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Executives

Steve D. Tschiegg - Director of Capital Markets and IR

James W. Griffith - President, CEO and Director

Glenn A. Eisenberg - EVP of Finance and Administration

Michael C. Arnold - EVP, President - Bearings and Power Transmission Group

Salvatore J. Miraglia, Jr. - President of Steel Group

Analysts

Eli Lustgarten - Longbow Research

Wendy Caplan - Wachovia Securities

Mark L. Parr - Capital Markets Inc.

Melissa Cook - Calyon Securities

Martin Pollack - NWQ Investment Management

The Timken Company (TKR) Q3 FY08 Earnings Call October 24, 2008 9:00 AM ET

Operator

Good morning ladies and gentlemen. My name is Tina and I will be your conference operator today. At this time, I would like to welcome everyone to the Timken's Third 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]. Mr. Tschiegg, you may begin your conference.

Steve D. Tschiegg - Director of Capital Markets and Investor Relations

Thank you and welcome to our third quarter conference call. I'm Steve Tschiegg, Director of Capital Markets and Investor Relations.

Thank you for joining us today and as after our call should you have any further questions, please free to contact 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 of Bearings and Power Transmission Group; Sal Miraglia, President of our Steel Group.

We have remarks this morning from Jim and Glenn. Then I will be available for Q&A. At that time, I would ask you that you please limit your questions to one question and one follow-up at a time to allow an opportunity for everyone to participate.

Before we begin, I would like to remind you that during our conversation today, you may hear forward-looking statements related to future finance 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 in our website www.timken.com.

Reconciliations between GAAP and non-GAAP financial information are included as a part of press release. This call is copyrighted by the Timken Company. Any use recording our transmission of any portion without the express written concern of the company is prohibited.

With that I will turn the call over to Jim.

James W. Griffith - President, Chief Executive Officer and Director

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

In September, the price was $550, all the down to the current price of $290 per ton. As Glenn walks you through the results for the quarter, he will take you through the details of how these scrap price fluctuations and the impact on our LIFO charges affected our numbers in the third quarter, as well as going forward. It's important to appreciate how the timing of raw material pricing and a recovery of our cost from customers can create significant swings between the third and fourth quarters. But the bottom line, it is a timing issue and on a full year basis, the company expects to fully recoup all raw material costs and to deliver record earnings for the year.

It's much more important to observe that the company is delivering strong structural performance. When you peel back to phenomenon created by the rapid change in scrap prices, I'm confident that you'll see the results for this quarter. As well as the past several quarters demonstrate that our strategic initiatives are indeed taking hold.

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

On the growth side, sales in our aerospace and defense business grew almost 60% this quarter, compared with previous year. About half of that growth is from the strategic acquisition of Purdy, which has solidly positioned us in the helicopter powertrain market. Our Process Industries business grew 33% for the quarter leveraging the $230 million of investments we have made in large-bore capacity over the past three years as well as strong growth in Asia.

Yesterday, we announced the addition of new capacity here in United States to serve the wind power demand. Later in the quarter, we will be breaking ground for the previously announced XEMC joint venture targeting the Chinese wind energy market. These investments add to our already strong position in energy markets, highlighted by our acquisition of Boring Specialties in the steel business in the first quarter.

While part of our strategy is focused on growth, we're equally focused on optimization. Mobile industry demand continues to weaken. This is no surprise. As we optimize the performance of this part of the business, you see our portfolio changing. We continue to be successful with pricing.

At the same time we are shifting mobile industry capacity to serve industrial markets, wherever it makes sense. We are also rationalizing our capacity to match current demand. Year-to-date, we have reduced total employment by 650 positions in our mobile industry unit. And we can turn the use of variety of means to align output with demand. Overall, we believe our results provide solid proof that our strategy is generating improved execution, structural transformation and profitable growth.

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

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

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

Now I will turn it over to Glenn for more detailed review of Timken's results.

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

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

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

In addition, the company had LIFO income in the quarter of approximately $30 million, which resulted in the benefit of approximately $50 million compared to a year ago. The change in LIFO was due to significantly lowered projected year-end material costs used to value inventories.

The company was also able to leverage SG&A as the margin improved 40 basis points over last year to 13.1%. During the quarter, the company increased its reserve for automotive industry credit exposure by $6 million. Well our current customer account balances where within normal levels we felt it prudent to increase our reserve given the uncertainties within this industry. As a result EBIT for the quarter came in at $212 million or 14.3% of sales, 780 basis points better than last year.

Net interest expense for the quarter was $10 million, up $1 million from last year due to the higher debt levels associated with the companies acquisitions, partially offset by lower interest rates. The tax rate for the quarter was 33%, compared to 33.9% a year ago, reflecting the benefit of increased earnings from lower tax rate foreign jurisdictions. While we expect to maintain the tax rate of approximately 33% going forward, our fourth quarter rate is forecasted to be roughly 30% reflecting the benefit of the U.S. R&D tax credit which was reinstated in early October.

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

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

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

For the fourth quarter, we expect performance to be the low last year, lower demand in the light-vehicle and rail market sectors as well as higher raw material costs are anticipated to more than offset stronger pricing. The company expects full year results to be below 2007 for the Mobile Industries segment.

As Jim mentioned, the company has taken actions to actively address the impact of weakening automotive market through adjustments in manufacturing capacity and costs. For us as industry sales for the quarter were $346 million, up 33% from year ago. The company benefited from strong industrial markets as new capacity continues to come online and existing capacity is shifted from other market sectors. The company also benefited from strong pricing and currency.

For the quarter process industries EBIT was $82 million or 23.6% of sales, more than 10 percentage points higher than last year. The benefits of strong volume and pricing were partially offset by higher material and manufacturing costs.

Fourth quarter performance is expected to be above last year driven by strong industrial demand, increased capacity and improved pricing.

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

Improved earnings resulted from strong demand, the Purdy acquisition, pricing and improved manufacturing productivity. Partially offsetting theses benefits, were the impact of capacity expansions including the start-up of the company's new facility in Chengdu, China earlier this year.

Results for the fourth quarter are expected to be comparable to last year, benefiting from demand that is projected to remain strong.

Steel Group sales for the quarter were $537 million, up 41% from a year ago. The group benefited from strong demand across all markets sectors, except automotive. The increase in sales resulted primarily from surcharges to recover raw material costs and the acquisition of boring specialties.

Steel Group EBIT for the quarter was a $134 million or 24.9% of sales, over 11 percentage points higher than last year. Improved earnings resulted from the timing of raw materials surcharges and LIFO income which were partially offset by higher material and manufacturing costs and the affect of weaker automotive demand.

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

Looking at our balance sheet, we ended the quarter with net debt of $645 million; $49 million lower than the end of last year due to strong cash generation from operations which was partially offset by seasonal working capital requirements and capital investments in support of our growth initiatives.

As a result the company's leverage of net debt to capital decreased to 22.6% from 26.1% at the end of 2007. The company expects to continue to generate free cash flow for the reminder of the year driven by earnings and improved working capital management.

During the quarter, the company received an improved debt rating from Moody's to Baa3 reflecting the company's strong financial performance and balance sheet. Timken is now rated investment grade by both Moody's and Standard & Poor's. The company has strong liquidity including approximately $560 million of committed credit available as of the end of the quarter.

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

We contributed $3 million to our global pension plans during the quarter brining our year-to-date contributions to $18 million. Our full year 2008 contributions are expected to be approximately $20 million, down from roughly $100 million last year.

Based upon current market conditions the company pensions plans are expected to be under funded at the end of the year. Similar to prior years, we will consider making additional contributions into the plan based upon our funding status and balance sheet strength.

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

We expect to see higher profitability in margins for the full year 2008 compared to last year, benefiting from improved pricing, operating performance and portfolio management initiatives, without constrain due to weaker automotive demand and high raw material costs.

The company expects earnings per share excluding special items to be $3.35 to $3.45 for the full year, which would be a record for the company and above $2.40 earned last year. For the fourth quarter, we anticipate earnings per share excluding special items to be $0.16 to $0.26, compared to $0.51 for the same period last year and our prior outlook of $0.52 to $0.57 per share.

Our current estimate reflects weaker automotive demand and lower surcharge recovery of raw materials, which benefited the third quarter. From a cash flow standpoint, we expect to see higher free cash flow in 2008 benefiting from earnings growth and lower global pension contributions, capital expenditures should be comparable to last year as we continue to invest in growth initiatives, while cash taxes are expected to increase reflecting the company's higher earnings.

This ends our formal remarks and will be happy to answer questions that you have. Operator?

Question And Answer

Operator

[Operator Instructions]. Our first question will come from the line of Eli Lustgarten with Longbow Securities.

Eli Lustgarten - Longbow Research

Good morning.

James W. Griffith - President, Chief Executive Officer and Director

Good Morning.

Unidentified Company Representative

Good morning.

Eli Lustgarten - Longbow Research

I am not sure, I know where to start with this quarter. Quite a... I think your battle has been going on. Can you take us through the both I guess the mobile and the steel business for the fourth quarter and its impact, because it only gets to $0.16 to $0.26 with a 30% tax rate. You got to have a pretty good sizable loss in motive and you've got a have maybe mid single digits that best in steel from the probability standpoint and that in the context, what I am told this morning is scrap is in threefold and the 290 numbers double where it is today from what I understand. So we... overstating the decline in mobile and steel at the same time.

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

But clearly, steel's being impacted by that timing mechanism which again is not structural, but also steel obviously plays in the automotive industry as well and clearly you're seeing the negative impact of that, but again still looking at positive performance for the quarter.

On the mobile side though, again obviously, we have a big component, which is automotive related. We're seeing continued declines in demand. We're managing it as well as we can and I again I can speak to a lot of the actions that we're taking, but it is our expectation that we will lose money in the fourth quarter within the mobile growth which grew, which will take us down from a year-to-year basis.

So the assumptions that we have taken, given especially the uncertainties in the market reflects at least what our current thinking would be on that, but again to make that strong distinction, that low level of operating earnings within the fourth quarter clearly are skewed by some timing issues that benefited our third. But Mike, you may want to comment more on the mobile?

Michael C. Arnold - Executive Vice President, President - Bearings and Power Transmission Group

No, I think Glenn. Eli, this is Mike. I think Glenn covered it pretty well. I think if you look at Q3 and then try and compare it to Q4, the mix change continues. There is two different stories in the mobile industry's aspect, there is the automotive industry that you're all very much seeing and the reductions that have taken place throughout the entire year. And that's been offset by what we've seen is real strength in our ability to move that capacity towards other parts of the mobile side of the industry.

So we've gotten very attractive growth up to the first three quarters in the off-highway and rail and our aftermarket segments within there, and that's been really good. In addition to moving that capacity to process industries, which again as you know we've talked about and that's been really good.

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

Salvatore J. Miraglia, Jr. - President of Steel Group

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

Eli Lustgarten - Longbow Research

I mean the follow up, what are we doing to talk about 2009 in these businesses? I mean we are sitting there, but it's... you get stabilization of scrap on some of these demands. I mean is it just that we get much more profitability next year on the same... on the lower sales. Is that how we should treat. Doing that, we expect to trying to make some outlook next year and the impact we're trying to assess, how the impact on our thinking would be given the extraordinary conditions that exist at this point.

Unidentified Company Representative

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

We are going through, as you know our process of going through our budgeting for next year and looking beyond. And we'll comment more about '09, what our expectations will be at the end of next quarterly results and obviously at that time we'll have an other quarter behind the belt, so you can have a little bit more comfort level if you will that what things will look like, but clearly we're well positioned, to do well next year.

Again fourth quarter, you can't look at us as the decline being an impact of lower numbers going forward, because they are beyond the aberration and the timing that's impacted. But again, we're well positioned. We're clearly nervous like everyone else is on the global economy, but we believe that we are well positioned to manage throughout it well and come through it as a stronger company.

James W. Griffith - President, Chief Executive Officer and Director

Eli, this is Jim. Let me see if I can step above what Mike and Sal said and give you our framework. And then I will turn it to Mike to talk a little bit about what we are seeing in the marketplace that maybe can help. The fourth quarter, Sal said this the other day is a confusing mix of timing seasonality and then the whole economy. The timing piece... you have to understand in our steel business, there is a mismatch in timing between when we recover the scrap surcharge and when we actually charge the value of the scrap that we buy to earnings.

So what happens in the fourth quarter is we are recovering based on current scarp price in indices, but we are charging against those sales, the scrap we bought, when the scrap prices where high and so that artificially depresses earnings in the fourth quarter, the reverse happened in the third quarter. So that's the timing issue that we are explaining.

Secondly, we got a seasonality factor that it is the fourth quarter and our customers tend to take extraordinary shutdowns, particularly in the down market to blow inventory out and that creates a seasonality issue for us. And then obviously, we are in a very uncertain time in the economy. As we look at this that means the fourth quarter is depressed earnings for us.

Now, obviously then you try to look across that carries them into 2009 and you got to start with what is the fundamental demand in the marketplace. And I think that's perhaps the more important place to go. Mike, you want to take a minute just sort of talk about what's in the market.

Michael C. Arnold - Executive Vice President, President - Bearings and Power Transmission Group

Yes, given the diversity of the three business units, I think it's important to a certain extent to separate them and maybe talk a little bit about what's happening in each of them, because they are very different stories. In the areas like aerospace and I will take the true aerospace side of that business, as you all know a big portion of our business there is the defense oriented. Also, it is oriented towards not fixed, in commercial which is a major concern certainly in the market, but very much towards the general aviation, helicopters etcetera.

At this point both defense remain strong and of course this is something that is subject to change. But the... our order book and the strength of that order book still remains very good throughout 2009. Again subject to the change in the economics, but at least as we look at it today and communicate with our customers and the industry of that still remains at a relatively strong rate.

If you look at the process industries, here is the area where we have invested in our growth and that investment is starting paying off in the fourth quarter of last year and now we can see that not only throughout the first three quarters of this year. But we'll still remain at a relatively strong level through the fourth quarter, the question around again is how the macroeconomics will impact the energy industry, the infrastructure built through out Asia. But at least as we go in to 2009, the order book still remain strong or be it lots of questions and concerns from the customer base and the marketplaces and the various geographies. So, we're seeing what most of you are seeing North America and Europe obviously, significantly softening across many industries. Asia still remaining strong, but it'll a slower growth and then of course the mobile side of this will continue to be a challenge as the automotive industry continues to weaken.

There are some positives in there as our material costs will actually begin to trend or slow both from the standpoint of the increases that we saw, but out and out reductions with regards to some of the pricing and the marketplace. So there's a positive with regards to material prices of both as the volume goes down. So, it's kid of a tale of three different cities. The good news is where there remains strength, compared to historical levels, it is the place where we have focused our new capacity and focused our efforts and, therefore, the improved profitability.

And the areas where we have talked about fixing and or getting out is the area that the shrinking and probably if anything is accelerating the strategic implementation.

Salvatore J. Miraglia, Jr. - President of Steel Group

Eli, this is Sal. Kind of a similar story. Clearly, our automotive and light industrial order book is currently weak. And you read everything as I read it. Though we don't expect that to recover very quickly, but it's not dead. It's just weaker than that we have seen before. Clearly, our very attractive market, energy market has remained strong, just this morning I heard they are taking, the OPEC is taking a 1.5 million barrel a day capacity out, so we probably will not see the price of oil drop a whole lot more from where it is now, but I don't know how to predict that either.

So currently, we still expect to fairly good energy markets. And similarly, on the positive side as Mike described material costs sub-$200 a ton scrap gives me better than integrated mill raw material costs, which up to this point in time has been a disadvantage for us as we have been paying much, much higher pricing. And, especially, those mills that have their own integrated mines had a big advantage. I think that's just disappeared and so as this continues that will give us some advantage in the market space and a margin advantage, that I think we would have not seen otherwise.

Eli Lustgarten - Longbow Research

Okay, thank you. I'll get back in the line.

Operator

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

Wendy Caplan - Wachovia Securities

Good morning.

James W. Griffith - President, Chief Executive Officer and Director

Good morning, Wendy.

Unidentified Company Representative

Good morning.

Wendy Caplan - Wachovia Securities

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

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

Wendy Caplan - Wachovia Securities

No, I'm saying if I keep all else equal for your results in Q3.

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

Right.

Wendy Caplan - Wachovia Securities

And I simply adjust the steel margin back to Q2 level.

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

Right.

Wendy Caplan - Wachovia Securities

Can I get $0.60 in EPS?

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

Wendy Caplan - Wachovia Securities

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

James W. Griffith - President, Chief Executive Officer and Director

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

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

Wendy Caplan - Wachovia Securities

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

James W. Griffith - President, Chief Executive Officer and Director

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

Wendy Caplan - Wachovia Securities

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

James W. Griffith - President, Chief Executive Officer and Director

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

Michael C. Arnold - Executive Vice President, President - Bearings and Power Transmission Group

Yes, I think it is a combination of three things going on Wendy. One, any new capacity that includes brick and mortar tied directly to a commitment from the customer base. And then some of those cases includes an investment from the customer base, so that we all have an investment and both enjoy the rewards as well as the risk, so that's one example.

The announcement we made yesterday with regards to expansion in our Tiger River facility is again directed towards contractual commitments from the industry and the desire in wind to meet that growth, it's not brick and mortar, in fact it is additional equipment that allows us to expand our capabilities as we move forward. So, it is a very measured improvement, which has a significant return on invested capital from that perspective.

But, more importantly, what Jim was describing is our capacity implementation over the years has driven us to a very, very different mix in the bearings and power transmission business. And to give an example, if you look at the third quarter of '08 versus third quarter of '07, our exposure now to the light vehicle side of the automotive industry is today is 21%, one year ago it was 33%. So it has driven the fact that we have been able to put that capacity and to catch the growth in very attractive markets that fit more strategically to what we're doing and have been the growth markets around the world.

We still believe that those will be the markets that will outperform anything within the light vehicle systems area of the automotive industry. And, therefore, we will be very well positioned to both commercialize that, and take advantage of any growth opportunities or any strength that remains in those markets. So our position today, versus just one year ago is significantly enhanced in the industry.

Wendy Caplan - Wachovia Securities

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

James W. Griffith - President, Chief Executive Officer and Director

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

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

Wendy, I guess our, I will just at least provide some color, not to say the absolute loss again we track this within the segment now. And so we're not breaking out the old, call it automotive and again, we did talk about the shifting of some of that capacity that auto was losing by putting it into the process which again benefited that groups very strong performance. But there is no question that we are seeing losses within the auto, but similarly within Mobile we continue to see good profitability within off-highway, within our rail business and our automotive aftermarket piece.

So again the blending of that at least enabled us to mitigate the downfall in the automobile... automotive markets, but again as we've said, as a fourth quarter with continued deterioration, we don't think that will be able to offset that such that the mobile group will turn to a loss in the fourth quarter.

Operator

Our next question will come from the line of Rod McKenzie with Lafayette Capital [ph].

Unidentified Analyst

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

Michael C. Arnold - Executive Vice President, President - Bearings and Power Transmission Group

Yes, this is Mike. I will take it from bearings and power transmission. And probably take it from steel perspective. The areas that we have the greatest concern with regards to inventory levels in the marketplace generally is the distribution side of our business. And we have very good visibility of those inventory levels at our distributor partners across the world. We have good visibility to their sales of our products and our sales obviously, to them of our products.

So we're able to have great transparencies on those inventory levels and I would tell you that at this point that is not a major concern of ours. Now that all is again dependent upon what directions the markets take and the decisions that they make with regards to any inventory reductions they may choose. But at least at this point there hasn't been any significant impact one way or the other on our business, because of inventory levels in the distribution channels.

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

Salvatore J. Miraglia, Jr. - President of Steel Group

This is Sal Rod. Probably the place that's the most volatile for us right now is simply the automotive space. The automotive companies, I don't think themselves know exactly what they need to do. They are taking schedules out. The week before, we're supposed to deliver. We clearly have some stranded inventory, but I do think we're seeing the effect of the double whammy, both of their need to move to some more controlled level of their inventories. And so the reduced operating levels will keep the pipeline of the flow of products to them that they would need pretty long for a period.

So that's the place that we have the most, that was the poorest visibility, everywhere else as Mike described, we're having a lot of dialogue and everyone is simply going nervous. No one knows what the demand level will be. At this stage in time, we're just watching like hawks and talking.

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

Michael C. Arnold - Executive Vice President, President - Bearings and Power Transmission Group

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

Unidentified Analyst

Alright, well thank you. I'll turn it back over to the rest of the people.

Operator

[Operator Instruction's]. Our next question will come from the line of Mark Parr with KeyBanc Capital Markets.

Mark L. Parr - Capital Markets Inc.

Hey good, morning.

James W. Griffith - President, Chief Executive Officer and Director

Good morning, Mark.

Mark L. Parr - Capital Markets Inc.

A couple of follow up questions. And I appreciate all the clarity and the color that you're trying to cast around this current situation. The first related to the increase in your receivable reserves. Glenn, I think you mentioned you increased $6 million.

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

Yes, right.

Mark L. Parr - Capital Markets Inc.

Is that more than normal? I mean would you characterize that as an unusual level?

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

Mark L. Parr - Capital Markets Inc.

Right.

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

Mark L. Parr - Capital Markets Inc.

Does the fourth quarter outlook include further additions to automotives related reserves?

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

No, I would say no. Unless we see just a change, especially in the volumes we believe we are pretty fully reserved, but we assess it every quarter.

Mark L. Parr - Capital Markets Inc.

Okay.

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

So it's fair to say that the guidance and one of the reasons obviously you give ranges is to be able to build in additional things, But, we feel we're well reserved. We look at insurance rates of what we could actually sell those receivables to and we're more than reserved relative to that exposure. So we feel like it's prudent and to the extent we feel we need to build up the reserve, we will, but as of right we think we're fully reserved for those exposures.

Mark L. Parr - Capital Markets Inc.

Okay, as far as the... I have a couple of questions on the steel business. Sal, could you give me some color on what the volume expectations are, 3Q and 4Q?

Salvatore J. Miraglia, Jr. - President of Steel Group

Well the third quarter that we just finished was a relatively good quarter for us all the way around. And probably, operating at the decent levels. All I can really say about the fourth quarter Mark is we've probably seen this lowest level of demand and ordering in the auto and light industrial that we've seen in an awfully long time. So, the plans that we have are dedicated to some of that kind of operations. We'll see fairly curtailed operations as a consequence of that, just because we've seen it for a long time. But, again double whammy reduced consumption levels in those various plants that require inventory adjustments as well as a lack of consumption and I think we're going to see the footprint of that in the fourth quarter here.

Mark L. Parr - Capital Markets Inc.

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

Salvatore J. Miraglia, Jr. - President of Steel Group

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

Mark L. Parr - Capital Markets Inc.

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

Salvatore J. Miraglia, Jr. - President of Steel Group

That's your opinion, but pretty close.

Mark L. Parr - Capital Markets Inc.

Okay. Fair [ph] question isn't that far away, but okay, I'll --

Salvatore J. Miraglia, Jr. - President of Steel Group

And quite frankly, they are running, they are running at capacity.

Mark L. Parr - Capital Markets Inc.

Okay just --

Salvatore J. Miraglia, Jr. - President of Steel Group

[Multiple Speakers], Mark.

Mark L. Parr - Capital Markets Inc.

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

Salvatore J. Miraglia, Jr. - President of Steel Group

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

Mark L. Parr - Capital Markets Inc.

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

Salvatore J. Miraglia, Jr. - President of Steel Group

I'd say we're probably going to operate within the Harrison plant. And among the order of 60% of this overall capacity as supposed to where we had been before so it's pretty significant.

Mark L. Parr - Capital Markets Inc.

Okay.

Unidentified Company Representative

I'd say also Mark that obviously, we'll have the benefit of the Boring Specialties acquisition. So we should still see top line growth within our steel group year-over-year, but we will see some... expect to see volume declines, but we're also obviously between pricing and surcharges, normally we can offset that volume decline.

Salvatore J. Miraglia, Jr. - President of Steel Group

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

Mark L. Parr - Capital Markets Inc.

Okay, right and one last question on steel. I mean, we heard and Eli touched on this with scrap moving below $200 a ton right now kind of on a preliminary basis for the November auction and it's clear that export demand has dried up for scrap, because of the weaker production momentum coming out of places like turkey and Asian markets. Does your new guidance, I mean what's the underlying...what's your scrap outlook built into the guidance for the fourth quarter? I mean have you taken another $100 that you buy for the November timeframe?

Unidentified Company Representative

We're kind of looking at right now some $200 a ton scrap.

Mark L. Parr - Capital Markets Inc.

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

Unidentified Company Representative

Did not hear that.

Mark L. Parr - Capital Markets Inc.

Alright, anyway, good luck in the fourth quarter. And we'll be in touch soon.

Unidentified Company Representative

Okay. Thanks, Mark.

Mark L. Parr - Capital Markets Inc.

Yes, sure.

Operator

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

Melissa Cook - Calyon Securities

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

Michael C. Arnold - Executive Vice President, President - Bearings and Power Transmission Group

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

Melissa Cook - Calyon Securities

Thank you.

Operator

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

Martin Pollack - NWQ Investment Management

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

Michael C. Arnold - Executive Vice President, President - Bearings and Power Transmission Group

Fair question, clearly we talk more of the magnitude than the absolute, because with pricing and surcharges we view that as the total call it value proposition relative to the materials. But clearly, we price off of our... know what our mechanism is, know what we're surcharging. I guess the way we would categorize it is that it was a cost to us in the fourth quarter. It was a benefit to us in the third.

We would probably say of the decline that we're looking at between third and fourth and broad strokes, probably around two-thirds of that reduction. So the $1.41 that we earned, call it 16 to 26 that is our new expectations. Probably, around two-thirds of that reduction is coming from steel. Not all about due to the timing mechanism though, because again the weaker automotive demand is part of that as well. And then call it the other third of that decline principally coming from auto and we have other pluses and minuses, but, so, without kind of giving you the exact number of the change in our mechanism and how it worked other than again it works for the full year, we recouped all of our material cost for the full year or the expectation is, but it gives you the magnitude of the change how much we will expect to see our steel group decline. A good portion of that decline is that timing mechanism. A part of that decline is also weaker automotive demand.

Martin Pollack - NWQ Investment Management

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

Unidentified Company Representative

Well, I mean again from a ballpark perspective that's fine the way you are thinking.

Martin Pollack - NWQ Investment Management

Okay, thank you.

Operator

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

Eli Lustgarten - Longbow Research

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

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

Eli Lustgarten - Longbow Research

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

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

Yes, it does.

Eli Lustgarten - Longbow Research

Okay. And you're also looking and do you have any foreign currency discussions you can give, share of what's going on that's impacting you?

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

Well for the... it's never been a big movement for us Eli for the third quarter. It affected us by around between 1% and 1.5% on the top line. And that's maybe, it's for the year-to-date I think this much, it's up to 3%, so call it in the 1% to 3% range for this year.

Eli Lustgarten - Longbow Research

Any bottom line effect there?

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

Eli Lustgarten - Longbow Research

And you had anything factored in one way or the other for the fourth quarter?

Glenn A. Eisenberg - Executive Vice President of Finance and Administration

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

Eli Lustgarten - Longbow Research

Alright, thank you.

Operator

Our next question is a follow-up question from Rod McKenzie with Lafayette Capital [ph].

Unidentified Analyst

The question has been answered. Thanks a lot, guys.

Operator

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

James W. Griffith - President, Chief Executive Officer and Director

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

Operator

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

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