Timken Co (TKR) 2009 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 Timken's second-quarter earnings release conference call. (Operator Instructions). Thank you. Mr. Tschiegg, you may begin your conference.

Thank you, and welcome to our second-quarter 2009 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 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 & 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 we will then all be available for Q&A. At that time, I would ask that you please limit your questions to one question and one follow-up at a time to allow an opportunity for everyone to participate.

Before we begin, I'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 website, www.timken.com.

Reconciliations between GAAP and non-GAAP financial information are included as part of the press release, as well as on the investor's overview portion of our website. 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. Good morning. Earlier today, we reported results for the second quarter and updated our outlook for 2009. We also announced the sale of our Needle Roller Bearings business, which we expect to close at the end of the year.

As you know, we reported a loss for the quarter and we lowered our full-year estimate for 2009. Simply stated, the challenges to our profitability are a direct result of the rapid and broad-based decline of volume in the marketplace. Despite the drop in demand, the Company generated strong cash flow and improved liquidity with a radically reduced cost structure. Our associates have executed very well during these challenging times.

First, let's take a look at the market dynamics that are impacting our Company, and in turn, our revised outlook. Then I will touch briefly on the actions underway to offset these market conditions, and close with a few comments on the sale of our Needle business.

As you know, the economic recession has affected the markets we serve around the world. With the exception of our aerospace and defense business, which is experiencing strong demand, most of our customers have seen demand for their products drop anywhere from 25% to 60% or more. As a component in raw materials producer, the drop in sales of our customers is compounded by their efforts to reduce inventory. Therefore, we are seeing both structural and temporal reductions in demand for our products. The combination makes forecasting very difficult.

Let me give you some examples. One of the easiest markets to measure is the North American automotive market. Sales in the light vehicle sector have dropped from about 16 million vehicles in 2007 to a forecast of 9.6 million for this year.

On top of that, the OEMs have taken long shutdowns, reducing inventories by more than 1 million units. The result is a vehicle production forecast in the range of 8 million vehicles for the year. Add to that the inventory reduction throughout the supply chain, and our light vehicle plants have operated at about 25% to 30% of capacity this quarter.

The good news is that the auto industry appears to be nearing the end of its inventory reduction cycle. The combinations of Cash for Clunkers in Europe, the emergence of Chrysler and GM from bankruptcy, have resulted in an increase in orders in this segment. We expect a gradual improvement in demand over the balance of the year.

Other markets are not as transparent. Key mobile industrial customers like Caterpillar and Terex have made a point of talking about inventory reductions in their releases this quarter and expect to continue to reduce inventory throughout the year. Heavy industry is even more of a concern, as capital investment cycles tend to lag a manufacturing upturn; and they, too, are flush with inventory. The good news is that all our businesses are generating positive cash flow through inventory reduction.

Our Project ONE tools have assisted us in reacting faster and more effectively than ever before in a downturn. The obvious bad news is a temporary reduction in demand created by our customers' inventory liquidation that is exaggerating the impact of the economic downturn. These inventory factors have taken demand for key industrial products lower in the second quarter and caused us to reduce our sales forecast for the second half of the year.

This economic backdrop helps explain why we've adjusted our earnings outlook for the year based on what we believe to be a longer recession and a more moderate recovery.

Now let me shift to actions underway to respond to the market conditions while protecting our balance sheet and improving our liquidity. As demand dropped, we scaled back manufacturing operations to match. Inventory levels this year have been reduced by $215 million through a combination of temporary and permanent reductions in employment.

Since the beginning of 2008, we have eliminated over 5,300 positions, and expect that number to increase to roughly 6,500 by the end of the year. Capital spending has been reduced roughly 50% from 2008 and targeted to specific areas. We continue to support investment in our Project ONE initiatives, as well as focused investments in the wind generation industry.

The Company is on track to exceed the $80 million in annualized selling and administrative cost savings we announced last quarter. When combined with the reductions in our variable compensation programs and tight spending controls, we expect S&A spending to be down approximately $180 million in 2009 from 2008 levels. Moreover, we have strengthened our management capabilities in the process. We believe we have the right people in place to continue to manage through the downturn, and that the rightsizing of the organization will position the Company to leverage the recovery.

While earnings are down, we are projecting strong cash flow in 2009. Cash flow in the second quarter was especially strong, driven by $160 million in inventory reduction this quarter. The balance sheet remains strong, and liquidity has been enhanced with the completion of a new three-year $500 million credit facility earlier this month. We are pleased with our current condition, which Glenn will describe in more detail.

Finally, I would like to produce a strategic perspective on the sale of our Needle Rolling Bearing business announced earlier this morning. Timken has signed an agreement to sell this business to JTEKT Corporation, and will receive approximately $330 million in cash proceeds. This transaction is a major step forward in our strategy to transform the Timken portfolio focusing on those industrial friction management and power transmission sectors that have strong after-markets. The Needle business is about two-thirds automotive.

The sale, when completed at the end of the year, will shift Timken's portfolio toward more attractive industrial markets where we create profitable after-market opportunities. It will reduce Timken's overall exposure to automotive OE markets to less that 20% and provide additional liquidity.

We pursued the sale of this business as an effort to reposition the Company strategically. It will be positive for Timken's near term financial performance, as well as enhancing the long term.

In closing, I'd like to take a minute to thank our Timken associates for the extraordinary flexibility and tenacity they have shown seeing us through the many changes we have underway in the Company. Their ability to effectively manage near term business requirements, while keeping eyes trained on the long view of our strategy, have allowed us to not only weather the recession well, but also positioned us for stronger performance as the markets recover.

Now I'll turn to Glenn to walk you through the details of the results for the quarter.

Thanks, Jim. For the second quarter, the Company incurred a loss of $0.67 per share. Excluding special items, the second-quarter loss was $0.21 per share. These special items totaled $44 million of after-tax expense, including a non-cash impairment charge of $20 million mostly related to winding down the Canton, Ohio Bearing operations. The remaining expense relates primarily to severance costs resulting from implementation of the Company's cost reduction initiatives. The rest of my comments will exclude the impact of special items.

Sales for the second quarter were $829 million, a decrease of 46% from 2008. The decline was primarily due to lower volume across most of the Company's end markets, which were down in total around 38%, and the impact of lower steel surcharges. The negative impact of currency of around 4% was offset by pricing.

Gross profit margin for the quarter was 14.5%, a decrease of 790 basis points from last year. The negative impact of lower volume and manufacturing underutilization was partially offset by pricing and cost reduction initiatives.

As a result of weaker market conditions, the Company also took actions to reduce SG&A spending, which was down $54 million compared to a year ago. SG&A as a percent of sales increased 440 basis points over last year to 17.1%.

EBIT for the quarter was a loss of $22 million, or 2.7% of sales. Net interest expense for the quarter was $8 million, down $2 million from last year due to lower debt levels driven by strong cash flow generation during the past several quarters. Net debt has been reduced by $471 million over the past year.

The tax rate for the quarter was 34.3% compared to 32.4% a year ago, bringing our year-to-date tax rate to 28.1%, which we expect to maintain for the remainder of the year. The full year tax rate reflects not being able to currently tax-affect losses in certain foreign jurisdictions.

The Company incurred a loss for the quarter of $21 million or $0.21 per share compared to earnings of $0.96 per share last year.

Now I'll review our business segment performance. Mobile industry sales for the quarter were $366 million, down 42% from a year ago. The decline was driven by lower demand across all market sectors, especially heavy truck, off highway and light vehicle, and unfavorable currency. Partially offsetting these factors was improved pricing.

For the quarter, mobile industries had a loss of $36 million or 10% of sales, down $50 million from last year. The decline was driven by lower demand and the resulting manufacturing capacity underutilization, which was roughly $110 million. This was partially offset by the benefit of improved pricing and reduced SG&A costs, which totaled approximately $60 million. Mobile industry sales for the year are expected to be down approximately 35 to 40%, driven by lower demand across all of its end markets.

Process Industries sales for the quarter were $222 million, down 32% from a year ago. The decline was driven by lower demand across its industrial market sectors, especially metals, gear drive and wind energy, and unfavorable currency. Partially offsetting these factors was improved pricing. For the quarter, Process Industries' EBIT was $38 million or 17% of sales, 210 basis points lower than last year.

Earnings were impacted by lower volume and manufacturing costs, partially offset by pricing and cost reduction initiatives. Process Industries sales are expected to be down roughly 30% to 35% in 2009 across its broad end markets, with its greatest declines in the heavy industrial equipment and energy sectors.

Aerospace and defense sales for the quarter were $113 million, up 7% from a year ago, driven by favorable pricing and acquisitions. Excluding the impact of the EXTEX acquisition, sales were up 5%. EBIT for the quarter was $20 million or 17.2% of sales, 570 basis points higher than last year. Improved earnings resulted from pricing and the benefit of cost reduction initiatives.

The Company expects the defense market to remain strong in 2009. While the civil aerospace market has weakened, we do not expect this to impact our overall results in 2009 given our current order backlog. The Company expects the segment to achieve sales growth of roughly 5% in 2009.

Steel group sales for the quarter were $135 million, down 74% from a year ago. The change was driven by lower volume of approximately 40%, with the greatest declines in the energy, service center and automotive sectors. Raw material surcharges accounted for the other 35% reduction, due to declining material costs.

Steel group EBIT for the quarter was a loss of $33 million or 24.4% of sales, down approximately $115 million from last year. The decline in earnings resulted from lower demand and underutilization of manufacturing capacity, totaling roughly $125 million. Lower surcharges of approximately $180 million were essentially offset by raw material costs improving $150 million, and a favorable change in LIFO of about $30 million. The Company also benefited from its cost reduction initiatives. The Company expects Steel group sales to be down approximately 60% to 65% in 2009, due equally to lower demand and surcharges.

The Company continues to maintain a strong balance sheet with ample liquidity. We ended the quarter with net debt of $315 million, 175 million lower than the end of last year. As a result, the Company's leverage of net debt to capital decreased to 16.5% from 22.8% at the end of 2008. The Company's liquidity at the end of the quarter was approximately $1.1 billion, which included $277 million in cash, approximately $535 million of unutilized committed credit facilities and $300 million of unutilized on-demand credit facilities.

Earlier this month, the Company entered into a new $500 million unsecured senior credit facility, replacing the Company's previous facility, which was set to expire in June of next year. The new facility matures in July of 2012. The Company also plans to refinance its $250 million of public bonds in advance of their February 2010 maturity.

Free cash flow for the quarter was approximately $190 million. Operating activities generated $220 million in cash, primarily reflecting the Company's actions to reduce inventory. Partially offsetting this was capital expenditures of $21 million and dividends of $9 million, both of which were reduced from last year's level.

With regard to the sale of the Needle Roller Bearing business, the Company expects to complete this transaction by the end of the year. However, beginning with the third quarter, results for this business will be treated as discontinued operations, and therefore prior reporting periods will be adjusted.

For the first six months of 2009, sales were approximately $185 million. Cash proceeds from the sale of approximately $330 million will be used for general corporate purposes, including pension contributions and strategic investments. The current book value of the business is approximately $385 million.

In summary, the Company's outlook reflects continued weak markets that are expected to trough in the third quarter of 2009. Given the degree of uncertainty of the global economic environment, we have widened the range of our expected earnings outlook. Timken expects earnings per share for 2009, excluding special items, to be a loss ranging from $0.40 to $0.90 per share. This estimate includes the Needle Roller Bearing business.

As noted earlier, we anticipate lower year over year sales across all of our business segments with the exception of aerospace and defense. The decline in sales is expected to be driven by lower volume and surcharges. The Company will continue to take actions to mitigate the negative effect of its weak end markets. The Company expects to generate strong free cash flow in 2009 of over $100 million, driven by lower working capital. This cash flow is after investing approximately $135 million in capital programs, $70 million in severance, $45 million in dividends, and $25 million in pension contributions. As in prior years, the Company will consider making additional contributions to its pension plans in excess of its minimum requirements by the end of the year.

Despite the challenging economy, the Company continues to maintain a strong balance sheet with ample liquidity. This ends our formal remarks, and now we'll be happy to answer any questions that you have.

(Operator Instructions). Your first question comes from Eli Lustgarten with Longbow Securities.

Good morning.

Good morning.

Hey, everyone. Can you talk -- obviously the question -- you're going to treat Needle Bearing as a discontinued operation. You gave us a value of $185 million. Do you have any -- can you quantify the magnitude of the loss that we're seeing, or how much of the mobile loss is coming from that? Then how much is that -- would you have that in your forecast for the second half of the year, that $0.40 to $0.90?

Eli, the -- one, the Needle Roller Bearing business is included in the forecast that we have for the full year; and as you know, it's -- the contemplated sale would be -- call it by the end of this year.

We've not quantified the losses associated with the business at this time. When we report our third quarter results, we will do pro forma looking backwards, so you'll be able to see the sales as well -- actually the earnings -- or negative earnings in the case of this -- when we show that as a discontinued operation.

Was this a greater portion of the -- a majority portion of the loss reported by mobile directly related to the Needle Bearing business? Is that fair?

All I guess we're prepared to say at this time is this clearly was a big impact in the performance of the mobile group.

And a follow-up, your second half guidance shows weaker volumes across the board, particularly in process and even aerospace by a moment, because (inaudible) almost close to nothing. It will only be up 5% when you are up versus the first half. Can you talk a little bit about the margin impact we can expect from the lower volumes across these businesses, and particularly in process and in aerospace? And are the steel losses that we are seeing in the first half -- in the second quarter -- likely to continue in the third and fourth quarter? Is that the basis of the forecast?

Yes, Eli, this is Mike. Let me just take you through the three business segments, then I'll turn it over to Sal on the Steel side. If you look at aerospace, what we're seeing in aerospace right now is quite interesting. We come out of the second quarter with really record sales and record profits for that business. We've talked about the strength of the defense side, and in particular Rotorcraft on the defense side of that business. That's been good; it's been a good mix for us as a business, and the overall transformation of our move towards the after-market has been good overall.

However, remember as part of the aerospace business, there's also a component that we call Health & Positioning Control, and a lot of it has to do with even consumer demand. So that has shown weakness. The civil aerospace side and the fixed wing has shown weakness. And although defense is holding, what we're seeing right now is a little bit of weakness coming into the second half; but overall the performance of the aerospace business is staying pretty solid for the year, and of course will be up year on year. So that's still a pretty good story.

In addition to the markets remaining favorable to that business, we've also been driving cost reductions throughout that business very consistent with the rest of the Company. So that's improved the performance of the business, as well as the pricing remaining strong.

You expect to hold margins in that business, I guess?

I'm sorry, Eli?

Do you expect to hold margins in the aerospace business the second half?

Yes. They will be relatively flat. The process --

Second quarter or last year?

Towards second quarter.

Okay, okay.

So we're going to see just that little bit of weakness, both from the standpoint of the topside; and then obviously, the cost cutting impact is going to offset some of that volume reduction, et cetera. So I think we'll see a little bit of weakness on the topside, and relatively small impact on the margin side.

Yes.

If you go to Process Industries, it's a different story. There we've got markets that are still declining. In fact, we're seeing a combination of continued decline in those markets. And I'll say on a global basis, but I'll come back and maybe talk a couple comments as to how that looks geographically, but we're seeing a combination of weak markets, plus still some destocking going on with that customer base, both in the OE perspective and the distribution perspective.

The bright side to that is our Asian markets, the China market in particular, is still strong for us. Year on year, we're up in China in Process Industries, and so that's good overall. And that's been part of our strategic move with regards to the investments that we've made over the years, and so we're continuing to see some positive there.

Like aerospace, cost-cutting has been successful in maintaining reasonable margins in that business with such a significant decline in volume that we're seeing. So overall, pretty good performance to the bottom line; just trying to maintain those margins while we go through this significant reduction in the marketplace. But again, still seeing some decline; and the second quarter, we did not see the bottom yet on that side of the market.

Yes. I mean, what you're saying is the volume goes down more in the third and fourth quarter than the second. Can you hold margins anywhere near where you are today with the much lower volume?

It's going to be a little tough on the Process Industries side, because some of that is going to come out of the distribution channels as they continue to destock. So there's a little bit of a mix change that will happen in the Process Industries side.

Okay, thank you.

Okay.

And mobile?

Mobile is -- again, it's a mix. As Glenn and Jim talked about, the light vehicle side, we've actually seen the bottom in Q2, and we are seeing a pick up in orders across the world. Some of that is driven by the Cash for Clunkers first starting in Europe and now in the US. But we are seeing an uptick in the volume that will be positive, at least to contribution, and in our manufacturing facilities.

The rest of the mobile side of the business is actually still in somewhat of a declining mode. So when you begin to look at the off-highway equipment, heavy truck and the rail industries, still troubling markets, still with some declines coming through. So overall, we'll see some pressure on the top line for mobile the remainder of the year.

So a little bit of a mix, again, inside of that. Significant cost cutting; pricing still remaining relatively strong, consistent with what we said in the past. So it's kind of a synopsis of the three businesses.

Will the margins -- can margins improve somewhat? Or the loss is somewhat improved in the second half of the year, or is it still pretty much similar to the second half as the first half?

Pretty similar, maybe slightly down.

And steel?

Good morning, Eli. This is Sal. You pretty much called it when you asked about steel. We're going to see -- we believe we're going to see a weak second half. The only market that we have that has any life to it right now, just as Mike described, is the automotive areas where the plants have begun to restart, and they had begun their destocking the middle of last year.

All of the rest of our markets, we're just seeing them very weak; and some of our most attractive ones are very, very slow. Oil and gas, as an example, there's just -- with natural gas prices as they are today, all drilling has stopped, and that's what we serve. So we're seeing the second half to stay low, for the most part duplicating what we're seeing now -- or maybe just slightly better, but not with any strength whatsoever.

Thank you. I guess I'll let somebody else go.

Your next question comes from Steve Volkman with Jefferies.

Hi, good morning.

Good morning.

Good morning.

Could I get a sense, maybe Jim, on all of the cost cutting that you guys have been doing -- the headcount reductions and so forth? How much of that do you think is kind of permanent versus sizing the business for what's obviously a weak environment?

It kind of depends on what you think the forecast is going to be for next year. What we've tried to do, Steve, is the same thing we did back in the early part of the decade, taking advantage of a market to shift our profile; at the same time, structuring the Company for what we see as the future.

As we went through the S&A part of that, we looked at that as being basically permanent, downsizing the organization to deal with what we believe the market will be over the next two or three years.

When you then get into manufacturing, there's a mix. Because for example, we've taken the significant cuts in some of our higher cost plants that won't come back; while on the other hand, we've taken cuts in our lower cost plants that are simply taking out variable costs. I don't know how you translate that in terms of actual numbers of people or percentages of people within that. Does that give you a little color?

Yes, I guess that's helpful. Do you have a feeling about what your incremental margins are going to look like once production can start to recover?

My sense of that is obviously with that fixed cost structure down, you're going to see a more rapid rise in margins. Trying to put a percent on it requires you to forecast which markets are going to come back in which order, because there's such a dramatic mix issue between the different markets we deal with. It's the same thing Mike was talking about in Process Industries, now OE versus distribution. So I don't know how to give you a number that allows to you model that at a macro level.

Okay, that's fair. Obviously, things are tough here. How about maybe I ask it slightly differently? Do you -- would you be willing to think about what sort of normal mid-cycle margins would look like in each of the segments under the new cost structure?

I don't know how I would give you a number that would help you in that. Glenn, do you want to --

No. Again, you have to paint the -- sculpt the macro environment that we'd be operating in, which end markets would be affected. But as Jim said, we've taken structural costs out. So this isn't just variable to deal with just declining volumes. So as we come through the recession and we see our end markets, we should be leveraging better relative to the declining leverage that we've seen. And in fact, for the first half of this year, we've dropped probably around $0.24 per sales dollar.

Obviously, we have volumes that are down. We have the capacity issue of being so unabsorbed, and we're managing that through the pricing. But the biggest piece is through this cost reduction. We've taken S&A significantly down, as well as just obviously all of the operatives within the manufacturing plant. As volumes pick up, the variable costs will start to come back; but that structural S&A spending, which was a significant piece -- we targeted that $80 million, if you will, of structural S&A out of the Company -- that should not come back.

Steve, the other thing -- this is Mike -- to remember is, in the implementation of Project ONE, which is new business processes systems, capabilities, et cetera, we're also running this business with less cash. In fact, we're generating cash out of the business as a result of our ability to take that working capital down.

And when you try to forecast exactly what this business will look like, you have to think in terms of the structure reductions in S&A, the holding of pricing in the worst markets that we've seen in 50 years, and the fact that we're now able to run this business much leaner than we ever were. And that's a combination of Project ONE, but also a lean mentality all the way through the business in our manufacturing operations, et cetera.

Then you hang on that the movements that we've made with regards to our capacity and the changing of our manufacturing footprint and therefore structural costs over the years, provides a pretty good combination of attractive earnings obviously in the future as the markets recover.

Good, thanks. And then just a quick follow-up then. How much visibility do you think you have into your distributor at OE inventory levels? Not Company inventory levels, but customer inventory levels. And I'm trying to get a sense of if you have any view as to when you could simply stop underproducing and go back to kind of retail demands? So if we assume retail demand doesn't change at all, when can you start increasing your production so that you're not reducing inventory in the chain like we are now?

Well, there's -- this is Mike again. There's a couple of factors in that. One is, is what the distributors obviously use as a business model and the level of inventory that they want to carry on a normal basis. The destocking still continues in the distribution channels. So even if the level of their retail sales remained the same and their focus is on cash generation, then they will continue to destock, which obviously will impact our sales.

We do have good visibility. We do have the opportunity in most of our distribution channel across the world to see the actual sales of our products from them to the marketplace; then combining that with our sales to them, we can understand exactly what the inventory reductions are, and obviously also look at our own penetrations across the market. So we have relatively good visibility in the distribution channels.

The OE channels are a little bit tougher, right, because we're talking about tens of thousands of customers. From some of the major customers, you're able to see what their announcements would be publicly, and most of them still talk about inventory having to come out of their businesses, and no one is talking about significant increases in volume in their sales to their marketplace. So we're able to see it pretty well and estimate it, I think, across most of our markets relatively well.

So another couple of quarters maybe, and then they get their inventories where they want them? Or do we just not have a good sense of that?

Steve, I think if you go back to my comments -- again, you can't ask about the Company, you have to ask it about the segments. And at least our sense is -- and Mike reiterated this, Sal reiterated this -- in the light vehicle market, the inventory is pretty well out and we're producing pretty well to match demand. We've still got some inventory balancing ourselves to do.

In the industrial markets, it varies; and to Mike's comments, we have good visibility some places and others. The only thing -- the things I shared in my comments was in the mobile industries area that they are committing to us they're going to continue to reduce inventory the balance of the year. And then you get into some of the process areas and the energy market areas, it will be well into 2010 before we see that demand come back to balance. How far that is, we don't know.

Okay. Thanks very much.

Give you -- oh, never mind.

I'll listen if you've got more to say.

That's fine.

All right, thank you.

Your next question comes from Andrew Obin with Bank of America.

Yes, hi. How are you? Just a couple of questions post the automotive divestiture. First, in terms of the pension funding, are you going to maintain pension liabilities, or are those going to go to the buyer?

It varies by geography; but effectively, we're going to maintain the pensions for the already retired. And -- with the exception, I guess, over in Europe with Germany, effectively, the buyer will just take the active people going forward.

Because most --

We are retaining certain liabilities.

Because most of the liabilities are in the US, right?

We actually have a fair amount over in Europe, and to a lesser extent over in Asia. But effectively, we are keeping the North American in particular pension liabilities.

Okay, but some of the liabilities will go away, right?

Correct.

Okay. And just in terms of capital redeployment, I know it's too early to talk about it; but all of a sudden you guys are going to have virtually no net debt going into next year in an environment where evaluations are still very attractive. And if you could just talk strategically where you're thinking on taking the Company, and also how does pension funding in 2010 figures into that?

Let me at least take the first cut of it. Right now in this current environment, obviously liquidity and cash is a good thing given all the uncertainties that are out there; but with the completion of the sale of this at the end of the year, that obviously will add another, call it $330 million-ish of cash for us.

We do have still sizable unfunded pension obligations. We ended last year around $850 million; and so clearly, some of the proceeds will probably be allocated to shoring that up. And in the past, what we've done is put in more than the minimums required each year. So we'll make that assessment at the end of the year, how much more than the minimums that we would put that that.

But clearly, we'll evaluate other uses. Obviously in selling those assets, we're looking to redeploy it in more attractive, industrial markets with good after-market positions. So we continue to be very active in looking at strategic opportunities to redeploy that capital whether it be this year, next year or there after. But we continue to be very active on that front.

Generally, your areas of strategic growth were sort of international, more emerging market -- aerospace, wind. Is that the right direction that I'm thinking?

It's been the heavy industries. It's been Asia. It's been the distribution markets, and it's clearly been aerospace, both organic and inorganic.

And just if you could give a little more color, and I know you -- thank you very much for a lot of color when you were answering Eli's question -- but some of the companies, some of the OEMs made comments about orders starting to maybe pick up a little bit in June, production stabilizing in June a little bit. Have you seen any of that, or it's just -- there's this disconnect and they are still just talking. Any good news in June?

I'll say it for the third time. I think, Andrew, in the automotive segment, we've seen a pick up in orders. We're seeing the inventory coming out of the system and we're seeing it on both the steel side and the bearing side. We're seeing it in North America and Europe. It's slight, but we're beginning to see it happen. On the heavier industrial side, we have not seen that turn happen in the June orders.

Okay. Thank you very much.

Your next question comes from David Raso with ISI.

Hi, good morning. First question on steel. Just so I understand, there was a $345 million revenue decline year-over-year, and $180 million of it was the lower surcharge. So basically, $165 million kind of core decline.

And then when you look at the related hits to the earnings that were from the lower demand and underutilization, it's noted as $125 million. Sal, am I understanding that right? On a $165 million of revenue decline there would be a profit hit of $125 million? Is it that big an incremental margin?

I don't think you've got the numbers added correctly there, David. But let me just give you some of the sense of why it is leveraged in a negative way worse than you would otherwise expected. We were shipping much more than we were making. We were draining inventory. So we had a very high cost inventory because of the inflated value of the raw materials we had had from last year that we continued to flow through and ship, which were negatively impacting our earnings.

We were not melting at the rate that we were doing shipping, so we had an extreme unabsorbed condition associated with it. And we were upside down on the surcharge mechanisms, where that high cost of materials and the surcharge mechanism were flipped.

So when you put that all together, it's very difficult to try to project anything structurally about what we've got and how we've performed. There are just a lot of distortions that are in the numbers as we see it now with the huge and rapid decline in our sales volume in that period.

Have we worked through most of the high cost inventory you'd say at this stage, where if I run similar analysis on the core revenue declines the next couple quarters, should I see a lot less of a drag on that core decrimental margin?

It has been decreasing, but we actually expect that we will see a continuation of the effect of that into probably the September-ish time frame. But it all depends on how orders go, Dave, just because of the dependence on that flow to what the customers will want in the way of shipments at this time.

And any insight on the mix going forward of -- say it is a little auto, say truck picks up a little bit, versus some of the heavier industries still being weak. How does that impact your profitability, Sal?

Well, the coverage we're going to get from the improvement in the automotive sales will be positive form an unabsorbed point of view. But frankly, the remainder of our markets -- we have not yet seen them stop their decline, with just modest demand coming from them, and they do reflect some of our better margin products. The energy arena, in particular, is very weak. As you know, where oil prices in particularly natural gas prices are, there's just no drilling going on; and so we've seen a dramatic fall off in shipments in that line. And that's an important product for us.

Our distributors, that's a wild card call. The distributors are at the lowest inventory levels they've ever been. Now, these are our service centers, not the bearing distributors that Mike was speaking of a little bit earlier.

And they're all -- they believe that they're about ready to start ordering again, but they're not ordering until they see demand coming from their smaller customers, and we haven't seen that happen yet either. So that's a wild card in all of this. We expect that they will be our first signal that things are starting to get better, but they haven't yet.

And last question, on the business being sold, if I think of trying to handicap the size of the loss and just -- obviously for modeling purpose, we're going to have to make some assumption -- the remaining facilities serving the remaining end markets that you're still going to serve, is there any implication from these factories that are being sold when it comes to maybe some sense of overhead absorption that maybe if you try to do some cost allocation -- sure, they were losing money, but they were also helping out the margins in other end markets, some kind of shared cost issue, overhead absorption issue. How should I think about what's being sold, the ramifications on the remaining businesses? You know, shared plants, shared overhead, whatever it may be.

David, this is -- while it's been a very integrated business as part of the Company, one of the issues about this business is that it was separable. So effectively the plants that are manufacturing the needles are going; so to the extent that there's unabsorption within those plants, they go. But as far as servicing other parts of our business, it's fairly self-contained so that what is left with us is just what's serving our current needs.

Okay, so Jim, some of our conversations about some shared technologies, it's not as easy as you would think to sell off some of these assets? This was a fairly separate piece we could sell off without implications on the remaining piece? Is that a fair way to summarize it?

That is correct. That is correct.

All right. I appreciate it. Thank you.

And David, just one last thing, just to make sure the numbers work. With the decline in steel's sales of around $380 million-ish, we've got volume down around, call it, $210 million and the surcharge down around $180 million. So the impact of that volume and manufacturing costs are relative to, again, a bigger volume decline than I think you were using.

Okay. I was doing that maybe pre-intersegment. I have it down $345 million, $474 million, sell the $129 million.

Then the $125 million probably wouldn't be applicable.

Okay, terrific. That's helpful. Thank you.

Your next question comes from Mark Parr with KeyBanc Capital Markets.

Hey, thanks. Good morning.

Good morning.

Hey, couple of questions. I don't think this was in the release, but can you give some color on lower of cost to market, the magnitude of that for the quarter?

When you say lower of cost of market, you've got to explain.

It would be like an inventory charge. Sal had talked about high raw material costs. Some of the other companies have been characterizing this, or talking about it separately as a lower cost of market hits.

Oh, you mean revaluing inventory based on market?

Yes.

Yes. We didn't do any of that.

Okay. So there was none of that. And then I had another question. Could you talk a little about the contribution opportunity out of China? I mean, how big is it from a revenue perspective approximately, and what's the -- that's a growing operation. What's your return on capital, return on sales. associated with the Chinese operation?

Yes, Mark. This is Mike. Obviously we don't --

Hi, Mike.

Obviously we don't -- I don't -- we don't segment that out and report those earnings separately. But we've always talked in terms of the investment we've made in order to grow China. The returns on that are in excess of our costs of capital. That's proven out. These investments have been good. China does continue to grow for us. It's obviously becoming a bigger part of the Timken Company. And especially during this market, while the rest of the world is shrinking, China in our targeted markets continues to grow. We actually see some weakness in China on various parts of our business -- the mobile side, even the steel side. But the Process Industries side and now our investments in aerospace manufacturing and part supply in China in particular has shown growth year on year. And we forecast that to continue, even in light of the current global recession.

Okay. Have you ever quantified the magnitude of the investment that you've made in China?

No, Mark, we haven't. We would say, though, right now -- and again, it's just because we're in an unusual market -- Asia represents around 11% of our sales and the biggest piece of that's going to be over in China. And as Mike said, we've made a lot of investments there that are very attractive, given their very industrial focused -- some of their larger products for wind.

Obviously, we're sitting on some excess capacity now that's obviously impacting their results as well. Plus, we still export out of China. So as we continue to grow into China as well, we're still exporting out. And given what's going on in Europe in particular, that's having a negative impact on our absorption. But from a long-term strategy, a long-term return on invested capital, that's an area that we continue to be very excited about.

Okay. I just want to shift gears a little bit to the divestiture that you're in the process of concluding. Can you give me some idea of what percentage of the assets involved here were related to the Torrington acquisition back in late '02 or early '03.?

Effectively 100% of the assets came to us with the Torrington acquisition. Obviously it's not 100% of the Torrington acquisition. It is the part that specifically manufactured needle bearings.

And that was my next question, Jim. I was wondering if you could give us what percentage of the Torrington Company were those needle bearing assets from a revenue perspective, I guess?

When we acquired Torrington, we would have said that it was about half needle and half industrial. Now, obviously, those balances have changed over time, and we have so integrated it with the rest of the Company that it's no longer reflective. But that gives you a feel.

Okay. I thought the needle was a little bit bigger piece of Torrington; but that's okay, we're in the same ballpark. And just, I guess, the -- this was -- again, going back to '02 -- and I realize it's seven years ago, so it's a long time. Maybe 6.5 years ago. But I mean, this was something that was talked about as a major enhancement for the Timken Company, product diversification, opportunities for cross-selling, opportunities for geographic expansion. And it was really -- I realize you're not selling all of it here, but could you give us kind of a -- maybe -- I don't know if you want to give us like a report card, or like -- this seems like a fairly meaningful shift in strategic direction for the Company, and I'd really be interested in your comments and your color around this change in your feeling about the needle bearing business.

I think --

Is that -- I mean, is that fair? Am I -- is that a fair question, I guess?

Yes. It's a fair question.

Okay.

And I'll give you two answers to it. When you look at the Process Industries group and the margins, which were very high teens even in a bad first half of the year market, the Torrington acquisition was the facilitation of us creating a Process Industries group; because in that business, we needed a broad line, particularly of heavy industrial bearings, to be credible -- and as Mike says so regularly, in the after-market segment, in that market.

Okay.

And so it was a great success from that point of view. The sale of the needle business is actually reflective of the strategy change that we talked to you about two years ago when we combined the automotive and industrial businesses and created the mobile industries business, and we said our focus is on growing things that have after-markets, and that there was a big chunk of the mobile industry that didn't have an after-market. And it just takes time to complete the transactions associated with that change in strategy.

Okay. So this really isn't anything new. This is just kind of a continuation of the process that you've been going through over the last several years. Is that a fair way of thinking about it?

Yes, Mark. This is Mike. It's just one in a series of tactics that is taking us towards much more attractive markets. We talked a lot about where we were investing. I think there was an earlier question about that. We talked about China and aerospace and heavy industries and after-market. This obviously frees up resources and capabilities to go focus on those markets versus spending a lot of time fixing and/or debating exits from other markets. This was predominantly focused on the automotive industry, although some of these products did go into industrial markets, and we didn't see a way to make that equivalent to the other opportunities that we have.

So it's actually a perfect fit to the strategy that we've been talking about for several years now. I wish we could have talked about it earlier, but obviously this was a very confidential thing as we moved through it.

Right.

But this is something that we've been intending to do for quite some time.

Okay, all right. Thanks very much for that color. I really appreciate that. Thank you.

The next question comes from Chris [McRae] with Black Rock.

Hi, guys. Big day on this divestiture. Congratulations. I just wonder, in terms of further background, it was sort of all of our understanding that it was always difficult to separate auto from other businesses, and clearly in this transaction you've got one-third outside of auto. But maybe you could just speak to whether this business always had that ability to separate -- this specific business -- or whether you had to actually make some changes internally or operationally to enable that? And then I just have a follow-up on that.

Yes, Chris, this is Mike. When we acquired Torrington, we took the approach to integrate Torrington into the Timken Company, and therefore we integrated into the industrial group and automotive group, and they became fundamentally products and assets that operated within those businesses. So we integrated systems and engineering and supply chains, et cetera, that made it a little bit more difficult when we made the decision to finally exit a big piece. And Needles was one where at least the asset base was very separable. That provided a challenge for us, which we've really been going through over the last 12 months, as to how to separate the rest that had been integrated into the Timken Company so that it was a stand-alone business that somebody could purchase and run and let foster for the future.

The $185 million, six-month sales, can you give us any kind of compare to what a peak run rate of sales might have been, since presumably with two-thirds auto that's down hard?

Well, in 2008, we ran at about $620 million.

For the whole business?

For the entire needle bearing business.

Okay.

It's down in line with what kind of what our end markets are doing, down give or take around 40%.

Okay. Shifting to the steel business for one second, I guess if you get inventory relatively in line towards September, can we look forward to a fourth quarter where you might be selling any inventory that you produce inclusive of new pricing that might reflect the market which has been indicating a little bit firmer price in part to capture raw material increases? And given the complexity of this quarter in terms of looking at the actual numbers, can you give us a little more color on when we might report a little bit more of a normalized view? Would the fourth quarter be the time?

First of all, Chris, keep in mind that we still have -- we have contract business and we still have operational surcharge mechanisms. So the pricing as a consequence of raw material inflation will occur automatically in terms of our -- the transaction levels with our customers.

We feel a lot like you do. We hope that we're going to be moving more towards a cadence of producing what we ship as we move through the third quarter and move into the fourth quarter. And that's essentially what we're forecasting right now. We don't know that's going to happen. We don't know that the demand levels will stay there and we won't just continue to ship from inventories, but we've pretty much gotten to a plateau, unless demand really falls off and there's not much necessary after that. But we're looking -- that's exactly what our forecast incorporates.

And we believe in the fourth quarter we will get back to more normal surcharge levels, which is, I think, the other piece of your question.

Right. We think that the prices of raw materials -- they've taken a jump up. We don't think we're going to see the extreme volatility unless demand surges, in which case we will. But if it doesn't, we think we're simply going to see these higher raw material costs that will move in much less volatile ways as we get towards -- move towards the end of the year.

Okay, thanks much.

(Operator Instructions). Your next question comes from Rick Piper with Piper Group.

Am I on?

You're live.

Good morning, gentlemen.

Good morning.

Good morning.

We're all having to do things we never thought we would do in this challenging economy. My firm works in mergers and acquisitions, and you've put on hold a lot of your -- or I should say a lot. I don't know how many you have. But you have put on hold some proposed acquisitions. And one company that would open up a new market for you in the extreme bearing environment is one of those companies on hold, and do you feel you will proceed with the new acquisition, say, in the third quarter? Or do you think you'll wait until the Needle Bearing transaction closes before you resume looking at some proposed acquisitions? This would open up a new market in the extreme bearing environment for you.

I guess, Rick, first of all, obviously, we don't comment on acquisitions and divestitures that we've not announced. And clearly, we have not announced any other transactions other than the one that we have just announced, if you will, today.

Right.

So we commented earlier that we continue to look for strategic opportunities to improve the broad profile of the Company, and that will continue in the normal course. Thank you for your question.

Thank you, guys.

Your next question comes from Marty Pollock with NWQ Investment Management.

Yes. Hi, gentlemen. I guess one of the direct questions that perhaps wasn't asked, but with regard to the mobile -- sale of the Needle Bearing business, can you just make a broad comment on whether the losses you're keeping on the rest of automotive are actually more moderate than the ones that you perhaps would be selling? So I mean, can we get the color on whether you are actually still keeping a lot of those losses? And secondly, on the rest of Volvo, the non-automotive side, do you see trucks next year as some offset to whatever would be the continuation of the decline in highway and some of the other markets there?

I'll go ahead and take the fist part, and maybe have Mike talk on the latter. But as we mentioned earlier, Marty, we're not providing to the extent of the losses, if you will, that we've incurred within the Needle side of the business this year relative to other parts of the Company. What we will do is in the third quarter pro forma the results, so you'll be able to see specifically what the results of the Needle business was, as well as what the other pieces of the business. So we're trying to give you a flavor, at least relative to size, by providing sales. And we can walk you through a little bit of where each of the three segments within the bearing and transmission group, where Needles fit in there; but relative to profitability, we'll hold off on that until we put out our third quarter results -- or 8-K financials maybe before then.

I guess just before you answer on the trucks side of that question, the rest of the mobile. Strategically, what you might still retain in automotive, you're comfortable that you're well positioned there to the sense you continue to see the benefit of more leverage pricing and everything. So in other words, just some color on the comfort level of what you still will retain. You feel good about that on a relative basis?

Yes, Marty, this is Mike. Let me just take it. The process hasn't changed. We are evaluating the entire mobile industries group -- the markets, et cetera, the products that we have, We will continue to look at this very much as a fixer exit where we, in fact, can leverage improved pricing on the value that we, in fact, create in the marketplace. It fits with our strategies such that there is opportunities to create after-market businesses, et cetera. These are things that we will invest in. If we come to the conclusion that the remainder of the market does not provide those opportunities, then we'll look at opportunities to either divest, restructure, whatever it might be. So this is just, again, one piece of that overall strategy that we talked about over the last sort of year and a half, and that will continue on. But it'll be putting those markets and our business and value creation under the microscope on an ongoing basis.

So is this -- yes?

This is Sal. For the steel business, we've always enjoyed automotive business. It's been very, very attractive for us. We have made an asset investment just last year. Unfortunately, the market did kind of crash on us; but in fact, the product styles that will be adopted as a consequence of the things that caused that are very well suited to our small bar mill. So we want to say that auto is not a four-letter word with us. We're very happy with it. It's just a matter of how much we have.

And if you want to again, just on the heavy -- I guess heavy and medium truck, that segment of the market looking into next year, is that likely to be off of -- I mean, would that market look better next year? Clearly, we're seeing truck markets right now in an extreme weakness, and whether you've got next year a recovery on the pre-buy. Is that likely to be something at least that could offset some other weaknesses outside of the automotive area?

Marty, I think it's too early to tell on 2010 at this point. You're correct that those markets have been down 50 to 75% across the world -- again, depending upon geography. It's just too early to tell on any kind of recovery in 2010.

Thank you.

Yes.

I'll now turn the call back over to Timken for any closing remarks.

Okay, thank you very much. Obviously, these are challenging times due to the continuing weakness in our core markets. We're confident we're making the right structural move,s both tactical and strategic, to position the Company for improved long-term profitability. We look forward to meeting with you again when our results reflect the benefit of the actions that we're taking. Thank you.

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