Timken Co (TKR) 2010 Q2 法說會逐字稿

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

Thank you and welcome to our second quarter 2010 conference call. I'm Steve Tschiegg, Director of Capital Markets and Investor Relations. Thank you for joining us today and if after our call, should you have any further questions, please feel free to contact me at 330 471 7446.

With me today are Jim Griffith, President and CEO. Glenn Eisenberg, Executive Vice President of Finance and Administration & 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'll then all be available for Q & A. At that time, I would ask that you please limit your question to one question, and one follow-up at a time, to allow an opportunity for everyone to participate.

Before we begin, I would like to remind you that during our conversation today, you may hear forward looking statements related to future financial results, plans and business operations. Actual results may differ materially from those projected order implied, due to a variety of factors. These factors are described in greater detail in today's press release and reports filed with the SEC, which are available on our websitewww.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. Buy now you have seen our press release and know that Timken delivered very strong results for the second quarter. I'm exceptionally proud of the company's (inaudible) during the period. We successfully leveraged the upturn and picked up operation -- (inaudible) posting strong profitability, that well exceeded our expectations.

Overall, our top line sales driven primarily by improved demand in mobile markets, were up an impressive 37% versus the previous year. Our operating margins improved to 12.9% for the quarter, while free cash flow was $140 million. Clearly our results underscore our ability to deliver improved shareholder value with a performance driven portfolio. Before I turn the meeting over to Glenn, for a more in depth view of the Financials, let me give you a glimpse into the market place, a roundup of our segment's performance and characterize how we see the balance of the year.

In many ways, this recovery is following the pattern, of a typical cycle. Albeit, coming off the deepest recession of our lifetime. We have seen stronger more sustained demand across mobile markets. In the North American marketplace, light vehicle production continues to improve slowly, with current estimates in the range of 11.6 million units, for 2010.

We have also seen improvements in heavy truck production, construction equipment and mining, heavy industrial markets traditionally lag in a recovery and this cycle is no different. Capital spending remains low and few major projects are being launched, with the notable exception of Asia. In the industrial distribution channel, weak demand from end users has been exacerbated over the past year, by a reduction in inventory's. So called, destocking.

And Aerospace, traditionally a late cycle business, is following a similar pattern. Improving demand from mobile markets, has bolstered both our industrial -- our mobile industry segment and our steel business. In mobile industries, we gained higher returns on increased volumes, as improved pricing and lower costs, combined to yield a especially strong margins.

In our steel business, the increase in volume was supplemented with demand from industrial distributors and the energy markets, as last year's destocking trend was reversed, with restocking in the second quarter. The steel business rebounded well from utilization's of less than 30% in the second quarter of last year, to levels approaching 70% this quarter. And while we did not see increased shipments, in process industries or aerospace, their order patterns have picked up, reinforcing our confidence of improving business conditions, in the second half.

Beyond execution efforts, we continue to concentrate on key opportunities to grow our business. This growth has been in new market spaces, for our innovation and highly engineered products or value. For example, we continue to build momentum in Asia. We have expanded our presence in India and China, as well as in the commodity markets, which have benefited from their growth. Our sales in the Asian region, for the quarter, were up 35% from last year.

Wind energy, is another market space, where we are making great progress. We shipped our first ultra large bore bearing, which is about 6 feet in diameter, from our Xiangtan plant to XEMC Wind Power, in China. We also just announced, a $26 million contract to supply wind turbine products and services, to Goldwind in China. One of the world's top five wind power equipment manufacturers.

We are also adding breadth to our portfolio, with a recent agreement, to acquire QM Bearings and Power Transmission. QM manufactures spherical housed units and takes us into couplings. The addition of QM expands our penetration in high performance applications and extends our power transmission capabilities. I'm very pleased with the progress evidenced in the performance of the Company. All four businesses are contributing to our improved performance.

This is a direct result of the transformational changes we have made. And that makes me and our leadership team extremely optimistic, about our Company's prospects. That optimism is what underlies our improved outlook, for 2010. We are seeing improvements in demand from our customers and are taking steps to increase staffing at our plants to meet it.

Since the trough of last year, we have brought back more than a thousand, full time production associates, in industrial and steel operations. We have also ensured our flexibility to adjust our work force, with the addition of a 500 full time equivalent contingent, employees. We are continuing our pursuit of opportunities to expand our portfolio and grow revenue around the world. At the same time we are constantly aware of the risks, facing the recovery in the global economy.

We continue to be prudent in our investments and maintain strict spending controls, while adding capacity and capabilities, in ways that retain our flexibility to adapt to economic changes. Nevertheless, our performance in the second quarter, increases our confidence that our strategy is correct, and that Timken Company which emerged from last year's recession, is a very different entity, from the one that entered into it. Now, let's turn Glenn, to give you a more in depth, financial view.

For the second quarter, the Company's fully diluted earnings per share from continuing operations, were $0.84. Excluding special items, earnings were $0.85 per share. Special items during the quarter, were less than a million dollars of after tax expense, relating to severance and manufacturing rationalization. The rest of my comments will exclude the impact of special items.

Sales for the second quarter were $1 billion, an increase of 37% over 2009. The increase was primarily due, to stronger volume within our mobile and steel segments, as well as the impact of higher surcharges. Gross profit of $269 million was up $142 million from a year ago. Gross margin for the quarter was 26.6%, up 940 basis points from last year.

The improvement was driven by higher volume, manufacturing utilization and pricing. For the quarter, SG&A was $141 million, up $13 million from last year. The increase reflects higher costs related to performance based compensation plans, amounting to roughly $20 million, which were partially offset by cost reduction initiatives. SG&A as the percent of sales for the quarter, improved 340 basis points over last year, to 13.9%.

EBIT for the quarter was $131 million, or 12.9% of sales, up from a slight loss a year ago, which marked last year's trough earnings. 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 this tax rate of roughly 32%. As a result income from continuing operations for the quarter was $82.2 million, or $0.85 per share, compared to a loss of $0.07 per share, last year.

Now, I will review our business segment performance. Mobile industry sales for the quarter were $400 million, up 37% from a year ago. The increase was primarily driven by higher demand across light vehicle, off highway and heavy truck market sectors. From an earnings perspective, the mobile segment achieved strong profitability, with EBIT of $69 million or 17.1% of sales, compared to a loss of $12 million last year. The improvement was driven by increased demand and better manufacturing utilization, as well as cost reductions and improved pricing.

Looking ahead we expect mobile industry sales to be up between 20% to 25% in 2010. The Company expects improved demand, in the light vehicle, heavy truck and off highway market sectors. While rail is expected to be relatively flat. However, profitability for the second half of the year is expected to be lower than the first, primarily due to sales mix, higher material costs, and the impact of seasonality.

Process industry sales for the quarter were $212 million, up 2% from a year ago. Stronger demand within the aggregate wind and gear drive market sectors, was partially offset by lower demand in the oil and gas and metals markets. From a geographic perspective, the increase in sales came from Asia. While demand down in both North America and Europe.

For the quarter, process industries EBIT was $29 million, down from $35 million a year ago. Margins were 13.7% of sales, compared to 16.9% last year. The benefit of cost reduction initiatives, was more than offset by higher material costs, production ramp up costs to serve the wind energy market and higher SG&A costs.

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 the heavy industrial and power transmission market sectors. While we are beginning to see signs of improvement within the distribution channel, most of the industrial original equipment markets, remain weak. Aerospace and defense sales for the quarter were $83 million, down 24% from a year ago.

Since the first half of 2009, the business has experienced a continued decline across the late cycle, commercial and general aviation market sectors, while defense related demand remains relatively flat. EBIT for the quarter was $7 million, down from $19 million a year ago. Margins were 8.7% of sales compared to 17.1% last year. The decline in profitability, was primarily driven by lower demand and manufacturing capacity, underutilization, as well as higher SG&A costs.

Aerospace and defense sales for 2010 are expected to be down between 5% to 10% primarily due to a drop in commercial and general aviation demand and relatively flat defensive defense markets. However, we are seeing signs improvement in commercial and general aviation markets, including increasing passenger flight mileage and freight traffic. And expect improved sales in the second half, compared to the first half.

Steel group sales of $338 million for the second quarter, were up 151% from last year's second quarter sales, of $135 million. Which was the low point in 2009. The increase was driven by strong demand in most of the steel group's end markets, with the greatest increase in automotive. In addition, surcharges were up $84 million for the quarter, due to higher raw material prices and overall demand. EBIT for the quarter was $43 million or 12.7% of sales, compared to a loss of $33 million last year.

The increase resulted from higher volume, improved manufacturing capacity utilization, and cost reduction initiatives. The Company expects Steel Group sales for 2010, to be up between 70% and 80% 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 $303 million.

Operating cash flow for the quarter was $178 million, while free cash flow after CapEx and dividends was $140 million, primarily driven by strong earnings. For the year the Company expects to generate cash from operating activities, in excess of $380 million and free cash flow in excess of $200 million. This improvement is expected to be driven by improved earnings and working capital management and after investing approximately $135 million in capital programs and $135 million in pension contributions.

Consistent with prior years, we will consider making additional pension contributions, based on our funded status and financial leverage. Including cash and available credit, the Company had liquidity in excess of $1.6 billion at the end of the second quarter, with no significant debt maturities until 2014.

Providing flexibility to pursue strategic investments. During the quarter, the Company purchased 500,000 shares of its stock for approximately $15 million. Now, turning to our full year outlook.

We expect sales to be up approximately 25% to 30% over 2009 and earnings per diluted share excluding special items, to be between $2.40 and $2.60, up from our prior estimate of $1.60 to $1.80. This increase reflects the Company's second quarter performance and an improved outlook for the second half of the year. This ends our formal remarks and we will now take questions. Operator?

(Operator Instructions). Our first question comes from the line of David Raso with ISI Group.

Hi, good morning. My question is about the mobile margins in the second half. You mentioned mix, material cost and seasonality. Can you flush out a little bit more the issue of mix in the second half, versus the first half?It might shed light on which end markets are the key pressure points on margins. Can you take us through that, please?

David, this is Mike. Let me just walk you through each one of the, kind of sub segments, It'll give you a little bit of flavor as to what is going on. In the light vehicle side of the business, that is the one that really rapidly moved up, almost 60% year on year from a revenue perspective. But sequentially, if you look at it versus Q1, it was up less than 5%. So, we are beginning to see a little bit of flattening in the light vehicle and it is the one that causes us the most concerns for the second half, given if it flattens out and or the major car companies, etc., take shutdowns as they typically do at end of the year in December, impacting fourth quarter revenues. So, there's always a seasonality affect in the second half, plus the potential shutdowns in the December time frame, which is a possibility depending upon the economic outlook, all right.

That is roughly, what, 30%, 35% of that business right now is light truck? Just trying to get a sizing -- 25% or 30%.

It would be -- yes, that is probably fair.

Okay.

Then you have got the heavy truck markets, which have again ramped up in a very similar fashion, up almost 60% year on year, softened at least sequentially from the first quarter, down to about 5% that we see pretty steady towards the second half. A little bit of strengthening and then a big 2011. So we'll see some volume pick up there. So there is a little bit of the offset where I will say light vehicle is the one most concerning. Heavy truck is a little bit of flattening but still a strong second half. Off highway continues to strengthen?It hasn't been up as much as light vehicles and heavy truck, but it is up again in excess of 30% year on year and sequentially up over 15%. So that is becoming a little bit more attractive and we are seeing some strength there. We are not as worried about that. And then rail still really in their trough. As you know, a lot of our rail business is domestic freight car business and although beginning to pick up it is in a pretty significant trough. The story is really going to be around the light side of the business, David.

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

Hi, guys. I guess I will sort of pick up on that same theme. Obviously, it is sort of an eye popping mobile margin here and doesn't intuitively make sense to me, that concerns about the light vehicle, would actually lower your margin in the second half. Is the light vehicle margin now that good, that it's actually sort of explains why we had such a high margin here?

Well, if you go back to the last several quarters, Steve, as we talked about the completion of our transformation, of this entire side of the business. We talked both in terms of our activities to focus on specific geographies, applications, customers, etc. And then the fact that we were also losing some volume, as we move forward as a result of a lot of the implementation of our strategy. To a certain extent, it is playing out exactly as we thought it would. We provide enormous value into that market share. Most of our customer base is staying with us, but we have predicted and we continue to forecast, some revenue loss as we go into the second half. So you can't look at just the economic dynamics. You also have to consider the fact that we have lost some business in that marketplace. So depending upon what ramps up fast and what doesn't and the applications and customers that we stayed with, it does impact that second half.

Okay. I guess, but it looks to me like the 17% margin you guys didn't provide numbers, but you sort of back into your second half guidance. I think we going to have to have something closer to 10% or 12%, in mobile going forward, which is a pretty big sequential decline. So, I don't know. Am I wrong about that, or is that something that is really that big an impact in the second half?

I tell you a couple of things, Steve. First of all, as we talked last quarter and we talked as to what we thought the on going margins would be in the mobile business, if you will recall we were talking in kind of the mid to high teens which seemed reasonable for a business that was in a turn around. We had seen attractive margins coming into the first quarter and you now see it in the second quarter. Which was impacted by a few quarter specific things, but now as we begin to talk about the second half and look for the full year, we are moving our thinking from that kind of mid to high teens to low double digits. Or I mean, sorry, mid to high single digits to low double digits. So, we are seeing the structural improvement in the business. We think we have got a revenue deterioration from the second quarter. Based upon what we see, at least on the light vehicle markets and their potential, to take some shut downs in the second half of the year. Some of that lost business impacting us in the second half of the year, but improved basic structural performance in the business that will still bring those or keep those margins relatively high.

Great, thanks.

You bet.

Our next question comes from the line of Eli Lustgarten with Longbow Research.

Good morning. As they say, whatdo you do for an encore after this great quarter? Nice to see it. Since we spent all the time on mobile, can we take us through the other three pieces of the Company, process, aerospace and steel. As far as second half what you are seeing profitability wise and happening to the current margin. I guess the implication is, that you expect both process and aerospace to go up and steel to probably come up just a little? Is that sort of the expectations.

Let's walk you through the segments, Eli, this is Mike. And then I will turn it over to Sal on the steel side. If you look at process, we got two things going for us in the second half of process. A continued strong Asian market, which I think as Glenn and Jim both alluded to, were up over 30% again in our Asian markets and even stronger in China and India. So that is working out real well and that basically, comes up through the process industries business. The second part of that and this is something that we talked about over the last year, was the destocking in the distribution markets and we believe that that's about done. Because we are now beginning to see the balance between what our distributors, our industrial distributors, are buying and selling in the market. And where they were really destocking, I think given the economic conditions across the world, that is over. So we will begin to see the second half strengthen, with regards to our distribution sales to our distributors. So we will start to see those margins begin to bump up in the second half versus the first half. The troubling part of that business still is the original equipment markets of the major capital producers, capital equipment producers are still lagging. So the metals markets across the world and some other areas. The upside, though, on the OE side is what we have been talking about, in our wind energy business and the new contracts and business that we have gained in China, in particular. It has been significant. And that being impacted also as we gain those contracts, we are ramping up capacity pretty rapidly, so that is costing us a little bit. So, a pretty good picture in still a relatively low economic period for process industries, so we are real tickled about that. The aerospace side of it, is as we talked about, it a late cycle business, and it is playing out about the way we thought it would, Eli. The civil aerospace part of it, we are beginning to see some strength, but there's still a lot of aircraft that's parked, etc. The defense part and in particular, the Roto Craft part of the defense market, which is where we participate, has remained relatively strong, but you can see overall it has hurt our revenues, as you look at the entire business. Those revenues based upon our bookings and the backlog of business, we know will improve in the second half, so we would expect those margins to begin to move back up from the trough in the second quarter, both through the third quarter and the fourth quarter, into a stronger 2011. So, pretty good overall I think, as your opening comment said, as we look at the whole Bearings and Power Transmission group. It is a nice mix of market moves, balances of cost reductions, leveraging all of the investments we made in Asia. So it is allowing us to put some pretty good numbers on the board.

Eli, with respect to steel, you had it just about right. I can give you a little color behind it too. We were kind of early in the bull whip of seeing the demand, both from the improving health of the economy and then the restocking or restoration of the pipeline of product and in fact in response to that, we actually postponed a regularly scheduled mid year maintenance and early year maintenance activities, in order to synchronize it with when we thought we would see the -- diminishing of the restocking issues. So, we actually think we are beginning to see that now. And so our second half, we will be down a little, predominantly due to two pieces. One, we will have maintenance outages, that will be in harmony with we think will be the restocking alleviation. We will have a bit of a problem, now that we have restored our workforce to a full force, of a bit of a productivity issue, because we have got a lot of new people and a lot of new jobs. And the combination of those two will put -- we will see a bit lower volume in tonnage. We will see a little bit lower volume on dollars, because of the compounded impact of the lowering raw materials. And we will see a little pressure from our maintenance costs and productivity issues in the second half, that we didn't see in the first half. Then be prepared for a pretty solid 2011 when that time comes.

Are those maintenance costs in the third quarter or fourth quarter, that's shut down? Or spread out between the quarters or how are you doing it?

It will be split out between the two. We will start between three to four weeks and then have a second piece of that in the fourth quarter, after the end of October.

All right. Thank you.

Our next question comes from the line of Andrew Obin with Bank of America, Merrill Lynch.

Yes, good morning.

Good morning.

Just a question just going back to Dave's question on mobile industry margins. First just to make sure, were there any sort of extraordinary one-time gains in the quarter?

We wouldn't categorize it, at least from a significant stand point. There are always some adjustments being made to our accruals and so forth, but relative to the performance, it probably helped a little bit. But your still looking at very strong double digit, mid teens kind of margins. But that happens every single quarter, so we wouldn't say it really affects it dramatically.

If my model is correct there's $105 million for bearings in the quarter -- my model goes back to '98 on a quarterly basis. Seems like it is the highest absolute quarter for the bearings sector like, in over a decade, if not ever. And we are only in the first year of recovery. So the question I have for you, could you separate the EBIT for the quarter? Just order magnitude, sort of heritage Timken, versus EBIT that is coming from your growth initiatives that you have taken over the past couple of years, India and China. So we could get just a sense of how much better the core profitability of the historical Timken has given the changes in your pricing strategy and how much profitability you have from all your growth initiatives, over the past couple of years?

Andrew, this is Mike. Let me see if I can give you some color, because it is relatively difficult to separate it out. But let me see if I can walk you through that. I would tell you that the two biggest pieces of the performance improvement versus historical, has been, I'll call it the operational side. Which basically over the last ten years, we have taken on strategies to drive our cost structures lower, across the world. And if you look at our manufacturing footprint as an example, that the opportunity to go after an Asian market was two fold. One was, it was an attractive market for the future of which we believed, our value proposition, was going to allow to us compete and sell at very desirable margins, in a very fast-growing market. But one that was deemed to be one of low cost products etc. And then we found that to be absolutely not true. That market is full of opportunities for high value products, from companies that provide enormous value from the perspective of knowledge based technical capabilities and etc. And we leveraged both our growth in our manufacturing capacity installation in Asia, to both that market and catching that market. Which is a significant piece of the change of the Timken Company, as we look at the transformation. But also bringing down our global cost structure by which to serve it. And so that has been a big piece. Now, obviously the pricing initiatives that we've taken on over the last several years. In particularly in the mobile industry, has been very successful in getting this business turned around. But again reflects the value that The Timken Company creates in these markets and then are able to obviously get paid for it. Significant move, if I go back to your original comment, this would be a record month for the Bearing and Power Transmission Group. Historical on a quarterly basis. And but, done in a period of time, again, if I continue on, that we still are only utilizing 70% of our capacity. A lot of our capacity is still available for growth in Asia. And so this is relatively low cost, high value, high performance type product, to serve that -- those markets and the global markets. So there is still more upside on this story.

Any way you could share with us what percent of EBIT came from Asia Pacific manufacturing?

Well, we don't break it out -- we don't break it out by Asia. And then when you talk about Asian manufacturing, it is used to serve the global markets.

No, no, I -- okay. I'm just trying -- I guess what I'm trying to separate is, A, the impact of the pricing initiatives that you have taken over the past several years. And B, as you have pointed out, strategically shifting manufacturing footprint into India and China. That is what I was really getting at.

Yeah, Andrew, this is Jim. I don't think you can really break it out. That is why we call it a transformation, because it is a fundamental change. I will think if you come back to your original question, what part of the profitability is the new Timken Company. And what part is the old Timken Company. The change in mobile is basically the improvement in price cost combination. The growth of the process that was a part of our business, but it is now a much bigger part of our business. And it has always been profitable. And aerospace is a fundamentally new business. It is where effectively we have taken and gone well beyond bearings in that space. So if you kind of look at it from that point of view. The old Timken model is primarily the mobile model. The other two are the growth and the new Timken.

So pricing structure most of it is in Mobil, manufacturing footprint, most of it is in process?

It is a combination across the three. Or across the two. You can't be -- you can't break it out that way.

Thank you very much. Fantastic quarter.

(Operator Instructions). Our next question comes from the line of Mike Parr with KeyBanc.

This is Phil Gibbs for Mark. How are you guys this morning?

Doing well, how are you doing.

Doing okay. A couple of questions. First on mobile and I don't mean to beat a dead horse here. The results were very solid. I'm just looking at the incremental revenue and the incremental EBIT. And how should we think about that from the second quarter, over the first quarter, because you had $26 million in EBIT on $32 million in incremental sales. Was that cost reduction? Was that mix? Can you guys help me think about that right?

Yeah, there is -- it as combination of all of those things. As we talk about this mix change and I walk back and said sequentially, that we had two of our segments were up as much as 60%, but sequentially they were only up less than 5%. Other segments that traditionally have been good profitability for us, were up not as much year on year, but sequentially quarter on quarter, they were up more. So.

Okay.

A lot of that is a mix change. So we see that in businesses. We talked, when we began talking about the transformation of the mobile industries, that we had good parts of that business and we had troubling parts of that business. So now we are beginning to see those fixes come, over a period of time, but yet the mix of that business changes from quarter to quarter. So, I think going forward, as we get through this and we are done with, especially the loss business in certain parts of the business. We will begin to see those start to flatten out and be more predictable, versus the mix. So that all of the businesses are attractive.

Okay. Was there any -- were there any LIFO gains in the second quarter? I don't know if you mentioned that.

No, we haven't. And really it is very nominal. As a matter of fact, we really don't have LIFO in the quarter, other than if you compare it to our prior year period where we would have had income. But LIFO is relatively flat.

My last question here is just for Sal. Sal, what kind of sequential volume pickup did you see in the steel business in the second quarter?

What I can tell you, Phil, is that -- in the first part of the year, the first quarter we were operating in the low 60% capacity range, as we saw business return from it the depths of 2009, towards the last part of the year. In the second quarter we moved very evenly up from there to just about 70% of capacity. So, that is about a 6 -- about 16% improvement in terms of first quarter, to second quarter.

Okay. That helps. And then just to reiterate, you said that you expected that the -- volume to taper off a little bit in the third quarter, in line with some reduced -- reduced restocking and some maintenance outages that you guys would we be taking.

That's correct. That is what we are expecting to see and that is what our forecast and earnings sort of reflect.

Thanks a lot, guys.

Thank you.

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

A follow-up on the balance sheet. Looks like at the moment you are at $3 a share of net cash, so, even after debt, $3. And looking at how the model is playing out for the rest of the year, wouldn't it be crazy to be at net $4 by the end of the year. Can you help us understand the use of cash going into 2011, how you are thinking about it?

Sure, David. Again, we talked about, that we are expecting to generate or continue to generate free cash flow throughout the year. We talked about, from a capital allocation standpoint, obviously continuing to meet all of our internal growth needs. We also talked about strategically, we continue to look at acquisitions. We just recently completed or announced, the agreement to acquire QM Bearings and we will continue to be inquisitive and look for strategic acquisitions, that meet all of our criteria. We also talked about the issue that we still have fairly significant pension and OPEB liabilities. We've made a $100 million discretionary payment into our pension plans earlier this year. We will continue to evaluate putting more in there, but obviously that is still a significant liability to us. So, again, as we have talked in the past, acquisitions continue to be a focus to redeploy some of that capital. Pensions, internal needs and obviously we to have an authorized share repurchase plan, where we have been in the market on a fairly nominal basis. And have recently increased our dividend as well.

I understand that kind of past answer of all things you could use it for. If you end the year, let's say upside earnings, a little better cash flow, net cash of $400 million,.

Right.

In you generated zero cash next year, which obviously is not very likely. But zero cash. You can pay off the $150 million of CapEx next year. Which probably is roughly what you will do. And put another 100 in the pension and you're still 150 net cash and that is with no cash generation next year. Can you go a little further on helping us understand, at least your pecking order, on share repurchase, dividends and acquisitions. And what is the lay of the land right now, on the M&A pipeline, how you see it?

Sure, again. I hate to disappoint you and give you a similar answer to what I have just done, but clearly from a priority or pecking order as you called, it is meeting all of our internal growth opportunities, which we are within our free cash flow numbers, for the most part work. We are looking at strategic acquisitions. Again, we do have -- seen increased activity in the M&A markets. But no guarantees that will come about, but we are encouraged on what we are seeing and our ability to do good transactions, that add value to the Company. Again, reiterate that we have around a billion two of liabilities within our pension and OPEB obligations. And we'll need to get our pensions fully funded by 2015. But, frankly we are on a pace that we will most likely get there earlier than that. And obviously, it is a function of interest rates and asset returns that come into play there. So those are key priorities. Then when you look at dividends and share repurchase, you see the track record we have in dividends. You saw the increase. That is more a function in the profitability of the Company. We have initiated a share repurchase program back this year. And we have been in the market the first two quarters of this year, repurchasing some shares. But again, our view is that acquisition opportunities are out there. The needs for our pension OPEB obligations. We will see how we redeploy that capital, but clearly those with be the orders within, we would use that capital.

Thank you very much.

Our next question comes from the line of Samuel Eisner with Sterne, Agee.

Good morning, everyone.

Good morning.

Good morning, Sam.

A couple of questions , Sal, on the steel side. You talked about scrap surcharges were $85 million or $84 million in the quarter. With the new base price increases, how are you looking at surcharges or at least that mechanism, into the back half of the

Our mechanism stays in place. Base pricing increases have -- will be taking effect on all non contract business and sort of sets the stage, for a dialogue, as we move into our negotiation season, which is typically last end -- last piece of the third quarter and into the fourth quarter of this year. So, but we have no intention of abandoning our surcharge mechanisms, because of the clear unpredictability of these raw material movements.

You say that your visibility is better now? I mean because that was one of the things that you guys were talking about in the first quarter a little bit. This quarter. I mean has visibility improved or is it still pretty murky?

Asking about the company or the steel business?

Specifically steel.

Right now, I would say our visibility is better than the backs of our eyelids, which means our eyes aren't closed, but for example our lead times have moved out quite considerably. We are booked nearly to the end of the year right now, so from that point of view we are -- we see pretty well what the demand is like. And most of those in our particular segment of the industry, seemed to be in similar situation. Having said that and I don't mean to throw any cold water on a nice warm fire, but we saw an order book evaporate in two weeks in November in 2008. So there is enough uncertainty that, we don't want to count it on it. But right now it looks very good and we are getting no real indications from our customers, that they see anything other than continued, gradual and relatively, equilibrium based consumption increasing. So we're -- we feel a lot better right now, than we did at the beginning of the year.

Okay, appreciate that. Mike on the mobile side, you guys have priced in or at least talked about attrition on the repricing initiatives. Is there any way to kind of flush that out, how much the repricing benefited you, in this quarter. And what you kind of expected for attrition for the year and maybe for 2011?

I would kind of put it in simple terms, Sam, I think you can look at the margin appreciation over the last, sort of, 18 months. And figure that most of that, had to of been done through our pricing initiative. So, I would keep it in that context that a significant portion of the change is purely due to the pricing initiatives in the market, you can see it in the margins, that's clear. At the same time, now with some of the attrition of the business, obviously some of the benefits of the pricing goes away, as you face volume that you had. But, at this point it is something to look at, to sort of counter act, what could be still strengthening of some of those markets, as we look at our forecasting. But to the fundamental bottom line performance of the business, it has almost no impact any more, from a margin perspective.

Okay. That definitely helps. And then on process. Are the Asian revenues that you guys are getting, are those structurally higher margin than what you are doing in I guess the average for process?

The margins from Asia, I will put this in the context that I always have, are just as attractive, if not more attractive, than anywhere in the world. Our business model in Asia has worked, with regards to our ability to provide value and yet be very profitable as we do it. So, yes, it is a very attractive market for us.

Thank you very much.

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

Yes, terrific, terrific numbers. I wanted to ask, you talked about the auto bearings pieces, as something you would consider selling obviously if you could fix it you would have strategy of perhaps of selling it or keeping it, whatever you might consider depends, of course, on the outlook. You have done with that the, with the needle bearing piece. Any -- what would be the a disappointed outlook for the balance of remaining auto side?

Marty, this is Mike. Are you talking about in terms of divestiture or -- .

Essentially what would be strategy related to the remaining auto business?

Well, I think at this point as we would always make that assessment on an ongoing basis. We are always looking at every piece of our business across the Company. To see if, one, there is a strategic fit and if there's not, then if there's not, then obviously we would always consider, as to whether or not it should be part of the Timken Company. And the secondly, if it does have a strategic fit and just isn't fixable then you might consider other types of restructuring actions. When we set out to fix the mobile site of this business the biggest part of that obviously was the automotive segment that had to be fixed and at this point the actions that we have taken which was a combination of divestiture of some entities, market gains, and customer gains and other entities and the loss of some business along with the pricing initiatives and restructuring and manufacturing and how we run our manufacturing and where the costs of those are, etc. Was all a combination so the only thing I could tell you is yes, we have divested the needle bearing business. We would divest or look at divesting of anything that wasn't strategic and or didn't fit our own financial hurdles but at this point as you can see the overall transformation is working. It is attractive and we are continuing actually to grow those businesses, that we are currently engaged with in the mobile side of the business.

Secondly, if I may, you have a target that you put out for 2012, 325 to 375 range clearly now becomes a lot more visible potentially a number that is not out of reach. In that, I was just wondering if you could talk about project one in general and what you see that as a contribution to sort of the change in your -- in the efficiency of the Company -- particularly with working capital initiatives and what all that could contribute in terms of generating more free cash flow and whatever else would obviously be part of that 325 outlook in terms of share repurchases etc. Is there any cost left on Project ONE?

Yes, Marty, we have completed Project ONE. I think we announced in April. So we have just completed the final wave, if you will. It is as we talked about before, it is a tremendous tool for us, without question has really improved our ability to manage the Company and even more specifically the working capital management. We generated a significant amount of cash as you know this past year from working capital and this year despite sales improving nicely working capital continues to be a positive story for us and from an efficiency standpoint whether you look at days or working capital as a percent of sales continues to decline. As we look out beyond this year, this year, next year and so forth. Obviously, hopefully, the end markets will be good and we may have to still use cash for working capital. But it's our expectation, that both days and percent of sales will improve each year. So It will clearly help the overall cash structure of the Company.

Have you announced any particular targets or do you have any targets for let's say working capital of sales as a metric over time?

We talked at least as we bench marked other very strong manufacturing companies where a $0.15 per sales dollar working number would be call it best in class or achievable. We are clearly still well above it. We are in call it the mid 20s right now. But as we said, we expect to see that number continue to decline each year and that is the aspiration and goal that we have set. Obviously we are a global company, different than others but it has been one of the bright spots if you will not only leveraging the improved sales that we are getting in an improving market with improved cost structure and mix of our business but also from extracting cash out of our working capital and based upon the improved tools that we have.

Thanks very much .

Our next question comes from the line of Steve Volkmann, Jefferies & Company.

Hi, guys. Actually my follow-up was answered but I will could a different one if it is all right. I'm still, I apologize for this, I'm sure it is my fault. I'm still somewhat mystified by this mobile margin and the huge uptick in the second quarter and implied down tick in the back half of the year and I'm still trying to figure out what the moving parts are there. Do you think high teens mobile margins are achievable again, in the next six or eight quarters? I will leave it at that.

Steve, this is Mike. I don't think you want to think in terms of high teens. I think we ought to keep our aspirations still within the boundaries of where, before we were thinking mid to high single digits. We have gotten ourself into the double digit teens which is very attractive. I think again, if the volume plays out differently for the second half such that, that increase continues then we will still see that double digit margin improvement. But I'm not going to tell you it is going to be at 17%. It will still be in the lower range of that. If the volume plays out such that we get some of the cyclical second half reduction in revenue and or we see the light vehicle side of the business soften in the fourth quarter because of plant shutdowns then you got to taper down your perspective on it. The other thing that I will tell you that I think is important when we talk about these segments, we always talked in terms of the bearing and power transmission group really doesn't have three pure stand alone businesses and we have shared assets that are used across those businesses, and a little bit of the second half improvement has to do with some of the volume improvement in the process industry side of the business especially with distribution. Whereas they are manufacturing their products. So they benefit from the over absorption of costs from a manufacturing cost perspective and the process industry benefits from the pricing and over our standard costs for those products. So there is a little bit of that, that also tells the tale that they are benefiting from a manufacturing cost perspective for added volume in other parts of the business. So there is a little piece of that.

Okay. All right. That's helpful. And then just quickly, are we pretty much done with all the contract renegotiation's that we need to do in mobile?

I will tell you in the fixing of that part of the business, we kind of said it after the fourth quarter of last year that the contracts were done. Obviously those contracts come up every year, so we will be continuing to renegotiate with our customers for both short-term and long-term contracts. But the structure of those contracts are much different today, than they were in the past. And the redoing of those contracts with strong terms of conditions and how we will do business going forward and cost pass through and those sorts of things, are very different. And that was basically completed last year and now we are back into, I would say, a more normal mode of business with all of our customers globally.

Okay, great. Thanks again.

(Operator Instructions). Our next question comes from the line of Eli Lustgarten with Longbow Securities.

Good morning, again. A couple of points which you brought up. How much of your steel business is non contract at this point and affected by the base price increase?

About 10% to 15%, Eli.

So most of it is fixed. So it really sets the stage for the next negotiations I guess?

A good observation.

And foreign exchange in the quarter and what are you assuming for the second half of the year, now that we know we are in a different currency situation. I assume was slightly positive in the quarter and pointing negative in the second half of the year?

That is a good observation. Currency was not a big impact for us during the quarter. Probably hurt us by around 1% of it's top line so it is pretty negligible. And while we expect it to go the other way for the second half of the year, again, we don't expect it to be a significant impact.

You have it factored in. Talk about how pricing and costs are unfolding for the second half of the year. You've raised prices in steel, (inaudible) some of the big stuff has gone out. What is going on in pricing and is part of your caution in the bearing and power transmission that you expect some of your costs to go up in the second half of the year in materials?

We are seeing, Eli, we are seeing some material cost increases. We began to see that in the second quarter. Obviously as the volume goes up across the world, we will continue to see some pressure on that. So, yes, as we continue to increase our capacity and I think I mentioned a little earlier we are still operating at less than 70% capacity. And once you get to the point where you start to operate in excess of 80%, you start taking on some additional costs of training and hiring people, putting in additional shifts etc. Yes, there is some cost pressure there. However, I will tell you so far we managed that very well. Our Asian plants have been ramping up constantly for the last two years and this is with people who probably have never seen the production of our types of products. And so we are managing extremely well, but we are seeing some pressure with regards to that in the second half, Eli.

And how is pricing doing and what are you doing pricing wise, particularly in bearings?

Pricing fine. We continue to move pricing in the distribution markets across the world so that will be a net positive along with revenue increases in the second half. The rest are a little bit, as Sal said, we have a lot of our business the non distribution side of all of our businesses, are pretty heavily contractual obligations so those are done on an annual basis, most of them. Some of them are multi year contracts, especially as they are applied to new -- product platforms where people need longevity of control of costs. But, in general there is no negative story to that. I think that except for maybe the major capital equipment markets where there still is a lot of pressure with regards to very, very few projects going on across the world.

So how much of your business is contractual in bearings that the point?

If you looked at the non distribution side of our business, and I know we don't break that out specifically for you, but I would tell you that less than half of our business is contractual, in the terms that you would think of us signing a full one year agreement etc.

And one final question. You expect process margins to get back, what, towards the mid teens I guess with what is going on in aerospace maybe back to first quarter kind of margins, is that sort of the takes in takes in the second half of the year?

I think both of those are pretty good assessments, Eli.

Thank you very much.

You bet.

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

Yes, we do. This is Steve. We really appreciate the interest in the company. If you have further questions for me, please give me a call at330 471 7446. Before we conclude today, I would like to turn the call over to Jim for final remarks.

Thanks Steve. Obviously, we are pleased with the results we are seeing. We believe it validates our strategy and we remain focused on growing in attractive industrial markets where we can create greater value for the long-term. Thank you for your continued support and interest in The Timken Company.

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