as going forward.

It's important to appreciate how the timing of raw material pricing and the recovery of our costs from our customers can create significant swings between the third and fourth quarters. But the bottom line, it is a timing issue and on a full-year basis, the Company expects to fully recruit all raw material costs and to deliver record earnings for the year. It's much more important to observe that the Company is delivering strong structural performance.

When you peel back the phenomenon created by the rapid change in scrap prices, I'm confident that you will see the results for this quarter, as well as the past several quarters, demonstrate that our strategic initiatives are indeed taking hold.

Our strategy model is simple -- to grow in targeted markets, geographies and channels where Timken can create significant value. And to optimize the rest of the business, shifting the portfolio toward more attractive global industrial sectors while driving execution across the franchise. This strategy is the foundation upon which we are growing our portfolio profitably, especially in uncertain times.

On the growth side, sales in our aerospace and defense business grew almost 60% this quarter compared with the previous year. About half that growth is from the strategic acquisition of Purdy, which has solidly positioned us in the helicopter power train market.

Our process industries business grew 33% for the quarter, leveraging the $230 million of investments we've made in large bore capacity over the past three years as well as strong growth in Asia. Yesterday, we announced the addition of new capacity here in the United States to serve the wind power demand. Later in the quarter, we'll be breaking ground for the previously announced XEMC joint venture targeting the Chinese wind energy market. These investments add to our already-strong position in energy markets, highlighted by our acquisition of Boring Specialties in the steel business in the first quarter.

While part of our strategy is focused on growth, we are equally focused on optimization. Mobile Industry demand continues to weaken. This is no surprise. As we optimize the performance of this part of the business, you see our portfolio changing. We continue to be successful with pricing. At the same time, we are shifting Mobile Industry capacity to serve industrial markets wherever it makes sense.

We are also rationalizing our capacity to match current demand. Year-to-date, we have reduced total employment by 650 positions in our Mobile Industry unit, and we continue to use a variety of means to align output with demand. Overall, we believe our results provide solid proof that our strategy is generating improved execution, structural transformation and profitable growth.

Given the global financial crisis, I also think it's important to comment on our outlook for Timken and the markets we serve. We are seeing real declines in the markets in the US and Western Europe that serve the automotive and housing industries. It is clear that it will be some time before these industries rebound.

Despite this, I am confident that Timken is solid and well prepared to manage through these economic uncertainties. In many ways, we've spent the last five years preparing the company to meet such challenges. We have a solid balance sheet with good cash generation.

The industrial markets and Asia, where we have focused our growth, remain a relative bright spot in today's global economy. They are still expected to show strength, although at a slower pace than in recent years. Overall, we believe the moves we have made to diversify and expand our business into high growth areas will sustain demand for Timken products. Timken is on track to deliver record sales and earnings this year. Now I'll turn it over to Glenn for a more detailed review of Timken's results.

Thank you, Jim. For the third quarter, the Company's fully diluted earnings per share from continuing operations were $1.35. Excluding special items, earnings were $1.41. Special items consisted primarily of manufacturing, rationalization and restructuring costs relating to actions taken in the Mobile Industry segment. The rest of my comments will exclude the impact of special items.

Sales for the third quarter were $1.5 billion, an increase of 18% over 2007. Strong demand across the Company's broad industrial markets benefited from capacity expansion initiatives in key market sectors, including heavy industries, metals and energy. However, this was more than offset by weaker North American and European automotive demand. Increased sales resulted from surcharges used to recover costs, pricing, currency and acquisitions.

Gross profit margin for the quarter was 27.5%, an improvement of 720 basis points from last year. Favorable surcharges, pricing and mix were partially offset by higher raw material and manufacturing costs. Surcharges were high in the quarter, reflecting historically high scrap prices, which have since dramatically declined.

In addition, the Company had LIFO income in the quarter of approximately $30 million, which resulted in the benefit of approximately $50 million compared to a year ago. The change in LIFO was due to significantly lower projected year-end material costs used to value inventories. The Company was also able to leverage SG&A , as the margin improved 40 basis points over last year to 13.1%.

During the quarter, the Company increased its reserve for automotive industry credit exposure by $6 million. While our current customer account balances are within normal levels, we felt it prudent to increase our reserve, given the uncertainties within this industry. As a result, EBIT for the quarter came in at $212 million, or 14.3% of sales, 780 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 associated with the Company's acquisitions, partially offset by lower interest rates.

The tax rate for the quarter was 33% compared to 33.9% a year ago, reflecting the benefit of increased earnings from lower tax rate foreign jurisdictions. While we expect to maintain a tax rate of approximately 33% going forward, our fourth quarter rate is forecasted to be roughly 30%, reflecting the benefit of the US R&D tax credit, which was reinstated in early October.

As a result, income from continuing operations for the quarter was $135.8 million, or $1.41 per diluted share, an increase of 176%, compared to $0.51 per diluted share last year. Results exceeded the Company's prior estimate of $1 to $1.10 per share, principally due to LIFO accounting, resulting from projected lower raw material costs and the timing of raw material cost recovery.

Now I'll review our Business Segment performance. Mobile Industry sales for the quarter were $539 million, down 8% from a year ago, driven by lower demand from the North American and European light vehicle market sectors. Partially offsetting this decline was stronger demand in the heavy truck and off-highway market sectors, as well as improved pricing and currency.

For the quarter, Mobile Industry's EBIT was $5 million or 0.9% of sales, 90 basis points lower than last year. The benefit of improved pricing and mix were more than offset by the effect of lower demand, higher material and logistics costs and an increase in our exposure for automotive industry credit exposure. We've increased our reserves.

For the fourth quarter, we expect performance to be below last year. Lower demand in the light vehicle and rail market sectors, as well as material costs, are anticipated to more than offset stronger pricing. The company expects full-year results to be below 2007 for the Mobile Industry segment. As Jim mentioned, the Company has taken actions to actively address the impact of the weakening automotive market through adjustments and manufacturing capacity and costs.

Process industry sales for the quarter were $346 million, up 33% from a year ago. The Company benefited from strong industrial markets as new capacity continues to come online and existing capacity is shifted from other market sectors. The Company also benefited from strong pricing or currency.

For the quarter, Process Industry's EBIT was $82 million, or 23.6% of sales, more than 10 percentage points higher than last year. The benefits of strong volume and pricing were partially offset by higher material and manufacturing costs. Fourth quarter performance is expected to be above last year, driven by strong industrial demand, increased capacity and improved pricing.

Aerospace and defense sales for the quarter were $110 million, up 56% from a year ago. Approximately half of the increase was due to the acquisition of Purdy at the end of last year, with the rest of the increase coming from volume and pricing. EBIT for the quarter was $12 million, or 11.4% of sales, more than 10 percentage points higher than last year.

Improved earnings resulted from strong demand, the Purdy acquisition, pricing and improved manufacturing productivity. Partially offsetting these benefits, were the impact of capacity expansions, including the start-up of the Company's new facility in Chengdu, China earlier this year. Results for the fourth quarter are expected to be comparable to last year, benefiting from demand that is projected to remain strong.

Steel Group sales for the quarter were $537 million, up 41% from a year ago. The Group benefited from strong demand across all market sectors, except automotive. The increase in sales resulted primarily from surcharges to recover raw material costs and the acquisition of Boring Specialties. Steel Group EBIT for the quarter was $134 million, or 24.9% of sales, over 11 percentage points higher than last year. Improved earnings resulted from the timing of raw materials surcharges and LIFO income, which were partially offset by higher material and manufacturing costs and the effect of weaker automotive demand.

Steel Group performance for the fourth quarter is expected to be lower than a year ago, due to higher material costs and the impact of lower automotive production volumes. Due to rapid decline in material costs, our raw material costs coming down fairly significantly beginning late in the third quarter, and the timing associated with our surcharge mechanism, we do not expect to fully offset raw material costs during the fourth quarter, but will have full recovery of these costs for the full year.

Looking at our balance sheet, we ended the quarter with net debt of $645 million, $49 million lower than the end of last year 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 22.6% from 26.1% at the end of 2007. The Company expects to continue to generate free cash flow for the remainder of the year, driven by earnings and improved working capital management.

During the quarter, the Company received an improved debt rating from Moody's, to B Double A 3, reflecting the Company's strong financial performance and balance sheet. Timken is now rated Investment Grade by both Moody's and Standard and Poor's. The Company has strong liquidity, including approximately $560 million of committed credit available as of the end of the quarter.

Capital expenditures for the quarter were $59 million, or 4% of sales, comparable to depreciation and amortization. The spending level is expected to increase in the fourth quarter as we continue to make investments in support of the our growth initiatives.

We contributed $3 million to our global pension plans during the quarter, bringing our year-to-date contributions to $18 million. Our full-year 2008 contributions are expected to be approximately $20 million, down from roughly $100 million last year. Based upon current market conditions, the Company pension plans are expected to be under-funded at the end of the year. Similar to prior years, we will consider making additional contributions into the plan based upon our funding status and balance sheet strength.

In summary, the global economic market continues to soften while credit markets are expected to remain constrained. However, the Company expects demand for our products to remain relatively strong in key market sectors where's we have invested for growth, including aerospace, energy, and heavy industries, while automotive markets are anticipated to decline further.

We expect to see higher profitability in margins for the full year 2008 compared to last year, benefiting from improved pricing, operating performance and portfolio management initiatives, though constrained due to weaker automotive demand and high raw material costs. The Company expects earnings per share, excluding special items, to be $3.35 to $3.45 for the full year, which would be a record for the Company and above $2.40 earned last year.

For the fourth quarter we anticipate earnings per share, excluding special items, to be $0.16 to $0.26, compared to $0.51 for the same period last year and our prior outlook of $0.52 to $0.57 per share. Our current estimate reflects weaker automotive demand and lower surcharge recovery of raw materials, which benefited the third quarter.

From a cash flow standpoint, we expect to see higher free cash flow in 2008, benefiting from earnings growth 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, reflecting the Company's higher earnings. This ends our formal remarks, and we'll now be happy to answer questions that you

OPERATOR INSTRUCTIONS). Our fist question will come from the line of Eli Lustgarten with Longbow Securities.

Good morning.

Good morning.

I'm not sure I know where to start with this quarter. Quite an epic event we're seeing going on. Can you take us through both -- I guess the Mobile and the Steel business for the fourth quarter and its impact? Because in order to get the $0.16 to $0.26 with the 30% tax rate, we've got to have a pretty good sizable loss in automotive, and you've got to have maybe mid-single digits at best and steel from a profitability standpoint. That in the context of what I'm told this morning, is scrap is in free-for-all and the $2.90 number is double where it is today from what I understand. Are we overstating the decline and steel at the same time?

Eli, let me start then ask obviously Mike and Sal to drill down some more. Clearly, the fourth quarter issue -- we're going off of a record third quarter of unprecedented benefits in the markets. There's a lot of the unique timing, if you will, that's going on within the scrap market, as you know, again in our mechanism. So clearly, we benefited from the third quarter as a result of our mechanism. We got hurt in the fourth quarter, which is why it's structurally well below what would be a more normalized level of profitability for the Company and as well for the steel business.

But clearly, Steel's being impacted by that timing mechanism, which again is not structural. But also, steel obviously plays in the automotive industry as well, and currently is seeing the negative impact of that, but again still looking at positive performance for the quarter. On the Mobile side, though, again, obviously, we have a big component which is automotive-related. We're seeing continued declines in demand. We're managing it as well as we can. And again, Mike can speak to a lot of the actions that we're taking. But it is our expectation that we will lose money in the fourth quarter within the Mobile growth, which grew, which will take us down from a year-to-year basis. So the assumptions that we've taken, given especially the uncertainties in the market, reflect at least what our current thinking would be in that. But again, to make a strong distinction that that low level of operating earnings within the fourth quarter clearly are skewed by some timing issues that benefited our third. But Mike, you may want to comment more on the Mobile.

I think Glenn -- Eli this is Mike. I think Glenn covered it well. I think if you look at Q3 and then try and compare into Q4, the mix change continues. There's two different stories in the mobile industry's aspect. That's the automotive industry that you're all very much seeing, and reductions that have taken place throughout the entire year. That's been offset by what we've seen as real strength in our ability to move that capacity towards other parts of the mobile side of the industry. So we've gotten very attractive growth, up through the first three quarters, in the off-highway and the rail and our after-market segments. And that's been really good, in addition to moving that capacity to Process Industries, which again, as you know, we've talked about. And that's been really good.

Now we're starting to see some of that softening across several of the markets. You can see that in areas, certainly like construction, there's lots of concerns around the Ag markets. And once the general economy starts to soften, then you start to impact the rail industry in itself. So we're going to see the continued challenges, I think, with regards to volume perspective. But this is something that we've actually been focused on for the last three or four months with regards to reductions and schedules throughout our manufacturing plants, reductions in actual work force, and then taking time out the remainder of the year. So it's a good challenge just looking at the economies across the world and the changes in those economies. Sal?

Eli, Sal here. Again, your estimates were right on the button. Our -- the effects that we'll have in the steel business have a lot to do with the weakening in the automotive market, which everyone has seen, and it's pretty big. And you're exactly right. We're now seeing sub-$200 a ton scrap. We haven't seen numbers like that since 2003, 2004. And with lower operating levels, we're just going to be stuck with numbers that come through looking a little bit more poorly until we're able to work that through. But your estimates are right on target.

I mean, the follow-up is, what do we do to talk about 2009 in these businesses? I mean, we're sort of sitting there, but with its -- you get stabilization of scrap or in some of the demand -- is it just if we get much lower profitability next year -- on lower sales? Is that how we should treat -- we're stuck with trying to make some outlook for next year and the impact, and we're trying to assess how the impact on Timken would be, given the extraordinary conditions that exist at this point.

Eli, obviously, a couple comments on our outlook and then we'll open it up for the group, too, to talk. But clearly, a lot of uncertainties that are out there. We continue to see good, reasonably, especially if you want to use the word relative, industrial markets where we've targeted our growth. So we clearly have a lot of positives as we go into next year from an Asia standpoint of focus into certain markets. We clearly realize that production levels within the automotive markets are looking to continue to decline. So we know we have those headwinds. But similarly, we had a lot of those headwinds this year where we performed at record levels for the Company.

We're going through, as you know, our process of going through our budgeting for next year and looking beyond. We'll comment more about '09, what our expectations will be at the end of next quarterly results. And obviously at that time, we'll have another quarter behind the belt to even have a little more comfort level, if you will, of what things will look like. But clearly, we're well positioned to do well next year. Again, fourth quarter, you can't look at as the decline being an impact of lower numbers going forward because, again, the aberration and the timing that's impacted. But again, we're well positioned. We're clearly nervous like everyone else is on the global economy, but we believe that we're well positioned to manage through it well and come through it as a stronger Company.

li this is Jim. Let me see if I can step above what Mike and Sal have said and give you a framework. Then I'll turn it to Mike to talk a little bit about what we're seeing in the marketplace that maybe can help. The fourth quarter, Sal said this the other day, is a confusing mix of timing, seasonality and then the whole economy. The timing piece -- you have to understand in our Steel Business, there is a mismatch in timing between when we recover the scrap surcharge and what we actually charge the value of the scrap that we buy to earnings. So what happens in the fourth quarter, is we are recovering based on current scrap price indices, but we are charging against those sales, the scrap we bought when scrap prices were high. And so that artificially depresses earnings in the fourth quarter. The reverse happened in the third quarter. So that's the timing issue that we're explaining.

Secondly, we've got a seasonality factor that it is the fourth quarter, and our customers tend to take extraordinary shutdowns, particularly in a down market, to blow inventory out and that creates a seasonality issue for us. Then obviously, we're in a very uncertain time in the economy. As we look at this, that means the fourth quarter is depressed earnings for us. Then obviously, then you try to look across that chasm into 2009, and you've got to start with, what is the fundamental demand in the marketplace? And I think that's perhaps the more important place to go. Mike, you want to take a minute and just sort of talk about what we're seeing in the market?

Given the diversity of the three business units, I think it's important to a certain extent to separate them and maybe talk a little about what's happening in each of them because they are very different stories. In the areas like aerospace, and I'll take the true aerospace side of that business. As you all know, a big portion of our business there is defense-oriented. Also, it is oriented towards not fixed-wing commercial, which is the major concern certainly in the market, but very much towards the general aviation helicopters, etcetera. At this point, both defense remains strong., and of course this is something that is subject to change. But the -- our order book, and the strength of that order book still remains very good throughout 2009, again, subject to the change of the economics. But at least as we look at it today and communicate with our customers and the industry, that still remains at a relatively strong rate.

If you look at process industries, here's the area where we've invested in our growth, and that investment has started paying off in the fourth quarter of last year. Now we can see that not only throughout the first three quarters of this year, but we'll still remain at a relatively strong level through the fourth quarter. The question around again is how the macro economics will impact the energy industry, the infrastructure build throughout Asia.

But at least as we go into 2009, the order books still remain strong, albeit, lots of questions and concerns from the customer base and the marketplaces and the various geographies. So we're seeing what most of you are seeing, North America and Europe obviously significant softening across many industries. Asia still remaining strong, but albeit, it will be at a slower growth. And then of course the mobile side of this will continue to be a challenge as the automotive industry continues to weaken. There are some positives in there, as our material costs will actually begin to shrink or slow both from the standpoint of the increases that we saw, but out-and-out reductions with regards to some of the pricing in the marketplace. So there's a positive with regards to material prices both as the volume goes down. So it's kind of a tale of three different cities. The good news is, is where there remains strength, compared to historical levels, it is the place where we have focused our new capacity and focused our efforts and therefore the improved profitability. In the areas where we have talked about fixing and/or getting out, is the area that, in fact is shrinking and probably if anything, is accelerating the strategic implementation.

Eli this is Sal. Kind of a similar story. Clearly, our automotive and light industrial order book is currently weak. And you read everything as I read it. We don't expect that to recover very quickly. But it's not dead, it's just weaker than what we've seen before. Clearly, our very attractive market, the energy market, has remained strong. Just this morning, I heard they're taking -- OPEC is taking 1.5 million barrel-a-day capacity out so we probably will not see the price of oil drop a whole lot more from where it is now, but I don't know how to predict that either. So currently, we still expect to see fairly good energy markets. Similarly on the positive side, as Mike described material costs, sub $200-a-ton scrap gives me better than integrated mill raw material costs, which up to this point in time, has been a disadvantage for us as we have been paying much, much higher pricing, and especially those mills that have their own integrated mines had a big advantage. I think that's just disappeared. And so as this continues, that will give us some advantage in the market space and a margin advantage that I think we would not have seen otherwise.

Thank you. I'll get back into line.

Our next question will come from the line of Wendy Caplan with Wachovia.

Good morning.

Good morning, Wendy.

Good morning.

Perhaps my math is off slightly, but we calculate that all else being equal, if steel margin in Q3 had equalled Q2 level, that you would have earned about $0.60 a share not the $1.41 that you reported. Glenn, can you give us some sense that that's the correct order of magnitude here?

Trying to understand your question, Wendy. I mean obviously, if you go ahead and -- you're saying is the first half of the year more indicative of the steel performance?

No, I'm saying if I keep all else equal for your results in Q3, and I simply adjust the steel margin back to Q2 level, then I get $0.60 in EPS.

Yes. That sounds right. They did 15% margins versus 25%, so if you backed it down, that would be obviously a significant driver of the increase that we had during the quarter.

Okay. And can you perhaps, Jim, help us understand why you consider it prudent to add manufacturing capacity during this very uncertain time when you've consistently cited, and again this morning cited, your flexibility to switch products manufactured in your facilities depending on end-market demand?

Wendy, I think the answer is we made -- we are finishing a third year of record capital investment, which are targeted at specific markets that have showed continued strength. And they're markets that we did not have the capability to manufacture -- a sufficient capacity to manufacture what the market demands. Those are the markets that are driving our aerospace, which is up 60%, year-on-year. Process industries, that's up 33% year-on-year and are driving the margins of the business up.

The places where we have not had demand growth, we've actually shuttered capacity over the last three years. And it is driving the portfolio change that Mike described. It's the same process we went through in the steel business over the last four years that has left us with a much more attractive portfolio of businesses, and positions us as well as Company can be positioned to face the markets that we're facing.

But my question is, on a net basis, you will have additional capacity, I assume, I guess that's my question. Will you have on a net basis additional capacity once across -- across Timken once all this capacity addition is complete?

The answer is yes. As long as the demand pushes us in that direction, we continue to see opportunities for profitable growth.

Okay, but Jim, my confusion here, is we're facing a period of time when there is a no-growth, lack of lots of growth, negative environment on a global basis. Does it make sense to go ahead with these projects or simply to put them on hold until we have more visibility into demand?

Wendy, we are in a period of very significant uncertainty, and we have committed ourselves over the last three years to a series of investments, and those investments will be completed. now, we have at the same time, stepped back and taken a pause and we will pause until we see the opportunities to invest. but some of those investments are in markets where we still have very strong demand, and we have contracted business that is -- we have commitments for business which will be produced from them. The XEMC plant is exactly one of those areas. Maybe Mike can comment on that.

Yes. I think there's a combination of three things going on, Wendy. One, any new capacity that includes brick and mortar is tied directly to a commitment from the customer base. And some of those cases includes an investment from the customer base so that we all have an investment and both enjoy the rewards as well as the risks. So that's one example. An announcement we made yesterday with regards to expansion of our Tiger River facility, is again directed towards contractual commitments from the industry, and the desire in wind to meet that growth. It's not brick and mortar. In fact, it is additional equipment that allows us to expand our capabilities as we move forward. So it is a very measured improvement, which has a significant return on invested capital from that perspective.

But more importantly, what Jim was describing, is our capacity. Implementation over the years has driven us to a very, very different mix in the bearings and power transmission business. To give you an example, if you look at the third quarter of '08 versus third quarter of '07, our exposure now to the light vehicle side of the automotive industry is -- today is 21%. One year ago it was 33%. So it has driven the fact that we've been able to put that capacity in to catch the growth in very attractive markets that fit both strategically to what we're doing and have been the growth markets around the world. We still believe that those will be the markets that will outperform anything within the light vehicle systems area of the automotive industry, and therefore we will be very well positioned to both commercialize that and take advantage of any growth opportunities or any strength that remains in those markets. So our position today versus just one year ago is significantly enhanced in the industry.

Okay. I can follow up offline. One other auto-related question. Can you tell us the -- first in the mobile equipment sector, you said, Jim, that you had reduced head count by 650. What percentage was that,? And also, can you comment on how much auto specifically lost in Q3?

Wendy, I don't have those numbers at my fingertips. I think the more relevant point is we have taken two to three times that in equivalent hours' work over that period of time.

Wendy, I guess I'll just at least provide some color, not to say that absolute loss. Again we track this within the segment now, and so we're not breaking out the old, call it automotive. And again, we did talk about the shifting of some of that capacity that Auto was losing by putting it into the process which again benefited that Group's very strong performance. But there's no question that we are seeing losses within the Auto, but similarly within Mobile we continue to see good profitability within our off-highway, within our rail business and our automotive after-market piece. So again, the blending of that at least enabled to us mitigate the downfall in the automotive markets. But again, as we said as a fourth quarter with continued deterioration, we don't think that we'll be able to offset that such that the Mobile Group will turn to a loss in the fourth quarter.

Our next question will come from the line of Rod McKenzie with Lafitte Capital.

Hi guys. Have you noticed amongst any of your customers, people that are saying with the uncertainty out there, start to hoard cash, minimize inventories, basically, just preparing for what might be coming in terms of liquidity issues going forward or contractions within their customer base? And along those lines, do you have an ability to figure out about what you've got in in terms of inventory at your major customer segments? How much months of inventory might be out there?

Yes. This is Mike. I'll take it from Bearings and Power Transmission, and then Sal will probably take it from a steel perspective. The areas that we have the greatest concern with regards to inventory levels of the marketplace generally is the distribution side of our business. And we have very good visibility of those inventory levels at our distributor partners across the world. We have good visibility to their sales of our products, and our sales obviously to them of our products. So we're able to have great transparencies on those inventory levels. I would tell you that at this point, that is not a major concern of ours. Now, that all is again dependent upon what directions the markets take and the decisions they make with regards to any inventory reductions they may choose. But at least at this point, there hasn't been any significant impact one way or the other on our business because of inventory levels in the distribution channels.

If you look at the original equipment manufacturers, obviously everyone is looking at 2009 and deciding as to what they're going to with their capital, and most would like to transform it into cash versus inventory, and/or are questioning some of their own capital expenditures going forward. So yes, we're having dialogue with all of our customer base throughout all of these segments as to what their, certainly not only intentions are with respect to -- where their estimates are as to what the markets will look like and what they will be serving, but what their internal intentions will be as to how they want to manage their capital.

This is Sal, Rod. Probably the place that's the most volatile for us right now is simply the automotive space. The automotive companies, I don't think themselves know exactly what they need to do. They're taking schedules out the week before we're supposed to deliver. We clearly have some stranded inventory. But I do think we're seeing the effect of the double whammy, both of their need to move to some more controlled level of their inventories. And so the reduced operating levels will keep the pipeline of flow of products to them that they would need pretty long for a period. But that's the place that we have the most or the poorest visibility. Everywhere else, as Mike described, we're having a lot of dialogue, and everyone is simply very nervous. No one knows what the demand level will be. At this stage in time, we're just watching like hawks.

Yes, as I guessed everybody is. Then I guess a follow-up along those lines, if the automotive sector, I am assuming, is deteriorating perhaps at a more rapid rate than other parts of the economy at least appear to be, does that give you guys a chance to accelerate the redeployment of manufacturing capacity away from automotive into off-road to industrial or whatever.?

Yes, Rod, this is Mike again. That's exactly what we've been doing, really for the last year. In fact, we began that before some of the aggressive reductions in the industry anyway. And that was just prudent on us with regards to our strategy to move more products into the more profitable markets that we serve. This has provided an opportunity to accelerate that in some cases, but I can tell you that the cuts in the automotive industry are getting pretty deep. So, I wish all of our capacity was completely flexible. It is not. So in some of those cases, as Jim mentioned earlier, we are taking facilities down for periods of times and/or reducing workforce.

Thanks a lot. I'll turn it back over to the rest of the people.

(OPERATOR INSTRUCTIONS). Our next question will come from the line of Mark Parr with KeyBanc Capital Markets.

Hey, good morning.

Good morning, Mark.

A couple of follow-up questions, and I appreciate all the clarity and the color that you're trying to cast around this current situation. The first, related to the increase in your receivable reserves. Glenn, I think you mentioned you increased $6 million. Is that more than normal? Would you characterize that as an usual level?

Well, Mark, as you know, we've been periodically, been increasing our reserves, in particular relative to the automotive industry.

Right.

Our experience continues to be very positive. We're not seeing extensions in our days of receivable and so forth. But given the uncertainty, we frankly have been probably reserving on average, relative to our automotive customers that are around the 25% rate, where a 5% would be maybe more normal. So again, we just think it prudent to build up those reserves, but have not seen anything that would cause us to say that they won't be there, other than just the uncertainty that's out there.

Okay. Does the fourth quarter outlook include further additions to automotive-related reserves?

I'd say no unless we see just a change, especially in the volumes. I believe we're pretty fully reserved. But we assess it every quarter, so it's fair to say that the guidance, and one of the reasons obviously you give a ranges is to be able to build in additional things. But we feel we're pretty well reserved. We look at insurance rates of what we could actually sell those receivables to, and we're more than reserved relative to that exposure. So we feel it's prudent, and to the extent we feel we need to build up the reserve, we will. But as of right now, we think we're fully reserved for those exposures.

Okay. As far as the -- I had a couple questions on the Steel Business. Sal, could you give me some color on what the volume expectations are of 3Q and 4Q?

Well, the third quarter that we just finished, was a relatively good quarter for us all the way around, and probably operating at the decent levels. All I can really say about the fourth quarter markets, is we're probably seeing the lowest level of demand and ordering in the auto and light industrial that we've seen in an awfully long time. The plans we have dedicated to some of that kind of operation will see fairly curtailed operations as a consequence of that. It's as weak as we've seen it for a long time. Again, double whammy. Reduced consumption levels of those various plants that require inventory adjustments, as well as the lack of consumption. I think we're going to see the full brunt of that in the fourth quarter here.

Okay. Have you curtailed any capacity at this point, or any operations?

Actually, we are running light schedules in one of our shops right now, that's correct.

Okay. It's probably Harrison, that's probably running at less than full capacity?

That's your opinion. But pretty close.

Okay. Faircrest isn't that far away.

Quite frankly they are running at capacity. [It's the adjustment] from the energy markets. (Inaudible).

Okay. And again, I'm just trying to get a little more color and to try to understand what your fourth quarter outlook means. What are the assumptions underneath it from a volume? How much do you expect volume to be down on a year-over-year basis in the fourth quarter given -- that's built into the current guidance I guess? I'm just trying to understand what the current guidance means from a volume perspective. What's your expectation?

Well, I don't know if you were on the line when Eli was speaking, but he talked about single digit EBIT margins. And that's -- he's pretty accurate there.

No. I can do the math on the margins. But I'm just trying to understand what the volume means. What's the implication on the top line for volumes.?

I'd say we're probably going to operate within the Harrison Plant at on the order of 60% of its overall capacity as opposed to where we had been before, so it's pretty significant.

Also Mark, obviously we'll have the benefit of the Boring Specialties acquisition so we should still see top line growth within our Steel Group year-over-year. But we will see some -- expect to see volume declines, but we're also -- obviously between pricing and surcharges normally can offset that volume decline.

And frankly, as we've talked before, although we don't share that, that the margin mix on that product mix is much more positive.

Okay. All right. Then one last question on steel. I mean -- Eli touched on this with scrap, moving below $200 a ton right now, kind of on the preliminary basis for the November auction. It's clear that export demand is dried up for scrap because of the weaker production momentum coming out of places like Turkey and Asian markets. Does your new guidance -- what's your scrap outlook built into the guidance for the fourth quarter? Have you taken another $100 out of your buy for the November time frame?

We're looking at right now, sub-$200-a-ton scrap.

Okay. All right. I don't know if you guys heard the news, but National City just got bought by PNC this morning. So I thought I'd share that with you.

Did not hear that.

Good luck in the fourth quarter, and we'll be in touch soon.

Thanks, Mark.

Yes, sure.

Our next question will come from the line of Melissa Cooke with Calyon.

I wonder if you could give us an update on the capacity expansions in China and India. How is that going? As we think about the comparability for '09, how much will that new capacity be adding versus just what would be the underlying market growth?

Yes, Melissa, this is Mike Arnold. Let me give you some color. One, the capacity expansion's gone very well. In fact, I will tell you the two plants that are currently ramping up right now are actually ahead of schedule. And that has, in fact, impacted the ability to improve our financials from a revenue perspective, targeted specifically at the process industries. So that's gone very well. It positions us very well for the remainder of 2009, again based upon what we see on the order book, which still remains strong, but with the caution towards what's going to happen in the economics and the change in that. So capacity ramp-ups have gone well, actually ahead of schedule. The volume has moved into the marketplace. It's given us great leverage on the bottom line, which again I think you can see, and positions us very well. Now we have to watch the markets.

Thank you.

Our next question will come from the line of Martin Pollack with NWQ Investment.

Just wonder if you might characterize the fourth quarter in a sense -- with regard to the surcharge in raw material mismatch. It seems like fourth -- you borrowed from the fourth quarter, or at least there was a sense of fourth quarter being affected by the inflated third quarter numbers. If you normalize that, what would the fourth quarter have looked like? I mean, is it possible that we would have been, in a sense, to a $0.40, $0.50 type number if you didn't have the third quarter impact and the mismatch? Just so we have some sense of that more normalized look at the fourth quarter.

Fair question. Clearly, we talked more of the magnitude than the absolute, because with pricing and surcharges, we view that as the total, call it value proposition relative to the materials. But clearly, we can price off of our -- know what our mechanism is, know what we're surcharging. I guess the way we would categorize it, is that it was a cost to us in the fourth quarter, it was a benefit to us in the third. We would probably say of the decline that we're looking at, between third and fourth in broad strokes, probably around two-thirds of that reduction. So the $1.41 that we earned, call it the $0.16 to $0.26 that is is our new expectations, probably around two-thirds of that reduction is coming from Steel. Not all of that due to the timing mechanism, though, because again, the weaker automotive demand is part of that as well. And then call it the other third of that decline principally coming from auto. And we'll have other pluses and minuses. So without giving you the exact number of the change in our mechanism and how it worked, other than again, it works for the full year, we recouped all of our material costs for the full year, or the expectation is. But it gives you the magnitude of the change. How much we'll expect to see our Steel Group decline? A good portion of that decline is that timing mechanism. A part of that decline is also weaker automotive demand.

I guess just maybe to clarify that one more time, if we didn't have the timing issue and we had captured that, let's say, that mismatch, automatically or let's say, sooner, is that number, if you're saying a third, two-thirds -- I don't know, it sounds like we still would have seen maybe another $0.15 to$0.20 easily of improved earnings or maybe much higher.

Again, from a ballpark perspective, that's fine the way you're thinking.

Okay. Thank you.

Our next question is a follow-up question from Eli Lustgarten with Longbow Securities.

It's quite a thing to try to have to talk through. One, can you make any comments on currency effects, particularly with currency going negative for most companies at this point and what you have factored in this year? And two, you just made a comment of two-thirds of the decline, the drop that you looking at, is steel. That excludes -- that's the steel earnings after -- excluding the LIFO charge, taking out the LIFO gain. So you take out the $30 million and then use that number to go down, is that correct?

Yes. That's right. We benefited from LIFO in the third quarter. It's our expectation that we'll benefit again from LIFO in the fourth quarter, obviously depending upon what happens. But based upon Sal's assessment of that sub-$200 number, it's fair to say we'll have LIFO for the fourth quarter. But even so, it's still our expectation that it will be a net expense for us for the full year. But again, it will be a positive year-over-year.

Your $0.16 to $0.26 forecast has a LIFO benefit in it?

Yes, it does.

Okay. And you're also looking at -- do you have any foreign currency discussions you can give [us] of what's going on and how it's impacting you?

ll, for the -- it's never been a big movement for us, Eli. For the third quarter, it affected us by around, between1% and 1.5% on the top line. And that's -- maybe it's for the year-to-date I think, it's as much as -- it's up to 3%. So call it in the % to 3% range for this year.

Any bottom line effect, though?

Again, less than the impact of that increase in sales. I mean it's been a net positive, but it's nominal.

And you don't have anything factored in one way or the other for the fourth quarter?

That's right. We're factoring a little bit of it. It's probably moving the opposite way a little bit, but it's not going to be a big number.

All right, thank you.

Our next question is a follow-up question from Rod McKenzie with Lafitte Capital.

Question has been answered. Thanks a lot, guys.

Thank you. And at this time, I would like to turn the call back over to Mr. Jim Griffith for closing remarks.

Okay, Again, let me just repeat what I said in the introductory marks. It is a confusing time, and we appreciate your interest and probing questions to help to understand and get it clear. The bottom line is that for Timken, we are generating record performance, and that we're well positioned for the uncertain times ahead of us. Thank you.

Ladies and gentlemen this does conclude today's teleconference. You may all disconnect.