Timken Co (TKR) 2010 Q1 法說會逐字稿

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

Thank you, and welcome to our first quarter 2010 conference call. I am 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 and Administration and CFO, Mike Arnold, Executive Vice President and President, Bearings and Power Transmission Group, and Sal Miraglia, President of our Steel Group. We have remarks this morning from Jim and Glenn, and 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 would like to remind you that during our conference call today, you may hear forward-looking statements related to future financial results, plans and business operations. Actual results may differ materially from those projected or implied due to a variety of factors. These factors are described in greater detail in today's press release, and in our reports filed with the SEC, which are available on our website at www.timken.com. Reconciliations between GAAP and non-GAAP financial information are included as a part of the press release. This call is copyrighted by the Timken Company. Any use, recording or transmission of any portion without the express written consent of the Company is prohibited.

With that, I will turn the call over to Jim.

Thanks, Steve. And good morning. Our first quarter results signal a strong start to the year for Timken. The top line is up 5%, we posted earnings that are more than double last year's at $0.57 per diluted share without special items. This performance exceeded our expectations, and clearly demonstrates our capacity to deliver improved shareholder value with a performance-driven portfolio. As you look at our progress and consider where we are headed, this is how I would sum it up. First, the economic recovery is real, but still modest.

Second, we have made fundamental, permanent changes at the Timken Company. The combination of these two is providing great leverage in terms of earnings and cash flow. A year ago I reported that the greatest detriment to our performance was insufficient volume brought on by the rapidly deteriorating global economy. We took decisive steps to protect our balance sheet, and to manage through the downturn. We projected that in 2010 there would be a slow gradual recovery in the economy.

Early in January, we were still debating how to read the early signs. But the first quarter actually played out a bit better than we anticipated. We have now seen sequential increases in demand for the last two quarters. As a factor up to our performance for the quarter and our outlook for the year, let me provide a brief insight into the economic climate we are seeing, and how it is impacting us. Demand in the mobile markets continued to strengthen in the first quarter, led by light vehicles and heavy trucks. We are also seeing improving orders in other mobile sectors. Demand from these sectors propelled the performance of our mobile and steel businesses in the first quarter.

The overall market demand for mechanical power transmission and heavy capital equipment continues to be weak, with the exception of strength in Asia. Their markets like wind energy and power generation continue to experience strong gains. Within aerospace, commercial and general aviation remain down, not surprising given their typical late cycle trend. On the other hand, defense markets have remained relatively stable. And lastly, it appears that destocking in industrial distribution may finally be winding down, leading us to project an increase in shipments later in the year.

Timken's results in the quarter certainly reflect these trends. The economic recovery, coupled with the success of our own actions to improve our performance, have led us to increase our outlook for the balance of the year. Let's see why. The actions we took in 2009 to fundamentally change the Company from resizing to transforming our portfolio through divestment, from pricing actions to growth investments made through the trough, all are enabling us to leverage the upturn quite well.

We reduced costs aggressively last year, reducing fixed as well as variable costs, at both the S&A and cost to goods sold levels. In our factories we made a special focus on implementing those reductions in such a way that would allow to us to quickly respond to the upturn. We reduced our inventories dramatically, so increased orders translate directly into increased plant utilization. Our output is higher, and our production workforce is leaner. With just a modest increase in sales, we are seeing dramatically better productivity. As a result we have been able to translate those sales almost directly to the bottom line. The combination of a modest improvement in demand, and the structural improvements we have made, allowed us to deliver a much stronger than expected first quarter. We have increased our outlook for the year, but given the uncertainty in the economy, we are still managing the Company cautiously.

As shared last quarter we expect to lose some business in the mobile industry segment during the remainder of the year, as a result of the pricing actions we have taken. Those losses, coupled with uncertainty in the timing and pace of an upturn in process industries and aerospace, as well as normal seasonal factors, temper our expectations about the strength of demand in the second half. We are maintaining tight controls on expenses and capital spending. We have added about 1,000 people to our manufacturing workforce, more than half of them are contingent employees, which allows us to meet the current demand for our products, and protects our flexibility. Moreover, our near-term caution should not be misinterpreted. We remain very confident that the structural changes we have made in the Company will deliver much stronger earnings as demand recovers.

The actions we have taken over the past few years have created a very different Company, and our current performance is providing a glimpse into the benefits. We have grown significantly in Asia, and are benefiting from our position in the fastest growing market in the world. We are ramping up our lower cost manufacturing base in Asia to serve the markets there. This month we started operations at our new facility in China, which is making bearings to serve the strong demand in the wind energy market. We will implement our final wave of Project O.N.E. this month. Thanks to the improvement it brings, we are more agile in adapting to customer priorities, streamlining our supply chain processes, and managing our working capital more effectively. We are in the midst of the largest new product launch in our history. In addition to the wind expansion, we have launched a number of new industrial products to expand our range. Those launches are proceeding extremely well, especially in Asia.

We are successfully embedding a lean culture deep into the Company, and we are confident and will continue to yield greater efficiencies. We have emerged from the recession with a much more attractive market portfolio in both our steel and bearing and power transmission businesses. We are focused on growing in those markets that value our capabilities and offer long-term profitability. As noted from our improved outlook, these actions are generating stronger results in 2010. We are confident that we are on the right track with the opportunity to deliver even higher levels of performance, as the economy recovers further. Now I will ask Glenn to give you a more in depth financial review.

Thanks, Jim. For the first quarter the Company's fully diluted earnings per share from continuing operations were $0.29 per share, excluding special items earnings were $0.57 per share. Special items totaled $27 million of after-tax expense. Included was a one-time non-cash charge of $22 million, reflecting a reduction in tax benefits for accrued post-retirement prescription drug costs, caused by the recently enacted US healthcare legislation. The remaining items in the quarter included expenses associated with the Company's restructuring and cost reduction initiatives. The rest of my comments will exclude the impact of special items.

Sales for the first quarter were $914 million, an increase of 5% from 2009. The increase was primarily due to stronger volume, the impact of higher surcharges, and favorable currency, partially offset by mix. Demand was strongest within automotive market sectors, positively impacting our mobile industries and steel segments. Demand was down, however, within our process industries and aerospace and defense segments. Gross profit of $224 million was up $68 million from a year ago. Gross profit margin for the quarter was 24.5%, an increase of 650 basis points from last year. The positive impact of higher volume, improved manufacturing utilization, and the timing of the Company's surcharge recovery mechanism was partially offset by higher LIFO expense from a year ago.

For the quarter SG&A was $133 million, up $10 million from last year. This reflects higher costs related to incentive compensation plans, partially offset by cost reduction initiatives. Margins increased 30 basis points over last year to 14.5%. EBIT for the quarter came in at $91 million, or 9.9% of sales, up 540 basis points from last year. Net interest expense for the quarter was $9 million, up $1 million from last year, reflecting higher fees associated with the Company's 2009 refinancings. The tax rate for the quarter was 32%, compared to 33.5% last year. The lower rate is primarily due to a higher percentage of the Company's earnings, coming from lower tax rate foreign jurisdictions. Going forward we expect to maintain a tax rate of roughly 32%. As a result, income from continuing operations for the quarter was $55.2 million, or $0.57 per share, compared to $0.22 per share last year.

Now I will review our business segment performance. Mobile industry sales for the quarter were $367 million, up 22% from a year ago. The increase was primarily driven by higher demand as well as favorable currency. Stronger demand in the automotive light vehicle and heavy truck market sectors was partially offset by lower demand in off highway and rail. For the quarter, mobile industry's EBIT was $42 million, or 11.6% of sales, compared to a loss of $2 million last year. The improvement was driven by increased demand and better manufacturing utilization and cost reductions. During the quarter the Company also resolved pricing disputes, which contributed a benefit of approximately $5 million. In 2010 we expect our mobile industry sales to be up between 15% to 20%. Increased demand in the automotive light vehicle sector is expected to be partially offset by lost business, resulting from pricing initiatives associated with the Company's fix or exit strategy.

The Company also expects improved end markets in heavy truck and off-highway, while rail is expected to be relatively flat. Process industry sales for the quarter were $207 million, down 8% from a year ago. The decline was primarily driven by lower demand, partially offset by favorable currency. Demand was down across the industrial distribution channel in nearly all original equipment market sectors, with the exception of wind energy and power generation. For the quarter, process industry's EBIT was $27 million, down from $43 million a year ago. Margins were 13% of sales, compared to 19.3% last year. The impact on results from lower volume, higher SG&A costs related to incentive compensation, and wind production ramp-up costs, were partially offset by cost reduction initiatives. For the year, we expect sales for process industries to be up modestly. Sales from new products and wind energy demand are expected to be largely offset by declines in heavy industrial and power transmission market sectors. While we are beginning to see signs of improvement within the industrial distribution channel, most of the heavy industry original equipment markets remain weak.

Aerospace and defense sales for the quarter were $92 million, down 16% from a year ago. Since the first half of 2009, the business has experienced a continued decline across the later cycle commercial and general aviation market sectors, while defense related demand has now leveled off. EBIT for the quarter was $13 million, down from $18 million a year ago. Margins were 13.9% of sales, compared to 16.6% last year. The impact of lower demand and costs related to incentive compensation was partially offset by cost reduction initiatives and better manufacturing execution. Aerospace and defense sales for 2010 are expected to be down slightly. This is primarily due to a drop in commercial and general aviation demand, while defense markets are expected to be relatively flat. Field group sales for the quarter were $270 million, up 9% from a year ago. The change was driven by stronger automotive demand, partially offset by declines in the energy and industrial market sectors.

In addition, surcharges were up approximately $23 million for the quarter, due to higher raw material prices and overall demand. The increase in surcharges was mostly offset by unfavorable mix. EBIT for the quarter was $20 million, or 7.4% of sales compared to a loss of $7 million last year. The increase resulted from higher volume, improved manufacturing capacity utilization, and cost reduction initiatives. EBIT also benefited from the timing of surcharges in excess of raw material costs, which was more than offset by an unfavorable change in LIFO of $13 million, and unfavorable mix.

The Company expects steel group sales for 2010 to be up between 65% and 75% over the prior year, reflecting last year's depressed levels. The increase reflects an improvement in end-market demand, primarily in the mobile on highway and industrial market sectors, and higher surcharges.

Looking at our balance sheet, we ended the quarter with cash in excess of debt of $193 million. Free cash flow for the quarter was a use of cash of $37 million. Strong cash generation from improved earnings was more than offset by pension contributions, which included a discretionary payment of $100 million in the quarter, and working capital. The Company expects to generate strong free cash flow for the full year in excess of $100 million, driven by improved earnings and after investing approximately $135 million in capital programs, and $135 million in pension contribution. Including cash and credit facilities, the Company had liquidity in excess of $1.5 billion at the end of the first quarter, with no significant debt maturities until 2014. We expect to use this liquidity for strategic acquisitions, pension funding, and share repurchases. During the quarter the Company purchased 500,000 shares of its stock for approximately $14 million.

In summary, our outlook for 2010 reflects the general improvement in the global economy that varies by end market and geographic region. We expect sales to be up approximately 20% to 25% over 2009, and to leverage this increase well through improved operating performance and cost reductions, partially offset by LIFO expense and variable compensation plans. For 2010 we expect our earnings per diluted share, excluding special items, to be between $1.60 and $1.80, up from our prior estimate of $0.85 to $1.15. This ends our formal remarks, and we will be now happy to answer any questions. Operator?

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

Good morning, everyone. Terrific quarter.

Good morning, Eli.

Some questions as far as (inaudible), as we go through some of your assumptions, as we go through the rest of the year and we can start with mobile if you want. You did an 11.6% operating margin, if you take out the $5 million gain from the settlement and pricing, you are right around 10%. And with the volume levels in autos really going up in the second and probably staying close to levels the rest of the year, and improvements across the board. In order to get the conservative guidance, you have to look at a reasonable drop in operating margins in that sector from the double-digits we are seeing today. And the business that you are losing is probably lower margin business that you really didn't want. Can you give me some guidance as to what should I expect for operating profitability in that sector as we go forward?

Yes, Eli, this is Mike. Let me give you a little idea as to what we are seeing top-line revenue for the remainder of the year for mobile, because obviously the first quarter has come in very strong. This is actually the third quarter in a row where you now have begun to see that in addition to the revenue, there are real structural fixes to this business. This is really good news. As we move forward, first, let's look at first quarter.

First quarter was a combination of not only some recovery in the market, but also of this inventory replenishment throughout the channels. So we have gotten kind of a double kicker. And that has provided both good revenue on a better improved business, but also high levels of utilization in the plants, higher than what we would have expected. As we move through the year, we think that this inventory replenishment is going to end in the second quarter. We believe that across the mobile industries, other than rail, we will continue to see strengthening of shipments in there, and we have got a little bit of concern from the back end of the year, because so much robustness has been in the light vehicle side of the mobile industry. So this is kind of the on-highway side. That we are still a little concerned about how the seasonality of mobile will work out in the third quarter. Then of course the fourth quarter, if it is robust production, a lot of vehicles put into the marketplace, we could begin to get back into the pre-recession mode of some shutdowns in the fourth quarter. So we are a little cautious on the back end from a mobile perspective.

What about on profitability? I mean, even if you go through that, when you are giving us a double digit operating margin in the first quarter, is it reasonable to assume that you should be close to that for the rest of the year in each quarter?

Yes. What I would tell you is that if you look at the steady improvement over the last couple of years with regards to operating margins, we will continue to see that improvement. I would tell you that the first quarter is pretty strong, compared to what we will see for the remaining quarters. But we still should be in this mid to high single digits in returns.

Can you take us through the rest of the Company at this point, process, aerospace. I will ask the same question on steel, for the same reason, that we've got this big volume change coming the rest of the year, and margins shouldn't really go down from where they are now?

Let me talk about process industries and aerospace and then I will turn it over to Sal, and he can comment on steel. From a process industries standpoint, all three of these businesses interestingly enough, they are all kind of in a different part of the cycle. So the process industries what we are still seeing is some degradation on the original equipment manufacturers, and in particular the heavy capital guys. So we are continuing to see that degradation, that is showing up in the volume that you are seeing. On the industrial distribution side, what we are beginning to see is that the pull from the end-user markets is beginning to strengthen. The sales of our distributors is beginning to strengthen. And now it is a question as to how much more inventory is there to bleed off, which we don't think there's a lot.

We think the second quarter is going to show us kind of the end of the trough of that distribution, and we are anticipating some strength in the back side of the year. So if you look at kind of first quarter, and I would characterize first quarter as revenue down, profitability down, quarter on quarter from last year. But if you look at the fourth quarter, for process industries, you see that, we have still been able to maintain relatively flat profitability, while they are still in this trough and these changes are happening. As you look at the remainder of the year, you can expect, as we talked last quarter, that we will still be pushing up towards that mid-teens from a standpoint of profitability standpoint.

So we will see some improvements in the second half. Most of that driven out of the distribution part of the business, and not as much on the OE. Now if we get some uptick in the economy and capital equipment starts to move, that would be great. But those are longer lead-time items.

If you look at aerospace, aerospace is what we would consider to be pretty close to the trough. So if we can predict the late-cycle part of this recession, we see aerospace as kind of in that late cycle. And so you have seen the reduction in volume from that market, I think Jim and Glenn both made comments with respect to the defense side and the rotor craft, which is where we are very strong, has remained relatively good with civil still down. I would anticipate that the second quarter probably is going to show us a trough with regards to volume and profitability. And then we will begin to pick back up towards what we consider to be more normal profitability as we come back up and out of there. So they are all kind of three operating in a little bit different market trends. All returning good profitability now in varying parts of this recovery. And some really good structural performance.

Good, steel.

Good morning, Eli. This is Sal. Frankly we had a very strong first quarter that had an extra boost for the same reason Mike described in mobile, that is that all of last year, just about every customer we had, particularly our distribution customers, were destocking as people have begun to see something more healthy this year. There has been not only the demand consumption, but a pretty good push towards the restocking, which we expect will mitigate to some extent as we move through the second quarter. We are actually beginning to see some signs of that.

So, we will see a little bit of a fall back in our utilization rates, just because we will move just back to replacement levels to some extent. Again same issue. If the economy recovery is more robust than it appears to be, and it does appear to be healthy at the current time, we could see an upwards surprise and positive results from that. But at the current time our order intake rate actually signals the fact that the restocking is mitigating a bit, so our guidance sort of includes the anticipation of just where that order rate will go, and what our utilization rates will be. On the positive side, we may see some of our better margin products begin to come back in the back half of the year, particularly in the energy area. So that is another upside possibility. But at the current time, it is very weak, even with the price of oil where it is today.

Thank you.

Your next question comes from the line of Steve Volkmann with Jefferies & Company.

Hi, good morning.

Good morning.

I am wondering if you can perhaps build out on your comment a little bit on the mobile side in terms of the headwind that you're going to be seeing from some of these renegotiations. Is there a way to kind of quantify that? Are going to be at sort of two-thirds the industry improvement, or something, in terms of the headwind?

Let me kind of give you a purview of how we see the year playing out and this kind of comes out of our comments last year as we finished up the renegotiation, essentially of all of the agreements we had throughout the industry. As we did that, we anticipated and, in fact, got some projected losses as we have talked before. The interesting thing that is going on in the market is, one, the strength of the market really is dwarfing those losses from a standpoint of what we have lost up until this point has somewhat been hidden by the strength in those markets. And so that has been really good.

As we look forward, we have anticipated some additional losses in the second half of the year, Steve. I would tell you, though, that we are still going to see, there is a combination of three things going on. Right. So some losses, some strength in the market, but then also this loss of the destocking that we have seen in the fourth quarter, or the additional stocking in the fourth quarter and the first quarter, that kind of replenished the supply chain. And we are going to see a loss of that. So there are actually three things going on, not just two.

And the other thing to remember is that the strength of our business in the mobile side is more on the heavier vehicles. So it is the heavy truck, it is the pickup trucks when you talk about light vehicle systems, and then it also includes all of the off-highway and rail industries. So we are going to see the uptick in those markets. Right now the first quarter volume was driven very much by the lighter vehicles, and that is where a lot of this kind of restocking of the supply chain happens. So I can't put it into perspective as to what percentage of that.

I will tell you that the business lost so far is relatively small. We have anticipated that to grow in the second half, but will I tell you with a strong market across the world, if it strengthens more than we thought, then obviously that business loss will be very difficult actually to resource from elsewhere. So there will be a demand on all of the capacity that is available in the market. So it could still turn positive.

Okay. Great. That is helpful. And then you guys have given some longer term financial targets recently. And it just seems like we are off to such a strong start here. Does this make you reassess those numbers?

Steve, this is Glenn Eisenberg. When we established those three-year targets, obviously we envisioned that the economy would be much better and that our markets would be fully recovered. So from a standpoint of the targets, we still feel they are very good targets for us to achieve over the next two and a half years to three years from now. If anything, it just gives us a little bit more confidence given the outlook that we have experienced, or what we have experienced at least in the first quarter. But still, we want to temper the enthusiasm to some extent, just given the lack of visibility and what will truly happen in the second half. But again let's say it more reinforces that we feel they are achievable targets, as opposed to a need to change.

Great. Thank you.

Next question comes from the line of David Raso with ISI Group.

Really just a straightforward math question. Trying to understand the margins for the rest of the year. If you look at the revenue guidance and assume that interest expense isn't going to change dramatically on a quarterly basis, and the tax rate, I assume we are still talking about 33% or 32%, it seems like for the rest of the year, you are implying margins of 6.5% or so. Can you walk us through why, I know I can appreciate some of the headwinds you speak of. But 10% going down to 6.6%, while at the same time you are growing revenues every quarter the rest of the year 29%. I am just trying to understand the math?

Let me walk you through a little bit and then obviously ask the others if you want to move in, or to talk more. When you talk about the revenues for the full year again, it is nice improvement year-over-year. But we had a declining environment last year. So sequentially it doesn't necessarily mean that our revenues are going to pick up materially from where we are. Albeit, we do expect some increase in the volume throughout the rest of the year. You do have the seasonality impact on our business. From that respect, second half, especially fourth quarter with shutdowns, Mike has talked a little bit about potential loss of some business.

We also have the advent of higher raw material costs. So there is the expectation of LIFO expense coming in this year. But to your point, at this stage, more so the lack of the visibility as we have throughout the full year, want to make sure that is just not a restocking that is there and that true demand is there. Overall, we do expect a stronger first half than second half. We will reevaluate that obviously as we go through the year and have more visibility towards the end of the year.

It sounds like the second quarter margins relative to the first, maybe not a dramatic change. You are just kind of holding your ammo for the second half on the guidance essentially to see how it plays out. But even if I gave you 9% margins in the second, 9% in the third, you need a 2.5% margin in the fourth to get to the guidance. So I mean, is that a fair way to assess it, that right now the second quarter is kind of feeling like the first quarter. It is all about beyond that?

Yes. I think our view is more of a full-year outlook. We have kind of gone away from trying to do quarter-to-quarter estimates or targets. But again the headwinds that we have talked about from material costs, LIFO, seasonality, and so forth, from our standpoint, would cause margins to come down first half, then down in the second half. But, I am sorry, go ahead.

I am sorry, Glenn. The visibility you have from your customers, I mean call it Cat, or whoever you want to think about, of course the schedules they give you can change. But the stocking and then maybe the third quarter, fourth quarter you are more concerned about what is really left after the stocking. What kind of levels have they already articulated to you about the third and fourth quarter. Does that really reflect that kind of environment, or is it just a concern you have, and their schedules don't yet reflect that slowdown?

Yes. Dave, this is Mike. If you look at, let's just take mobile industries as an example. So our outlook for the year would include what we already see on the order books, and what we anticipate any strengthening or weakening from the standpoint of one, the market strength, but two, the seasonality that Glenn was just talking about, and then the third piece was, in addition to seasonality, this fourth quarter is always a question mark, especially with regards to the automotive industry. So how it impacts the volume we get from LVS. The economy strengthens, and you see light vehicle builds that are approaching kind of 12 million, 13 million. Then they may run through that. If not, then they may have overbuilt even in the first half. It is a little hard to tell.

We have got good visibility. I will tell you if you look at the aerospace business, as I said, the second quarter actually is going to be the trough for them. So that is going to be what seems to be the low point. We are already beginning to see bookings and orders pick up for that part of the business in the fourth quarter. So we have got good visibility, it is part of our outlook. But there are a lot of moving pieces right now as to how much of it again was the inventory, pipeline replenishment, how much inventory destocking by the distribution players, and then how much this recovery will really take hold.

One last question for the bigger picture, kind of 2012. 2012 framework is roughly $5 billion of sales and $11 million on the EBIT margin. That gets you to 3.50. The quarter we just posted, we already had margins essentially double digit, with really not a huge difference between aerospace mobile and process, obviously aerospace was a little higher. But roughly low double digits. When you think about the 2012, basically steel, you would like to think will be a little bit higher than we saw this quarter. Are you thinking of the Company in that framework where they are all roughly kind of 10% to 12% margin businesses. Or should I think of when process gets some revenue growth again, that is inherently a 15% plus margin business, and it is a matter of can mobile stay double digits to make that 2012 margin target look conservative?

Again when we established the targets, it was the belief that in a normal economic environment that our process in aero both had high teens, rounding up if we wanted to hopefully see very good performance at 20%-ish kind of numbers out of the realm. When you look at our steel business, we talked about low double digit margins being kind of a more normalized level. Not hitting necessarily the peak that we had in 2008 because of the issue of the timing of the material recovery mechanism. So kind of low double digits. And within mobile, it was in the mid to high single digit numbers, but getting them back to earning their cost of capital. You blend those all together, you do get to your 10%-ish kind of operating margin in that environment, but with all of the businesses performing at a good level.

It sounds like where we are right now, first quarter. The other businesses climb, and mobile would really have to fall back somewhat notably to make that target on margins. I mean, of course it is predicated on getting the revenues. I understand that. If you think of a $5 billion revenue number, the target would seem conservative unless there is structurally a reason mobile should only be a 5%, 6%, 7% margin business, despite we just put up over 11%.

Right. And your math works. Again our view is that at that level of targets that it would be record performance for the Company. The one issue that we have is based upon what we did in the first quarter was mobile. Our expectation was not that double digit operating margins are a sustainable level for that segment, as we see it today in the mix of business. So that is the target assumption. As Mike said, we do expect those margins to come back more into the mid-single digit levels, so we will see how things transpire. But we have to see good operating performance, good volumes to generate those kind of targets, which again would be record performance for us as a Company.

I appreciate it. Thank you.

Next question comes from the line of Melissa Cook with CLSA.

Good morning. A few questions on Asia. I wonder if you could just talk to us about the capacity utilization and how far you have ramped up some of your newer plants in Asia. As we think about the next several quarters, and growth and contribution from that business, how much is coming from end market demand, and how much is just coming from productivity of your own operations?

Hi, Melissa. This is Mike. Let me give you some insight to what is happening in Asia. The first quarter for our business in Asia, we were up just short of 30%. And so while we have talked about our Asian business remaining relatively strong through 2009 during this global recession, you can see that as the economies begin to pick back up, we are really being able to leverage now the infrastructure and the capacity that we put into Asia. So this is really good. And this is really across Asia. So that has been the number one, actually Latin America was very strong for us also as we come to the first quarter.

From a capacity standpoint, as you know, we have put a significant piece of capacity across most of our product ranges in Asia to serve Asia. And we still have a lot of capacity to utilize. It is ramping up, it is actually coming very well. But I will tell you in one of our largest facilities that you visited, that we still probably are operating at less than what we would say, probably 30% of what the eventual capacity is. And yet so we have got a lot of upside in the investments that we have already made, with regards to serving those markets, and right now it is very attractive margins for us also. So that is to a certain extent, while we see the remainder of the process industry's business being hurt by the western world, the major capital equipment builders, and the destocking and distribution, it has been buoyed by very, very strong Asian sales.

So what does it take to get from that 30% utilization up to a much higher number? Is it just your own working through the kinks or is it demand?

No, it is a combination of two things. One, as we ramp up manufacturing facilities, this is the process by which we do it because we not only decide to put certain products in there, but we are expanding into hundreds and thousands of different part numbers. So they are very specific to customers' applications, et cetera. So there is always a normal ramp-up of both capacity, the capability of the people, and then the expansiveness of the products that we can actually produce there. So that is number one.

Number two is just purely the market. We anticipated the market demand, not only for Asia, but also for the rest of the world as these are global operations that can serve most of the markets around the world. So it actually, I will tell you, Melissa, it is actually a pretty nice ramp-up because at the time where we have continued to bring up these capabilities, is when many of the markets we anticipate are continuing to strengthen, in particular Asia. But when the rest of the world goes, there will be high demand on those facilities in that capacity in particular. So it is a combination of all going very much as planned. Pretty exciting because it tells us that we don't need to put enormous amounts of capital back into the business at this point to enjoy significant revenue increases over the next several years.

Okay. That is great. And question on wind. I am starting to get a lot of questions from clients as far as your wind facility. It looks like you went commercial this quarter. Can you just talk about your customers? Is it just the one customer that is your partner? And then today China came out and said they were going to try to increase the targeted amount of gigawatts of alternative energy, including wind. So what are your thoughts on wind in China, in terms of your own capacity and your own progression there?

Yes. Wind in China from a market perspective very robust. As you said, we have gone live now with our facility, which is a joint venture with our largest customer that will be utilizing that product. But at the same time, our demand in the wind energy market is up both from the standpoint of current production, but also new designs in the market. Hence, that in addition to the capacity increases that we put in China, specifically to serve that market, we have also been increasing our capacity in North America, and also in Europe, to serve similar markets with similar sized products, where we are really getting pulled into the marketplace, relatively aggressively. So very targeted. It has been a good investment. The wind energy markets do remain relatively strong, with regards to what the forecast is of new installed capacity. And it looks like we have hit some pretty good sweet spots with regards to the capabilities we have put in place.

Great. One final quick question on aerospace. There are a lot of new contracts being awarded from COMAC in China. And is that something we should expect to see from you, or would that be from one of your customers? What are your expectations to participate in the C919?

Yes, I think that as the future unfolds, we will talk more about what we're going to do aerospace wise in China. As you know, we put a new facility in China to make aerospace components. The demand has increased significantly on that facility. That is a new facility that we opened up last year. And that demand is coming both from the Asian market, but also from our customers across the world, because if you remember we were in a capacity constrained situation prior to 2009. We are now in this trough. But as I have mentioned earlier about now getting future bookings and looking at future orders, we are starting to see a pull on the new capacity that we have put in place. And that is kind of from around the world, Melissa, not just Asia. So it looks like it is positioned pretty well for the future, especially as that aerospace market in China, as you know, is going to grow and grow very rapidly. They are looking for people like us who have these kinds of capabilities there.

All right. Thank you.

You bet.

(Operator Instructions). Your next question comes from the line of Samuel Eisner with Sterne Agee.

Hi, guys.

Good morning.

Just had a quick question. I guess on the steel side. I guess what was utilization for the steel business in the first quarter?

Yes. Sam, this is Sal. We were in kind of mid-60% utilization rate during that boom, so to speak, with the restocking and demand improvement.

Okay. Great. I guess maybe you can put some color around, I guess the guidance for the steel business. Obviously you guys are anticipating obviously some, pretty substantial year-on-year increases. I know you talked about obviously volumes. There was a big increase kind of in the first quarter here. What are you thinking about steel pricing in the back half of the year? How does the pricing mechanism kind of parse into what you guys are expecting for the year?

Well, we are finished with our contract negotiations. We finished that up through the last part of last year, the fourth quarter. And for all practical purposes, we held prices steady. So we didn't see the pressure we were concerned we might see. We still retain our full surcharging mechanisms in place, that help mitigate the risks of the volatility in the raw material prices. So from the point of view of pricing, we think we are fairly well set for the course of rest of the year. The real issue for us is just how strong the market's recovery will be, and how extensively it will reach.

Clearly just as Mike described, we felt and saw very good benefit from the mobile markets as buyers went back to buying cars with some pressure that I think has been built up relative to that. We are still not seeing a great deal, although some surprising better than we thought recovery within the oil and gas markets. We have some hope that we will see that improve in the latter part of the year, probably about the same time there would be some mitigating of the mobile business.

Our biggest positive sign was, as we spoke last year, the distributors, our distributor base, which serves a much broader base of many smaller customers. We have watched them very closely. Because any sign of return there means there is a general economy recovering with a lot smaller businesses. And we are seeing some nice recovery there. It is not a boom. But it is very, very solid and it is steady. And so we think we will see something pretty steady throughout the rest of the year here. It is about as good as I can give you a picture that we have got. We are only seeing orders, we are booking now into June and July. So we don't really have good visibility to the back half of the year from a solid customer activity yet.

Okay. Yes, that color about the back half of the year visibility is definitely helpful. These are just more housekeeping items. As far as CapEx is concerned, I know you guys have stated that you are going to do about $135 million for the year, but in the first quarter you only did about $14 million or so. Is that a seasonality aspect? I guess when does more of the CapEx come into play throughout the course of the year?

It is timing related. So it will start to come in throughout, once they pro rata throughout the rest of the year. But we are again, especially with the lack of availability and so forth, we are continuing to put fairly tight controls on costs and capital spending. But it is our expectation that we will spend that $135 million during the year. But it will be a little bit more back-end loaded.

All right. Great. Then just lastly, you guys mentioned FX or currency definitely helped out in the quarter. Is there any way to parse out the differences between organic and FX for the quarter, or even by segment, if you have that type of granularity?

Currency affected our top line by around 2%, so call it around $20 million-ish in sales. Obviously the weaker dollar benefiting the top line. Across the segments, principally the bigger impacts would have been in mobile and process, which are our more global businesses than within aero and within steel. And in those two groups, both were roughly around 4%, benefited from currency on the sale.

Okay. Great. Appreciate the help. Thanks.

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

Hi, good morning guys. This is actually Jason Brocious in for Mark. How are you?

Good morning, Jason.

Hi. Most of my questions have been answered. I just have a couple quick ones on steel. Sal, I was wondering what you are seeing in scrap moving forward the next month or so?

Sure, Jason. As you know, the price has strengthened over the course of the first quarter. It appears at least for the near term, they have probably about peaked. We are actually expecting to see prices moderate a little bit through the May into the June time period. And then probably strengthen again. I think it was my interpretation is that it was the double pull of restocking and demand that really kind of stressed the iron unit marketplace, there probably was a lot of uncertainty with the big oligopoly of iron ore guys really pushing on that price to put a little bit of fear into the scrap market. But it appears to be mitigating to some extent, we will probably see just a very small pullback and then stabilization, unless the market takes off like crazy. A little bit of softening in the near term, probably returning back as we move further into the year.

Okay. And as far as an auto buyer, what does the competitive environment look like right now?

For auto bar products?

Yes.

Yes. Actually the environment is probably the strongest market we have seen in quite a while. Just about anybody that I know who serves that marketplace is working pretty hard, working pretty strong. The expectation again, I hate to be repetitive, but we believe that this is the case. It has been -- all of the capacity serving that market has been doubly hit for restocking, as well as an increase in the auto sales that we see. Every indication is that will just soften slightly as we go back into the latter part of the year. But currently that product is probably booked for eight to 12 weeks out.

Eight to 12. Okay. Great. Thanks, guys.

Sure, Jason.

Your next question comes from the line of Chris Mecray with BlackRock.

Hi, there. Your steel group performance really stood out relative to other steel mini mills out there, particularly broadly speaking metal margins haven't expanded much. Yours appeared to have expanded notably. In fact your dollar increase in EBIT in the quarter exceeded your sales increase. So I am wondering, given that there is a negative mix issue and a lack of LIFO benefit, whether it was really just coming from primarily the cost reduction initiatives that you have taken, and if you can quantify that, and speak to whether costs come back as we get through the year?

I will try to, Chris. As you may recall, if you were on any of the calls last year, we indicated that on the course for the average of the year, we operated our melt operations last year at about 30% of capacity, maybe 35%. That was a devastation for us. We have never operated under those levels before. We believe we have moved our breakeven point down south of 60% utilization. And frankly we have been so close to that breakeven point, and that was done through our own cost reduction initiatives, that these marginal volume increases have been very positive in terms of contributing to our ability to perform back in the black. So where we are, as I mentioned a few minutes ago, kind of mid-60%ish utilization rates for the first quarter. We expect we will stay in that territory, if everything we see has been right. We expect our cost performance will remain about where it is. The only wild card is how strong is the market, and where do these raw material prices go as a consequence of that. If it is different than what I just described a few minutes ago.

That is fair. I guess can you just speak to what your peak utilization was going back a couple of years ago?

2007 and 2008 we were basically at full capacity.

So the suggestion is another 35% increase in utilization could drive the double digit number that you referenced as a target, there should be a layup?

If the demand is there, we would agree with that, yes.

All right. Thanks.

Next question comes from the line of Marty Pollock with NWQ Investment Management.

Yes. If we could stay on steel. I am just wondering, the surcharge mechanism you clearly indicated was a big number for the quarter. But if we assume that let's say the surcharge, it's a surcharge, it is not something you would keep on as a base price if raw materials change on you with this new quarterly pricing mechanism across a number of sectors. What would be the negative or decremental margin impact here? I mean, could we assume that the fact, the numbers could be much weaker on steel, unless you expect to offset that with rising utilization? I would be concerned that at least know what would be your thought about overall margins that you could at least maintain for the full year. I mean at this point 8% margin I think for this quarter reflects a huge surcharge benefit. But looking for the full year, what should be assumed is still a number you are comfortable with, your guidance on the EBIT line?

Marty, this is Sal. Again a couple points that you made have me a little confused. But let me just sort of touch base on a couple of the points you made and see if I restate them properly. We have demonstrated about 7.5% EBIT margin for the first quarter. We expect when we have a proper or a more balanced and more optimum mix, that we would be in low double digit EBIT margin territory. So we would expect to see ourselves marching back towards that as we see demand improving. In terms of the impact that the surcharge has on our overall margins, please appreciate the fact that our LIFO and surcharge numbers kind of move in opposite directions.

So as our surcharge goes up, we will take a LIFO charge against that, because the raw material prices are going up. And similarly, there is a bit of a mitigating effect on the downside, only relative to how far through the year we go before we make some of those adjustments. So they kind of work in tandem to try to stabilize that, except in the case where you have got exploding raw material costs, or collapsing raw material costs, where that just happens all at one time. We are not on a quarterly pricing mechanism. We are on a monthly pricing mechanism. So that surcharge is adjusted and changed as the raw materials swing.

The only real issue is the fact that there is a bit of a timing delay in that the surcharge established this month is applied to the following month surcharge mechanism. So it is always about a month to eight weeks in arrears, depending on how long the cycle time is for any of the products we make. So we are pretty close to realtime when it comes to passing through or absorbing, whatever the swings in the raw materials would be, without much impact on our base pricing whatsoever. Did that clarify something?

Yes. That actually does. Because you are saying I think about the surcharge having the offset impact with the LIFO. Let me just then make sure I understood. Did you give us a margin guidance for the full year on this increase of revenues at 60% to 65% for the full year. But was there a guidance for the full year on margins for the steel group? I think it was Eli's question, but I am not sure if I heard the answer.

We did not give any guidance relative to what margins would be for the year. Just what we experienced in the first half, throughout the course of all of last year. We kind of talked about what is normal, for a normal demand time in that low double digit range. We don't know what it will be this year. What our guess is wrapped up into what our guidance is for the earnings for the full year.

But that current performance in Q1 could be still a number that would be reasonable, at least as a starting point for the full year with that improvement in your sales guidance?

I wouldn't argue with you. I think that is probably a very safe estimate.

Okay. Thank you.

Sure, Marty.

There are no further questions at this time. I would now like to turn the call back over to Jim.

All right. Thank you. I guess if you sum up the conversation this morning, we had a very solid performance on a modest demand recovery. Lots of moving pieces, especially including the economy as Mike said. That leads us to be cautious on the second half, but very confident that the results this quarter reflect a fundamental change in the Company's performance capability, and overall we are very pleased with the quarter. Thanks again for your interest in the Timken Company.

Thank you for participating in today's Timken's first quarter 2010 earnings release conference call. You may now disconnect.