Timken Co (TKR) 2009 Q3 法說會逐字稿

Good morning. My name is Chastity and I will be your conference operator today. At this time, I would like to welcome everyone to The Timken's earnings release conference call. (Operator Instructions). Thank you. Mr. Tschiegg, you may begin your conference.

Thank, you and welcome to our third-quarter 2009 teleconference 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, Variance Power Transmission group; and Sal Miraglia, President of our Steel group. We have remarks this morning from Jim and Glenn, and we'll then all be available for Q&A. At that time, we'll ask you 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 on 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 investors 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. As you've seen from our earnings release, Timken delivered improved performance in the third quarter, compared with the previous quarter.

Our cost-reduction programs have taken hold. As a result, our earnings, while only $0.05 a share on an adjusted basis, improved over the second quarter. Moreover, we continued to generate excellent cash flow, leveraging our Project ONE capabilities to reduce inventories by $100 million and generate $135 million in free cash flow this quarter.

These results are significantly better than we anticipated when we revised our outlook at the end of the second quarter. This improvement in Timken's performance is a result of our aggressive management plan, rather than an upturn in the economy. While we did see some increased volume in mobile industries, it was offset by reductions in other areas, leaving volume essentially flat compared with the second quarter.

We are realizing the benefits of our long-term strategy to optimize the Company's performance, and position it to grow in more diversified industrial markets. We've leveraged the recession to accelerate the implementation of this strategy. An example is the pending sale of the needle roller business, which is recorded in the earnings this quarter as discontinued operations.

This strategic divestiture will improve the mix of markets in which the Company will compete in the future.

The biggest impact on the third-quarter results is from continued cost reductions and the focus we've had on repricing our products over the past two years. This year, we've reduce our employment by about 25%, or 6,300 people, right-sizing the company to deal with the realities of today's market. Our SG&A spending is down $160 million compared with the first nine months of 2008.

These changes are resulting in improvements in operating efficiency, and more importantly, have been made in a manner that will allow us to ramp up production with lower fixed costs as the economy recovers.

We have reduced inventories over $300 million so far this year. We have used some of the resultant cash to fund our restructuring, put more than the required amount into our pension fund, and have reduced our net debt to $170 million, or about 10% of capital.

We completed two financings this quarter, which, along with our strong cash flow, further strengthen our balance sheet, providing excellent liquidity. In July, we negotiated a new $500 million credit line, and in September, we sold $250 million in bonds at attractive interest rates.

In addition, in September we positioned the Company for additional growth in Asia with the announcement of a strategic alliance with Japan's Daido Steel that will broaden our capability to offer highly-engineered steel products in the region.

We also announced plans to consolidate our North American logistics facilities to a new location. This marks another step in our efforts to streamline the supply chain for our products, improving customer service while providing opportunities for further inventory reductions.

And we recently announced a tentative agreement with the United Steelworkers of America, covering our operations in Canton, Ohio, which would improve the long-term competitive position of our steel business. The contract vote is scheduled for November 1.

We are on track to deliver our other major initiatives, including the separation of our needle business to support the closing -- to support closing the sale to JTech at year end; construction of a new wind energy joint venture in Xiangtan, China; and the final wave of the implementation of our Project ONE platform, which is streamlining our business processes.

While I'm not happy with the absolute level of our profitability, I'm extremely pleased with the level of execution underway throughout the Company and even more pleased to report that the actions we have taken put the Company on a solid base to face the future.

Our broad market participation exposes us to a wide variety of markets, and their impact on us varies. Like vehicles or automotive markets, we had been in decline since the beginning of 2008, have improved as Chrysler and GM have emerged from bankruptcy, and the government incentive programs have caused automakers in the United States and the U.S. to increase production.

Heavy truck and construction equipment markets continue to be weak. We have seen spot orders as customers begin to fill holes in their inventories. But we have yet to see any real increase in demand.

Heavy industry, oil and gas drilling, and distribution customers are continuing to draw down inventories, awaiting an upturn in demand. In those sectors, we expect to see destocking continue into 2010.

Aerospace markets show weakness associated with the drop in commercial flights and general aviation. However, defense demand, especially surrounding helicopters, continues at strong levels.

The notable exception to these trends is China, where strong stimulus spending has supported continued economic growth. We're seeing this in direct demand for our products in China and indirectly in the economies that provide the raw materials for that growth.

At this point in the cycle, we are preparing for a slow, gradual economic recovery, but have in place the capability to respond if demand rises more rapidly. Whatever the shape of the recovery, I'm confident that The Timken Company will meet it with the same strong execution that has characterized our performance this year.

Our talented and dedicated associates have taken aggressive action to serve customers in a highly unpredictable market and, at the same time, have made the changes necessary to transform our Company to position us for significantly improved performance for our shareholders, once demand improves.

Now Glenn will walk you through the details of our results for the quarter.

Thanks, Jim. For the third quarter, the Company incurred a loss of $0.52 per share. Excluding special items, earnings were $0.05 per share.

These special items totaled $55 million of after-tax expense, including a non-cash impairment charge of $25 million related to the needle roller bearing business. 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 and the results of the needle roller bearing business, which is accounted for as discontinued operations.

Sales for the third quarter were $764 million, a decrease of 43% from 2008. The decline was principally due to lower volume across most of the Company's end markets and the impact of lower steel surcharges, partially offset by improved pricing. Most of the Company's end markets were down, with the exception of automotive light vehicle and defense.

Gross profit margin for the quarter was 17.1%, down from 28.6% last year. The negative impact of lower volume and surcharges and less LIFO income was partially offset by cost-reduction initiatives, improved pricing, and lower material costs. The decline in surcharges primarily resulted from lower raw material prices compared to a year ago, which were at historically high levels.

In addition, the Company benefited from higher LIFO income a year ago, due to the dramatic decline in material costs at the end of the third quarter last year.

Given the declining markets, the Company continued to reduce SG&A expense. For the quarter, SG&A was $107 million, down $70 million from last year, while margins increased 80 basis points to 14%. The Company's previously-announced initiatives to reduce SG&A spending remain on track. As a result, EBIT for the quarter came in at $22 million, or 2.9% of sales.

Net interest expense for the quarter was $10 million, comparable to last year, reflecting lower debt levels offset by higher borrowing costs. The tax rate for the quarter was 33.5%, unchanged from a year ago, but higher than our 28% previous estimate, primarily due to improved earnings in higher tax-rate jurisdictions. For 2009, we expect to maintain the year-to-date rate of 33.5%.

As a result, income from continuing operations for the quarter was $7.5 million, or $0.08 per share, compared to earnings of $1.34 per share last year. While we expected that the third quarter would be the trough period for 2009, results exceeded second quarter, due primarily to increased automotive light vehicle demand, driven in part by consumer stimulus programs and improved manufacturing capacity utilization.

Now I will review our business segment performance. Mobile industry sales for the quarter were $328 million, down 23% from a year ago. The decline was driven by lower demand in the off-highway, heavy truck, and rail market sectors, partially offset by improved pricing and stronger automotive light vehicle demand.

For the quarter, mobile industries EBIT was $14 million, an improvement of $5 million compared to last year. Margins for the quarter were 4.2% of sales, an increase of 220 basis points from a year ago. The improvement was driven by pricing and cost-reduction initiatives, which were partially offset by lower demand and manufacturing capacity underutilization.

Mobile industry sales for the year are expected to be down approximately 30% to 35%, driven by lower demand across all of its end markets. Seasonal industry shutdowns and the wind-down of consumer stimulus programs are expected to have a negative impact on fourth-quarter demand and manufacturing capacity utilization.

Process industry sales for the quarter were $187 million, down 41% from a year ago. The decline was driven by lower demand across its original equipment market sectors, especially gear drive, metals, aggregate, and wind energy. A similar decline was experienced in its distribution channels. Partially offsetting this lower demand was improved pricing.

For the quarter, process industries EBIT was $16 million, down $57 million from a year ago. EBIT margins were 8.6% of sales, compared to 23.1% last year. Earnings were impacted by lower volume and mix, partially offset by pricing and cost-reduction initiatives.

Process industry sales are expected to be down by roughly 30% to 35% in 2009, across its broad industrial end markets, with the greatest declines in the heavy industrial equipment and energy sectors. While lower demand is anticipated in the fourth quarter, earnings are expected to improve, primarily from favorable mix and cost-reduction initiatives.

Aerospace and defense sales for the quarter were $100 million, down 4% from a year ago, driven by lower demand across the commercial and civil aerospace markets, partially offset by favorable pricing and acquisition. EBIT for the quarter was $19 million, up $9 million from a year ago, with margins at 19.1% of sales, 970 basis points higher than last year. Improved earnings resulted from the benefit of pricing and cost-reduction initiatives.

The Company expects this segment to achieve modest sales growth in 2009, benefiting from continued strength in the defense sector and the acquisition of [x tex], partially offset by weaker demand in civil and commercial markets.

Steel group sales for the quarter were $158 million, down 71% from a year ago. The change was driven by lower shipped tons of approximately 53%, with the greatest declines in the industrial and energy sectors. In addition, surcharges were down approximately $215 million, due to lower raw material and energy prices.

Steel group EBIT for the quarter was a loss of $20 million, or $154 million lower than last year. The decline resulted from lower demand and underutilization of manufacturing capacity, which affected EBIT by roughly $100 million. Lower surcharges and reduced LIFO income were partially offset by lower raw material and energy costs and cost-reduction initiatives.

The decline in third-quarter earnings performance relative to a year ago was driven in part by the timing of surcharges and LIFO in the second half of 2008. Historically high scrap prices in the third quarter of 2008 resulted in significantly high surcharges and LIFO income. As a result, third quarter 2009 compares unfavorably to 2008's third quarter for surcharges and LIFO.

The dramatic decline in scrap prices in the fourth quarter of 2008 resulted in significantly reduced surcharges and generated LIFO expense. As a result, the Company expects to have favorable surcharge and LIFO income in the fourth quarter of 2009, compared to the fourth quarter last year. The Company expects steel group sales to be down approximately 60% to 65% in 2009, due to lower demand and surcharges.

The Company continues to strengthen its balance sheet and maintain ample liquidity. We ended the quarter with net debt of $170 million, $320 million lower than the end of last year, primarily due to strong free cash flow. As a result, the Company's leverage of net debt to capital decreased to 9.6%, from 22.8% at the end of 2008.

During the quarter, the Company completed a five-year, $250 million, 6% Senior Notes offering. The proceeds will be used to repay the Company's 5.75% notes that are due in February.

The Company also entered into a new three-year, $500 million unsecured senior credit facility, replacing the Company's previous facility, which was set to expire in June 2010.

Free cash flow for the quarter was approximately $135 million. Operating activities generated $170 million in cash, primarily reflecting the Company's actions to reduce inventory. Partially offsetting this was capital expenditures of $28 million and dividends of $8 million, both of which were reduced from last year's level.

In summary, the Company's outlook reflects continued weak markets. 2009 sales from continuing operations are expected to range between $3 billion and $3.3 billion, down approximately 35% to 40% from the prior year, due to weak demand across most end markets and lower surcharges.

The Company raised its earnings per share estimate for 2009, including discontinued operations and excluding special items, to be a loss ranging from $0.10 to $0.30 per share. This compares with its prior estimate of a loss of $0.40 to $0.90 per share. This improvement primarily reflects stronger third-quarter performance and an improved fourth-quarter outlook.

The Company expects to generate strong free cash flow in 2009 comparable to last year's record $230 million, driven by lower working capital. This cash flow is after investing approximately $125 million in capital programs and $65 million in pension contributions, of which $50 million is discretionary.

In addition, the Company remains on schedule to complete the $330 million divestiture of its needle roller bearing business by year end.

This ends our formal remarks, and we'll now answer any questions.

(Operator Instructions). Eli Lustgarten, Longbow Research.

With so many conference calls, I may not have done it right, but just -- the implication that you're having in the fourth quarter is sort of a breakeven -- a slight profit to -- it looks like you could lose $0.15 or $0.20. I'm assuming that discontinued in the fourth quarter looks like the third quarter. Or something like that. So you're sort of saving a couple of pennies to a loss.

Can you give us what generates such a weaker quarter in the fourth quarter compared to the third quarter going on, and as part of that, can we talk about are the margins in aerospace sustainable? Are they not? And how much better will they get in process, just what's going on corporate wise.

Let me give you kind of the high-level view, and then ask Mike to speak specifically to the issue.

But fourth quarter compared to the third quarter is really a function of our outlook on what's going to happen from a seasonal shutdown basis, as well as the potential impact from the (multiple speakers) wind-down, if you will, of the stimulus programs.

With regard to the needle business, if you will, our expectation similar is that we would expect that to be down a bit in the fourth quarter as well because of the same issues, since the needles, if you will, most of that is still focused within the automotive OE. The extent that there is that seasonal shutdown within the automotive customers and that wind-down will affect them as well.

But overall, the other areas of the business, if you will, plus or minus really won't see that decline, with the potential exception of process, but again, expect to see improved profitability there, despite those markets continuing to slow down a bit. But Mike, you may want to provide some color.

Yes, Eli, let me just walk through the segments with some color. If you look at the aerospace side of the business again, we are seeing the weakening from the commercial and the general aviation. We still see strong from a defense perspective, so overall that combination of mix has actually given us some revenue reduction, obviously quarter on quarter, of about 4%, and that's with the addition of some of the inorganic additions that we've had.

(Multiple speakers). The margins would be up in the high teens?

The margins will remain in the high teens. And now as we go into the fourth quarter, and again we think we will see probably some basically flat revenues going into that quarter, and then maybe a little pressure on the margin because, again, if you compare it to third quarter, third quarter was very strong on an annual basis.

But if you look at the first half of performance out of the aerospace business, we would expect that to continue and look a lot like the fourth quarter. Okay?

(Multiple speakers). Continue. I'm sorry.

Okay. If you look at mobile, as you would note, a very good third quarter. This is an area where we were down year on year big time with regards to revenue, down about $100 million, and yet we were up from an EBIT perspective.

So that was good, which is essentially the message that transformation is working. So the work that we've done with regards to cost reductions, selections of those markets that we believe we can compete in and add value, the pricing, the divestments, etc., that whole transformation is making good progress.

Our nervousness, though, in the fourth quarter is, as Glenn said, the seasonality of the automotive industry. And now with the Cash for Clunkers essentially gone across the world, that volume could be under pressure in the fourth quarter if in fact the industry takes the seasonal December shutdowns. So that's our biggest concern with regards to that industry, or with that segment.

Most of the other industries, from the off-highway heavy truck we actually saw a nice little kick in the third quarter from heavy truck. That should help us in 2010, but again it's a big kickoff of a very small level.

So overall there, pretty good, but a little dicey in the fourth quarter only because of the seasonality and our concern over Cash for Clunkers going away, and then the inventories in fact going up over the next month and a half, and then them taking a shutdown significantly around the holidays.

Do you expect to be profitable there or marginally profitable as a way to look at it?

You know, I would talk more in terms of breakeven.

Okay.

Then the process industry side -- the process industry side is still a very mixed market. We're beginning to see a lot of the original equipment manufacturers, those industries are basically bottoming, other than probably the producers of heavy steel equipment. So that big cast (multiple speakers) equipment is still a bit constrained.

The distribution side is still weak. They are still destocking. They are not seeing the sales. You can see that in the industry, so we're getting both the reduction with regards to our sales to our distributors in those industrial markets, in addition to that destocking. It's a worse mix for us.

So the margins came under pressure in the third quarter, both from the volume perspective of being down 41% quarter on quarter, and then in fact the mix being worse than what we might have projected earlier on.

We do see a recovery of that margin in the fourth quarter. That's more a reflection of probably some one-time things going on between the quarters, but we see a recovery of those margins at least in the fourth quarter.

You expect margins in the low to mid teens in there after this point?

That would be a pretty good number.

And you expect that to be -- that's sort of the new norm looking into next year until markets volumes recover?

Until those volumes recover, again the pricing has been good. The cost control and the cash generation has been very good. And our focus on those markets, especially as we look at Asia, our growth has continued with regards to process industries in China. Not all of China has strengthened, but with respect to where we have been focused on has been good.

So there is still some real positives with regards to process industries, but the Western world is still very, very weak in that mix, so when the distributors start buying again we'll get an uptick with regards to our margins.

And as far as a steel? Can steel be profitable in the fourth quarter?

I think I'd talk more about breakeven as well, Eli. We -- you heard how much our sales were down. Our shipments are comparable to that, but more importantly, our melting rates are even lower, as we have been doing the same process of taking inventory out and watching our own customers destock, and we have historically seen the same kind of pattern of shutdowns over the holiday period that will take those levels even weaker.

So we would look to be more at the breakeven level than profitable.

Steve Volkmann, Jeffries & Company.

I was wondering if we could just have kind of a big-picture question. I'm just curious, as the quarter progressed, I mean things obviously came out quite a bit better than you had originally expected, and I'm wondering if you could give us a little more granularity on where things really did improve versus your previous expectation. I guess I'm just trying to figure out how much of that had to do with production maybe in auto and how much of that had to do with things that you are doing internally, and why the internal things maybe came in faster than you expected.

Again, let me take the first cut of it, then ask Mike and Sal to provide some color.

Clearly as the -- our expectation as we came into the third quarter was that we expected it to be really a trough period for us for the year. The expectation is that sales would continue to decline and therefore, while we continued to put in the cost-reduction initiatives and the improvements -- the manufacturing improvements, we would still be lower than what we would've done in the second quarter.

And in fact, we benefited from principally the light vehicle automotive markets, as we saw improved sales relative to what we expected in both our mobile group and our steel group. But driven off of that, better than expected automotive markets.

Having said that, we leveraged extremely well within the manufacturing plants. The fact that we were getting additional absorption just gives us a lot of confidence as we go forward that as we get more volume going through these plants, all the costs that we've taken out, all the improvements that we've taken out should provide very good leverage.

On top of that, we generated significantly stronger free cash flow over that period as well. So we've really been able to maintain, even with that higher-than-expected sales, we continued to drive more inventory out of the system.

So, the Project ONE initiative that we've had -- the visibility, the, again, the very focused effort to take cash out and reduce inventories has played as well. So it was a combination of improved sales, improved execution, from both an earnings and a cash standpoint. Mike, I don't know if you want to --

Well, the only thing I would add, Steve, to what Glenn had said, if you kind of look at actually sales third quarter versus second quarter and what our expectations of seeing the trough in the third quarter, mobile industries was up about $35 million third quarter to second quarter, process industry was down $20 million, and aerospace was down $9 million.

And that upkick in the mobile side of the business actually has tested a little bit of the new cost structure that we believe we have in place to serve that industry and, we've got some good upside leverage with regards to that.

So, and at the same time, the aerospace business, in fact, is held in there from a profitability standpoint, even with the lower revenue, again; the transformation of that business that we've talked about; and then process industries is the mix issue. But two really good transformations and one that continues to perform strong, but just in a little bit of a mix and still the kick-down from the OEs and the process industries.

That's great color. Thank you. Can you also just briefly -- what was steel capacity utilization in the quarter versus the second quarter?

Yes, Steve, I mentioned it when I was talking to Eli. We were about one-third of our melt capacity. That's up from where we were in the second quarter, but still below our shipment levels from a year ago. Shipping only about half -- a little less than half of where we had been a year ago.

You were at like 20%, I think, in the second quarter. Is that right?

Correct.

And if I can just sneak one more in for Glenn, on the free cash flow, Glenn, what's going to happen next year when things presumably start to get a little bit better, broadly? Are you going to have to rebuild your own inventories? We've heard a few companies talk about having to prepay some of their suppliers, given credit issues still out there among smaller businesses and so forth. Just what's your thinking broadly as we get into a recovery scenario with respect to free cash flow?

Again, we're pretty encouraged that, even with an improved economy, we'll continue to generate strong cash, and the reason why I think we feel that way in part is because of the working-capital focus and improvements that we've put in place.

So even painting the scenario of improved end markets and sales, we believe that we can still generate cash from working capital as we continue to drive the improvements. Whether you look at it on days or as a percentage of sales, we clearly still have room relative to benchmarking our peers, and with the new processes and systems that we have in place, we're pretty encouraged that we'll be able to continue to make improvements or at least efficiency improvements.

So in a modest recovery next year, it's very reasonable to expect -- or we would hope that we would generate cash as opposed to using cash at least from inventory, if not working capital overall.

Samuel Eisner, Sterne, Agee & Leach, Inc..

I just had a quick question on the mobile business. I guess outside of the Cash for Clunkers and government stimulus, would you guys have been profitable on the mobile side?

That's tough to assess because we don't look at the profitability necessarily per markets served, and those are shared assets that we use.

So, what we got was a combination of the Cash for Clunkers, which was a positive to what we call our light vehicle systems business. That is an area, in fact, where we've been very aggressive with regards to our pricing efforts over the last couple of years. That has been good, and therefore has given us the upside leverage on that.

We also got some uptick from a market perspective also in the heavy truck segment. Our heavy truck sales, quarter three versus quarter two, was up about 17%. That was good for us, again off of a very low base. Most of the other industries, in fact, that make up mobile were actually down, though, from the second quarter.

Okay, so would we expect then this 4% margin that you guys had in this quarter to come back a little bit but still be profitable going into the fourth quarter and then into 2010?

Well, as we said a little bit earlier, in the fourth quarter we probably expect something more close to breakeven because the volume that we did enjoy as a result of the Cash for Clunkers, one, doesn't appear to be there on an ongoing basis and there is a question as to the actual structural performance of that industry.

When you are going into the fourth quarter of any year, just from a seasonality standpoint, we're always looking at the time between the holidays of late November to late December as to exactly what the automotive industry will do with regards to shutdowns. So if Cash for Clunkers is over and if their inventory levels are high, they'll shut down.

And that will put pressure on our revenue and that's really what we're reflecting in our outlook for the fourth quarter, is reduced revenue in the light vehicles systems side.

Got you. And then, I guess, just going onto 2010, you guys are going to have a pretty significant amount of cash. Obviously, you have the $250 million payment coming due. I guess where the priorities for cash that you guys are looking to put to work? I think you spoke a little bit on the second quarter call about looking towards the process industries and maybe with some M&A activity, or are you going to make more pension contributions? I guess what's the -- what is going to happen with that cash?

Sam, the answer is yes. Effectively, we obviously wanted to make sure that we had a very strong balance sheet coming into the recession, which we did. We shored up our financings and our liquidity position, so we feel very good about the position we're in.

Obviously, we're going to generate additional cash coming from the sale of our needle roller bearing business. But again, that sale was a strategic divestiture, if you will. It wasn't because of the need for cash.

Our primary focus is to continue to operate the Company efficiently, to use that excess capital, if you will, to fund growth opportunities, as you said, within process and aerospace, in particular, our targeted growth areas. But clearly between pensions, capital requirements, acquisitions, and so forth, at least we have the wherewithal to make sure that we can make the right strategic investments as those opportunities come up.

David Raso, ISI Group.

My question focuses on process industries' margins. Just trying to step back, needle going away. What's the earnings power of Timken? The process energy margins, obviously high single digits. You alluded to that's obviously something you hope to improve upon in the fourth quarter.

The history we have with this division the way it's been reported for really not that long a period of time, it seems like a business where we have articulated in the past how it's a heavily aftermarket business and so forth. The margins have been above 10% before this quarter. Can you help us, in some regard at least, try and think through the earnings, the profitability of this division after what we just went through in the third quarter? I'm just trying to think through 2010 and 2011. Really kind of -- a little more big picture, but some granularity looking out to 2010.

David, this is Mike. Again, let me walk you back through a little bit of the process industries change in the third quarter.

What we're really looking at is two things. One, these are markets that have not seen the trough across the board. Some of the markets -- this is a business that serves probably 90 to 95 different industry segments, so it's a culmination of a lot of different industrial markets.

You have some markets like heavy capital equipment for the steel industry that probably will continue to deteriorate throughout 2010. You have other industries that have begun to hit the bottom, destocking is over, and now we will wait for a recovery of capital expenditures by major producers, and we'll see that.

The real issue, looking at third quarter and suppressing those markets -- or those margins, is really the mix, and that's our distribution sales. And we talk a lot about that this is the business where we actually create the installed base from which we sell for many, many years after-market parts, and we're just going through a period of time right now where the distributors across the world are looking at a prolonged economic slowdown and they are destocking at a very aggressive rate.

And that destocking will continue, in fact, until they either a reach a point at which they are comfortable with their inventory levels or the market begins to pick back up and they will start buying. So they are buying at a lower rate than they are currently selling. And that's the biggest drag on those margins at this point.

We will see some recovery of that in the fourth quarter, and then that fourth quarter and the expectations moving on to 2010 will be based upon what actually happens in the economy in general. But that's really the biggest issues.

Can you give us a little more help on when you sell to distribution, I assume it's a little bit of hand to mouth, but do you have a backlog to speak of or any reason for us to be comfortable that the distribution inventory de-stock is not a long enough stretch where we are looking at 2010 process industry margins no better than 10%.

Well, the destocking, and it's a great question for our distributors, to a certain extent is related to the economic forecast that they have versus their current inventory levels, but also strategic for them.

Some distributors across the world find inventory to be a significant strategic weapon, and they run at much higher levels and therefore they do less destocking. Others, in fact, manage much closer with regards to what they buy and what they sell, and therefore there's not as much destocking in there.

So, we actually can see that. Because in general we can see what our distributors sell of our product versus what we buy, so we can manage and in fact work with them with regards to the amount of destocking that's happening. So the ability to forecast that level of destocking is pretty good from our interaction with them. It's very difficult with regards to any continued slowdown in the economic picture for them.

So we have no concerns with regards to the structural margins of this business. This business is -- continues to be very attractive. It will continue to earn in the high teens with regards to margins. In fact, as we continue our growth and our spread of this business model throughout Asia, and China and India in particular, we expect that that will continue to grow over the long term. So, this is just a short-term issue of the economics plus the destocking that's going on.

Last quick question. What percent of the sales in the quarter went through this distribution channel and what would you characterize as normal?

We don't actually talk about the distribution break-out of our businesses, David.

Is it fair to say it's over a third?

Yes.

Obviously it had a big impact on the margins, so it can't be immaterial.

Absolutely. In general, if you look at industries with heavy aftermarkets, if you used a 50-50 number, you're pretty close.

I really appreciate the color. Thank you very much.

Mark Parr, KeyBanc Capital Markets.

I had a couple of questions. First, a comment. Great quarter. Wow. Nice being in the black, huh?

It's hard to connect those two comments.

Some of us aren't, Mark.

Yes, it's a long way to go. But at least we are recovering, so that's good. I was curious. Sal, I normally ask about scrap markets. I'm curious what your best guess is for the November buy relative to October.

Oh, you are going to ask that question -- I knew you were going to ask that kind of question. As we spoke before on the last conference call, we thought things would weaken a little bit, and they did from the second to the third quarter.

Every indication is that it will go down again. The scrap flows are up. This is probably weakening a little bit more in advance than we normally would expect to see it because of the demand and the customers' end use.

But as you've seen it, the global demand is down a little bit. The Middle East has gotten price reductions out of their export. We expect that we're going to see that weakening again as we move into the latter part of the year, Mark.

All right. Because I'm hearing numbers it could be, at least on the shred side, it could be down $30 to $40 compared to October.

You're hearing the same kind of numbers I am hearing.

Okay. All right. Another question. Just the new union contract. That happened in October, is that right?

We reached a tentative agreement in October, Mark. The actual ratification of vote is on Sunday, on 1 November.

Okay. Assuming that that occurs, is there any financial impact as far as the fourth quarter is concerned that we need to be aware of, in terms of upfront bonuses or anything like that?

Our current forecast for our year as a total includes what we believe will be the impact of that, Mark.

Terrific. And also, just in terms of the union agreement, could you talk a little bit about financial impact in 2010 versus 2009?

Unfortunately, we are not at liberty to talk about the individual terms of the contract until after ratification, but we will be very amenable to talking about it once we have seen it ratified.

Okay. And then, I guess the last question, are there any legal hurdles left that could get in the way of the divestiture of the needle business? Are all those boxes checked at this point?

Mark, we would say at this stage everything is still very positive for our expected completion by the end of the year. Everything is on track. We don't expect any issues to come up. But we'll continue to let you know as -- if there is. But everything looks good.

I just -- and then, one last question I had, we've spent a lot of time painting a conservative picture around the fourth quarter relative to the third quarter from a volume standpoint. But the [wards] numbers that are out for 4Q are actually indicating much higher production levels than the third quarter. And I just wonder if you could help me reconcile your comments about your expectation for weak auto shipments in the fourth quarter against overall higher production volumes expected by the market right now?

Again, I'll take maybe the first cut of it, Mark. The visibility we have is frankly not there for us -- . What we go on is what we're hearing from our customers and what macro issues that are out there.

Given the seasonal shutdowns that we historically see -- given the issue with the stimulus program winding down, it's our expectation, if you will, that revenues -- sales will be down across that market. To the extent they don't obviously that's the upside part of the range, if you will. And our expectation, again, is that we'll leverage it well.

But we just can't -- we can't definitively tell you what it's going to be. We're living month to month, like everybody else is, on trying to figure it

Mark, the other thing to remember at least on the bearing side of the business, is that information is total vehicles, etc., and our mix of that automotive industry is very different than the typical mix, so unless we're building a lot of light trucks, SUVs, etc., then the impact on our business isn't that significant.

So you have to also play with the mix of what our business really looks like within those numbers.

Yes, well, that's one of the things I was curious about is if there is a mix issue. Your fourth-quarter outlook has got to start with somewhat of a production estimate. I mean, do you -- based on your mix, are you suggesting that you think that the production mix for Timken in automotive will be lower in 4Q than 3Q, or are you looking at it as flat or up?

We are looking at our production as down in the fourth quarter and that's fundamentally based upon the fact that historical, and if you go back the past, whatever, 25 years, you would always see that in December with regards to the shutdowns during the holiday period.

And looking at inventory levels and, again, play out the year, as to Cash for Clunkers created an enormous amount of surge with regards to the demand. So manufacturers of components, parts, the vehicles themselves created all this surge. There probably is inventory in those channels now, and they may be assuming that a lot of that demand continues on -- maybe it's certain vehicles, etc..

But what we're seeing is that surge from Cash for Clunkers, that surge now coming off. No continuation of the Cash for Clunker programs across the world and therefore inventory levels relatively high versus where they were pre-Cash for Clunkers, and then coming out of the bankruptcy shutdowns, etc., all kind of lead you to the idea of looking at that November, late November, December shipments of being probably too high as forecasted in the market.

And from our internal information, the systems that we see in our own forecasting, we see a relatively weak December. It would be a pleasant surprise if that were not the case.

Terrific. Thanks very much, and congratulations on all the progress.

Melissa Cook, CLSA.

Good morning, everybody. A few questions about Asia. I wonder if you could bring us up-to-date on your Wuxi plant as far as productivity, and how is production going there, and are you seeing orders come through yet from some of the process customers who maybe had slowed down when the world fell apart?

Hi, Melissa, this is Mike. I was waiting for your Asia questions.

Yes, I'm always here.

Yes, let me give you a little color on what's happening in China right now, Melissa. From a top-level view, the incentives from the government have been very, very targeted.

As you know, there's a lot of activity going on, both from a stimulus standpoint in China, but also a selection as to which industries will get that stimulus and which industries will actually be allowed to grow from the standpoint of new capacity installation, etc.. And so far, that's played very well with regards to strategically where we're going to because the Wuxi facility, which is very much focused on larger-bore bearing products, from tapered roller bearings to sphericals to cylindricals, are very much tied into those industries, like wind, that is being driven very heavily by the stimulus programs and also obviously by the government decision as to what industries will get investments, etc..

So we are still very positive with regards to the type of capacity that we put in place. It's the right size of product. We are operating at a relatively low level, just because of the global demand for those products across the world, and so that's just taken it down overall.

Which actually has been a little bit of a benefit, Melissa, because it's given us an opportunity instead of just what we would call humping metal, we're actually being able to expand the amount of part numbers, product sizes, features, etc., throughout that capability much quicker than we typically would've in ramping up a plant, which is going to play out really well as the global markets recover.

So, still very positive. India is -- continues to be very positive. We'll be utilizing much of that capacity. So, weak on a global basis, China is good. We actually see some parts of China that isn't so good. But the process industry side of it is actually up year on year and in line with what our growth has actually been the last couple of years.

So we're still very positive with regards to what we have installed, and as you know, we've done more than Wuxi. We've actually installed some aerospace capacity over there, which puts us out in the lead with regards to the industry and some other things. So, in general, still pretty good. Very positive.

Okay. That's great. Then following on the aerospace comment, are you participating with all the other vendors trying to get in on the new [commack] and aerobody jet program?

Well, anything that happens in the local aerospace industry there, we have to be careful for two reasons. One is to the trickle over into the military side of the industry, but we are participating in everything locally that we possibly can.

And then, just -- in talking and listening to Caterpillar on their conference call, they were talking about giving their vendors a head's-up that their orders are expected to pick up. Are you starting to see indications from some of your heavy machinery customers, especially on the mining truck side, that maybe you need to start gearing back up?

Well, what we're seeing is, and we talked a little bit about this in the second-quarter call, is that many of these equipment builders have taken their inventories [down] low, and they are nervous about an uptick in the market.

What we began to see was many of the heavy equipment producers and the off-highway industry beginning to put in some inventory of parts and components so they don't get caught with a rapid uptick in the market, and that's really what we've seen.

We've not seen any kind of significant buys or ramp-ups of our capacity in most of those industries. It's been a little bit more filling out their inventories so they don't get caught, in essence, of higher equipment sales from them. But no general move in a macro numbers of 20%, 30%, 40% on orders. Not yet.

And, finally, could you just remind us where you are as far as the construction of your wind [bearing] capacity in China and when that's coming online?

Yes, it actually will be coming online in 2010. That's progressing very well, both from the standpoint of market demand, the equipment installation. Essentially everything is on time. So, we are pretty excited about that.

That is still an industry that the Chinese government will continue to invest in. They still have their target of a significant amount of their total energy coming from renewable sources, and they are investing, and we are with one of those that are winning. So, that's actually going very well.

Our expectations will be a pretty good jump in sales in 2010 going into 2011 from that facility in particular.

(Operator Instructions). Steve Volkmann, Jeffries & Company.

I think Mark was kind of digging in where I was going, but just to simplify it, your assumption for auto production, Q4 over Q3, sounds like it's down slightly. Is that correct?

The demand on our business for our products, given what we are now seeing in the production builds, would be down. Yes.

Just be careful. Don't take The Timken Company as being the forecaster of the auto industry.

I think Mike said it quite correctly. I think it was even more so true on the steel business side. There was an inventory deficit in that market, and we filled the pipeline to a great degree in the third quarter and early in the fourth quarter. We don't know what's going to happen later in the fourth quarter or into next year.

We've simply built our forecast based on an assumption that there would be a shutdown sometime near the end of the year.

Great, that's helpful. And then, heavy truck. What does that look like, 4Q over 3Q, for you?

You know, we are seeing strengthening in heavy truck. We think that that strengthening, at least the forecast from our customers and from the industry, would say that this is a gradual uptick in heavy truck going out through 2010.

As you know, that's a -- it's an incredibly cyclical market that is very difficult to forecast. But as I said, kind of quarter on quarter from third quarter, or to third quarter from the second quarter, we were up about 17%. But that is if you look back at third quarter this year versus third quarter last year, we're actually down almost 50%, so you got to put all that in context.

Okay, was there some inventory rebuild in that business, too, do you think?

You know, they run relatively lean, would've been my experience in this market, which makes it so heavy on the cycles.

You can see the actual builds of the classic vehicles, etc.. But not a lot of inventory bleed there or inventory build, that I can tell. This must be specific demand.

Great. And then, are there any, to speak of, major end markets or product types where fourth-quarter production will actually be down meaningfully over third quarter?

Only what we might see continuing in commercial aerospace. But other than that, we've begun to see things pretty much at the bottom, kind of bouncing along that bottom, and now it's a little bit of seasonality versus inventory positions in markets versus expected demand in the first quarter.

All those things are kind of playing into how the fourth quarter actually plays out. But I think our biggest concern, obviously, with respect to forecasting and looking at the fourth quarter, has been more the mobile side, and that is the uptick in Q3 versus maybe back to more of a norm in Q4.

(Multiple speakers). In steel, I think we would see probably weaker shipments into the energy, and especially oil and gas. That's still on the way down. That has not hit bottom yet because of the inventory glut that exists everywhere, but other than that, I am right in Mike's camp.

That's great. I appreciate it.

Marty Pollock, NWQ Investment Management.

Great performance all around. Question I have has to do with the mobile performance since at this point it looks like it includes the needle bearing sale. I assume that's correct.

If you look at performance in that segment, and certainly into the automotive piece, should we assume that needle bearings performance, like the rest of mobile, automotive, was in line? So in other words, you know, this will be sold but nevertheless participate fairly evenly with the rest of the mobile? Or should we assume that we know anything more about the difference between the two, between the assets for sale versus the assets still remaining in that segment?

Let me take a cut at that. First of all, the material that we have now, that show our segment numbers, if you will, are all from continuing operations, so they're purged from our pending sale of needle roller bearing, which we are treating as discontinued operations.

You can see, effectively, the net earnings impact after tax of the needle roller bearing business on the front page of our income statement.

Relative to your question of they both -- that mobile and needles, if you will, do participate in a lot of similar markets. In fact, around 80%, call it, of our needle business is in -- was in our mobile group and services primarily, again, the automotive OE marketplace.

So what we saw in the third quarter for mobile was very akin to the needle business. We saw improved revenues because of the, again, improved outlook or the stimulus program, and so forth.

Similarly, our expectation would be that mobile, as we've talked about, would have declining revenues in the fourth quarter, potentially. Again, it's still an issue, but our view, our estimate, if you will, is that we would see revenues in both our mobile as well as needle bearing business.

Again, you won't see that in our financials because of the discontined operations. You will see it on the, again, income after taxes from discontinued operations. We expect both mobile and needles in the fourth quarter to be down from what we experienced in the third quarter.

So in the case of needles, it had a loss. We would expect it will have a greater loss. In the case of mobile, where at least we were marginally profitable, depending on the sales outlook, we'll have negative impact on earnings in the fourth quarter.

But again, a lot of that is seasonal issues, so that obviously as we look forward into 2010, we expect that to obviously pick up.

But overall, the other part I guess I'll mention, too, is within the Steel group services that market, and so the -- from the automotive standpoint, if we make that basic assumption that those revenues will be down, obviously that will have an impact on steel, too. So there's an opportunity that steel will still record that loss for the fourth quarter, albeit our expectation is that we'll see improved performance, though, because of all the cost-reduction initiatives and potentially some mix.

So you balance that all together, that's why we expect at least our businesses that serve solely automotive-related markets to be off from what we experience in the third quarter.

There are no further questions at this time.

All right, thank you very much. Obviously lots of questions on the phone, lots of questions about the economy. The bottom line, however, is that despite a difficult economy, the third quarter demonstrates that our strategy is working.

Our execution has turned a corner from a short-term point of view. More importantly, it's poised us to emerge from this recession even stronger. Thank you for your interest in The Timken Company.

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