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Executives

Steve Tschiegg - Director of Capital Markets & Investor Relations

Jim Griffith - President and CEO

Glenn Eisenberg - EVP, Finance and Administration

Chris Coughlin - President, Process Industries and Supply Chain

Rich Kyle - President, Mobile Industries and Aerospace

Salvatore Miraglia - President, Steel Group

Analysts

Stephen Volkmann - Jefferies & Company

David Raso - ISI Group Inc.

Eli Lustgarten - Longbow Research

Samuel Eisner - William Blair & Company

Steve Barger - KeyBanc Capital Markets

Tom Mullarkey – Morningstar

Gary Farber - CL King

Holden Lewis - BB&T Capital Markets

Timken Co. (TKR) Q4 2011 Earnings Call January 27, 2012 11:00 AM ET

Operator

Good morning. My name is Carolina and I will be your conference operator today. At this time, I would like to welcome everyone to Timken's Fourth Quarter Earnings Release Conference Call. (Operator Instructions). Thank you. Mr. Tschiegg, you may begin your conference.

Steve Tschiegg

Thank you, and welcome to our fourth quarter 2011 conference call. I'm Steve Tschiegg, Director of Capital Markets and Investors Relations. Thank you for joining us today. Should you have further questions after our call, please feel free to contact me at (330) 471-7446.

With me today are Jim Griffith, President and CEO; Glenn Eisenberg, Executive Vice President of Finance and Administration and CFO; Rich Kyle, President of our Mobile and Aerospace and Defense Businesses; Chris Coughlin, President of our Process Industries; and Sal Miraglia, President of our Steel Group.

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

Before we begin, I'd like to remind you that during our conversation today, you may hear forward-looking statements related to future financial results, plans and business operations. Actual results may differ materially from those projected or implied due to a variety of factors. These factors are described in greater detail on today's press release and in our reports filed with the SEC, which are available on our website at www.timken.com.

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

With that, I'll turn the call over to Jim.

Jim Griffith

Thanks Steve. 2011 was a stand-out year for Timken. We achieved record sales of $5.2 billion, up 28% for the year. We grew earnings by a substantially higher amount, up 70% to a record $4.59 a share. These results reflect the degree to which we’ve elevated our performance. We reinvigorated growth and drove more to the bottom line, leveraging greater profitability from an improved operating model and lower cost structure.

We also had a strong year of cash generation, somewhat camouflaged by the need to put working capital in place to support our tremendous growth and large discretionary contributions to our pension and benefit plans, part of a long-term program targeted at reducing their impact on the company’s performance.

It should be clear that there is more to our improvement than the economic rebound. The real story is the development of a more efficient global business model and a mega shift in our market portfolio, which provides the foundation for profitable growth.

Over the past decade, we’ve broadened our sales and product offering to expand into diverse industrial markets. Today we serve a better mix of industries, including energy, mining, agriculture, infrastructure development, metals, aerospace and transport. They are attractive to us for several reasons. First, they present especially demanding requirements that play to Timken’s inherent strengths, bringing technical know-how, application engineering, precision manufacturing and services to improve our customers’ performance and create mutual value. Moreover they offer a lifetime of aftermarket business with prospects that suggest sustainable long-term growth.

The story behind our 2011 results is in the accelerated sales in energy, mining and related markets. The strength of these industries and our keener focus on them drove growth in our steel, mobile and process industries segments. More than anywhere else in the company, energy was the headline of our steel segment growth.

Sales volume from the oil and gas sector rose 80% for the year, while the business also gained ground in serving industrial demand. To capitalize on this demand, you may recall that we are exploring a major investment in our Faircrest steel plant. Since our current labor agreement will expire in September 2013, we opened early negotiations with the United Steelworkers to ensure a stable work environment through the proposed expansion.

On January 6, members of the union failed to ratify the agreement we reached with their leadership. However, just yesterday company and union negotiators agreed to continue discussions on the labor agreement. They are meeting today to discuss the vote and related issues.

If we turn for a minute to organic growth, sales from new products played a significant role in our process industries segment, which achieved its first $1 billion year in 2011. This business has been increasing penetration with new bearing varieties and growing in attractive industrial distribution channels. Off-highway equipment, mining and rail industries topped the growth of our mobile segment, which also saw incremental improvement in heavy truck and aftermarket sectors.

Our 2011 acquisitions also contributed to our profitable growth. Both Philadelphia Gear and Drives bring Timken new capabilities beyond our core bearing and steel lines. Acquisitions like these exemplify our continuing efforts to diversify our portfolio within the mechanical power transmission space and achieved new growth by expanding these capabilities around the world.

We are approaching 2012 with confidence, grounded in sound strategy and delivered performance. While we are seeing the impact of economic turmoil in Europe and the effects of credit tightening in Asia, overall markets remain strong. We are buoyed by the long term growth prospects that our markets present. We are bolstered by a strong balance sheet, providing ample capacity for growth. We are committed to our operating model, guiding responsive execution through whatever economic turns lie ahead.

We are confident in the heightened earning power of the company, and we are driven to perform with 21,000 dedicated Timken people worldwide serving our customers, communities and shareholders with distinction.

Now I ask Glenn to share more details about our 2011 performance.

Glenn Eisenberg

Thanks Jim. Sales for the fourth quarter were $1.3 billion, an increase of $194 million or 18% over 2010. The increase was due to strong volume across the company's broad markets with the exception of our aerospace and defense business. The top line also benefited from higher pricing, material surcharges and acquisitions.

Excluding acquisitions, sales were up 12%. From a geographic perspective, we posted the strongest gains in North America while most other regions were relatively flat.

Gross profit of $343 million was up $77 million from a year ago. The improvement was driven by higher volume and acquisitions, while surcharges and price more than offset the impact of higher material costs. The gross margin of 27.1% for the quarter was up 230 basis points over a year ago.

For the quarter, SG&A was $167 million, up $17 million from last year, primarily reflecting acquisitions as well as increased discretionary spending. SG&A was 13.2% of sales, an improvement of 80 basis points over last year as we continued to effectively leverage our cost structure. As a result, EBIT for the quarter came in at $167 million or 13.2% of sales, 310 basis points higher than last year. Net interest expense of $7.4 million for the quarter was down $1 million from last year, primarily due to lower financing costs.

The tax rate for the quarter was 32.1% compared to 13.3% last year. The lower tax rate in the fourth quarter of 2010 was primarily related to a one-time tax benefit from implementing a voluntary employee benefits arrangement or VEBA trusts. In addition, the fourth quarter tax rate in 2011 came in slightly better than the 34% anticipated rate due to a higher percentage of the company’s earnings coming from lower tax rate foreign jurisdictions. Going forward, we expect the tax rate to be 34%.

As a result, income from continuing operations for the quarter was $109.1 million or $1.11 per share compared to $0.87 per share last year.

Now I will review our business segment performance. Mobile industries’ sales for the quarter were $420 million, up 8% from a year ago. The increase was driven by higher demand led by off-highway and rail markets. In addition, the top line benefited from pricing and acquisitions. Excluding acquisitions, sales were up 5%.

The mobile segment had EBIT of $43 million or 10.3% of sales, compared to $42 million or 10.9% of sales last year. The favorable impact of stronger volume was offset by higher raw and administrative costs. The margin decline primarily resulted from purchase price accounting related to the Drives acquisition. Mobile industries' sales for 2012 are expected to be flat for the year.

The company expects improved demand from off-highway, rail and automotive aftermarket sectors and the Drives acquisition. This growth is expected to be offset by lower light vehicle sales resulting from the company’s strategy of focusing on markets which offer long term attractive returns. For 2012, we expect the negative sales impact of this repositioning to be approximately $150 million.

Process industries’ sales for the fourth quarter were $322 million, up 29% from a year ago, driven by acquisitions, stronger demand from industrial distribution and new products. Excluding acquisitions, sales would have been up 9%.

For the quarter, process industries’ EBIT was $67 million or 20.8% of sales, up from $44 million or 17.7% of sales last year. EBIT benefited from higher volume and mix as well as acquisitions. Process industries’ sales for 2012 are expected to be up 8% to 13% for the year, driven by a broad industrial market demand, growth in Asia, new product sales and the full year benefit of acquisitions.

Aerospace and defense sales for the fourth quarter were $80 million, down slightly from a year ago. Lower defense related demand drove most of the decline.

EBIT for the quarter was $4 million or 4.5% of sales compared to a loss of $4 million a year ago. The loss last year resulted from $7 million of expense related to increased inventory and warranty reserves. For 2012, we anticipate aerospace and defense sales to be up 10% to 15% primarily driven by a stronger defense and commercial aerospace markets.

Steel sales of $468 million for the quarter were up 23% over last year. The increase was primarily driven by stronger demand led by the energy sector as well as pricing. In addition, surcharges were up approximately $35 million for the quarter, due to higher raw material costs and overall demand.

EBIT for the quarter was $72 million or 15.3% of sales compared to $42 million or 11.1% of sales last year. The increase resulted from higher surcharges, pricing and mix, which were partially offset by higher material costs. Steel segment sales for 2012 are expected to be up 5% to 10%, driven by end market demand in the energy and mobile on-highway sectors and pricing.

Looking at our balance sheet, we ended the quarter with cash of $468 million and net debt of $47 million. This compares to a net cash position of $363 million at the end of last year. The change in net debt position includes the company’s investment in acquisitions of $292 million and discretionary pension and VEBA trust contributions of $256 million, net of tax.

The company ended the year with liquidity of $1.3 billion with no significant debt maturities until 2014. Operating cash flow for the year of $212 million reflects the company’s strong earnings partially offset by increased working capital to support the company’s growth as well as discretionary pension and VEBA trust contributions.

Free cash flow for the year was the use of cash of $70 million after capital expenditures of $205 million and dividends of $76 million. Excluding the discretionary pension and VEBA trust contributions, free cash flow for the year was $186 million.

The company ended 2011 with unfunded pension obligations of $491 million or roughly 84% funded. The benefit of contributions were more than offset by the negative impact of a lower discount rate and lower asset returns.

Turning to our outlook for 2012. We expect continued improvement in the global economy and estimate sales for the full year to be up 5% to 8% over 2011, generating earnings per diluted share of $4.90 to $5.20, an increase of 7% to 13%.

The company expects cash from operating activities to be $515 million which includes discretionary pension and VEBA trust contributions totalling $150 million net of tax. Free cash flow is expected to be $90 million after capital expenditures of $345 million and dividends of roughly $80 million. Excluding discretionary pension and VEBA trust contributions, free cash flow is expected to be $240 million.

Finally, on February 14, the company will host its annual analyst day meeting in New York where we will review our long term outlook. Additional details regarding this event will be announced early next month, including the webcast information.

This ends our formal remarks, and we'll now answer any questions that you have. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). We have a question from the line of Stephen Volkmann with Jefferies & Company. Please go ahead.

Stephen Volkmann - Jefferies & Company

I think what stands out to me as I think about your guidance is just the mobile number. And I just wanted to make sure I had a couple of things right, and then maybe you can help me through it. But I think what you are implying is that acquisition should add about $150 million in 2012 and that you think there is a $150 million headwind for some businesses that you are kind of exiting. Do I have that right?

Glenn Eisenberg

On a consolidated basis that’s correct. No just obviously the impact for mobile. The acquisitions that will benefit that we’ve done last year that we will get the full year benefit will come in both our process and our mobile groups where the exited business, if you will, that would take away from that is obviously just in the mobile group.

Stephen Volkmann - Jefferies & Company

Got it. Okay. And can you ballpark for me what acquisition should add to mobile in 2012?

Rich Kyle

It may be about $50 million.

Stephen Volkmann - Jefferies & Company

$50 million, okay. So you have a net headwind of about $100 million in mobile from that. How should I think about the margin profile of the businesses that you are not going forward with? Would that – can I assume that you are exiting lower margin or is that not the right way to think of it?

Rich Kyle

That would not be the right way to think of it as a result of the pricing actions that we took several years ago that, that business would have been in line with the rest of the portfolio. So we expect margin for the mobile business for the year to be comparable to the last couple of years in the low teens.

Stephen Volkmann - Jefferies & Company

Okay, great. So I guess the thing I am sort of going with is sort of the flat outlook and I guess you have what is it, it’s probably going to be up 6% or 7%, I am trying to do it in my head, percent headwind from the businesses that you are losing and yet, what we are hearing from our other companies is that all the other mobile markets are going to be up double digits. So coming up with a flattish overall, is that just kind of a conservative view of the world, or is this based on an order book kind of look? Or how should I think of that?

Rich Kyle

Steve, let me take on the lost business piece first and then I will talk about the markets. Going back to the 2008, 2009 timeframe, as you know we repriced our portfolio, we made strategic decisions that we knew would lead to the exited portions of our automotive portfolio and to a lesser degree, our heavy truck portfolio. As we entered 2011, we provided guidance that we would exit approximately $100 million as a result of those strategic decisions.

That guidance proved to be relatively accurate, and as a result of that, our light vehicle business shrank about 5% in 2011. That was despite relatively strong North American automotive markets as you are aware of. The other mobile markets were strong enough and our penetration in those markets was strong enough that we offset that 5% shrinkage in light vehicles which was our largest segment to achieve a net 13% growth for the mobile business.

As we enter 2012, we plan to exit $150 million, up from the $100 million, again mostly light vehicles. Of that, about two-thirds of that is one customer, one platform that ended in the fourth quarter of last year. We’ve known that was coming, we’ve prep-ed for it and we’ve taken the actions around that so that, that’s no surprise. The vast majority of the other third has also either taken place towards the end of the fourth quarter or will take place in the first quarter. So we expect that the first quarter results reflective of the exit and the go forward run rate for the business.

We expect growth in the other segments plus the acquisition to largely offset that but just moderately, not to the degree that we did in 2011. The projected result of that is again relatively flat year over year performance but a shift to more attractive and more sustainable markets that we are confident that we can grow in going forward. And going forward, after Q1 we do not expect exited business to be material from a sequential standpoint through the rest of 2012 and entering 2013.

Stephen Volkmann - Jefferies & Company

Okay, great. That’s super helpful. Will that impact margin then in the first quarter to some extent as well then?

Rich Kyle

No, no. Again, we’ve taken the actions through the course of last year, and the decline we saw in margins in the fourth quarter for mobile were not a reflection of exited business. It was a reflection of a typical seasonality as well as the Brazil charges that we took as well.

Operator

Thank you. And our next question is from the line of David Raso with ISI Group. Please go ahead.

David Raso - ISI Group Inc.

Really just one straightforward question. You are guiding your CapEx to be up 68% in ‘012 but a revenue growth that’s we haven’t talked a lot about pricing, currency to get the real volume number even stripping out the acquisitions but obviously not much volume especially given – decent pricing especially on steel. How do we square up that revenue guidance, with the company deciding to raise the cap at 68% in ‘012?

Glenn Eisenberg

David, let me take the first off and obviously we could spread it around the room, on any particular things. But clearly we see a lot of attractive growth opportunities and we are running into certain areas where we are capacity constrained and see markets that are pretty attractive that we want to continue to pursue. There’s obviously going to be a lag obviously for the capital investments that would be geared towards certain kinds of capacity additions. So it’s a lag effect.

When we are together later on, I guess, next month, I am talking more about our longer term outlook, you will start to see the benefits of investments coming in and showing up in stronger top line growth.

Jim Griffith

David, this is Jim. Just to put a little bit in perspective. Our capital program alternates between long cycle and short cycle investments. You recall when we were putting our capacity in China four, five years ago, we made some investments that took several years to get in place and then paid off. And then the last two or three years, we have been just spilling those out on an incremental basis. But we are back to where in 2012 we are launching a couple of fairly long cycle investments, the one that I mentioned in my comments, the caster is an example that’s still in the capital forecast at this point. And it’s a two-year investment cycle before we see the benefits of it.

David Raso - ISI Group Inc.

Well, I mean, at the end of the day, I guess, the idea of the volume alone to be investing that way, you must have at least some thoughts around a macro environment that’s not that trouble near term at the minimum. I know that some of these are long term investments, but the decision to be that confident makes some of those longer term investments, sounds like you are little more comfortable with the macro backdrop than -- if you full out the acquisitions, you are saying your mobile business – just pull out the acquisitions and the lost contract, your mobile business has only grown 5% to 6%, right? Your process industries ex Philly you are talking 2%, 2.5% growth.

So it just sounds like a very weak unit growth assumption for a company that confident in the macro backdrop to be spending that kind of CapEx? So you could maybe help me at least a little bit to get more granular on the revenue guidance. What do you have for currency in these businesses with this guidance? I mean, again the process industries business, I am talking about mobile, it’s not all of the U.S., right, especially process. How can we think through if Philly is adding say roughly $100 million of revenue to process, your revenue guidance is implying that low single digit revenue growth ex-acquisition. Can you take us through this little bit more detail? I appreciate it.

Glenn Eisenberg

Little bit, first again, we will deal with some rounded numbers. But the acquisitions of both Philly and Drives that would affect process year over year growth are going to be in the $80 million-ish kind of ballpark. Currency within our process group as we model it, again, obviously fluctuates day to day but is constraining the top line we think in ‘12 by a couple of percentage points. We have north of 50% of the sales that come out of process are outside of the U.S. markets. And given the stronger dollar, that’s going to have a constraint. For the whole company, it’s more like a point to point and a half but for process you’d see a bigger negative impact from that.

But again, as Jim said, we see opportunities to grow in markets, not over every market but in selected markets of oil and gas, mining and so forth that we feel long term are very attractive to us and as we talked about obviously you are talking with mobile and process opportunities. Within our steel group we’ve talked about the opportunity, as Jim said the Caster is focused on the oil and gas market in particular, the mining and so forth.

So we are bullish relative to certain markets on a global basis and again looking at the global markets and looking at the global outlook from a macro standpoint, you are still looking at 3%, 4%, 5% kind of global GDP kind of growth over the next several years. But we have gone through, as Jim said this before, through cycles and we are making selective investments, of the $345 million of capital investments, around $80 million-ish of that is maintenance. So clearly the bulk of the investment are where we feel we can redeploy our capital into attractive growth opportunities longer term.

David Raso - ISI Group Inc.

And would you commenting on the profitability you are looking for in process in ‘012 but the margins were pretty healthy in the fourth quarter, it might give us some insight on how you are thinking about, looks like ex-currency, ex-acquisitions you are looking for process to be up 6%. Maybe some sensitivity to what geographies up or down in the sense of where you are going to guide the margins toward? What kind of margins you are thinking for process for ’12?

Chris Coughlin

David, this is Chris. A couple of things. And let me go back just to the acquisitions just to get your math straight. The acquisition growth that we are looking at next year in process is only 5%. You were quoting a much higher number. And part of that has got to do with the timing of major contracts and that hit during this year et cetera. And I won’t get into that here. But that’s basically – there is more volume there than you were using in your math.

David Raso - ISI Group Inc.

So it’s 7.5% then?

Chris Coughlin

Yeah, okay. And where that number comes from, we do have some uncertainty with regards to Asia in particular, with regards to how 2012 is going to play out in that market space, particularly China. So we can debate whether that’s conservative or not but there is some uncertainty in both of our European and Asian markets. And I think as you know 60% of process sales are outside the United States. So that is primarily I guess the explanation on the volume side.

On the margin side, fourth quarter margin was generally pretty good from our perspective. Do remember we have the seasonal operating issues which we operate at lower levels in the fourth quarter and that put some pressure on the costs. Moving forward, we expect to see continued good margin performance in the 20s, and that will fluctuate based on a couple of different things. There is some inflationary cost pressure. Obviously we try to get that back with pricing but there are definitely timing issues with regard to costs coming in and when pricing is actually realized. So that’s one issue.

The mix is also a very important issue that we’ve talked about a number of times in the past. We had a very strong distribution mix in 2011. However, the original equipment business is very important to the long term health of our aftermarkets. So we are constantly trying to aggressively grow that OE business as well, even though it is lower margin than our distribution business. So as that mix fluctuates you will see some movement in those margins as well.

All that said, we expect to see margins healthy again moving forward. And we will see some bouncing little bit a point or two here or there on the basis of cost pricing and mix.

Operator

Thank you. And our next question is from the line of Eli Lustgarten with Longbow Securities. Please go ahead.

Eli Lustgarten - Longbow Research

Well, we’ve gone through two, so can we talk about the profitability of aerospace and steel, before I go on, in 2012?

Rich Kyle

I will start with aerospace. Eli, this is Rich. We expect, as we said, double digit growth and we expect very strong leverage off of that growth. Not to the extent that we get back to our peak margins in the high teens but that by the middle of the second half of the year approach double digits. The reason we are able to get that leverage is essentially some improved mix, with the volume obviously helping and then the result of cost improvement actions that we took during the course of 2011, and then some better execution as well.

Salvatore Miraglia

Eli, this is Sal. Again, we look at 2011, we had a record year for our performance. We are expecting ’12 to be comparable, similar volumes but with improvements in mix and pricing. So we think we are going to be operating in at least the same territory you’ve seen us in the low to mid teen EBIT margin range but with very – pretty healthy market demand in those market segments that we have been talking about.

And actually for us mobile is still looking healthy, mobile on-highway for us but particularly in our industrial and oil and gas segment, the strength is very nice.

Eli Lustgarten - Longbow Research

Can I get one clarification? You talked about the $150 million volume drop in mobile from the contracts that you exited. And you said about the impact from the first quarter, are we going to see most of the $150 million decline hit in the first quarter and or is it spread out over the year? I mean, the implication was that first quarter was the worse by far?

Glenn Eisenberg

It is almost exclusively hit in the first quarter. You will see very little impact after the first quarter.

Eli Lustgarten - Longbow Research

So the first quarter volume, whatever it is, you take the $150 million out and then the rest of it there, is the correct way to look at it?

Glenn Eisenberg

Yes.

Jim Griffith

Just to be clear, Eli, what he is saying is on a run rate, it hits almost 100% in the first quarter but the $150 million is an annual number.

Eli Lustgarten - Longbow Research

Okay.

Jim Griffith

Is that the way you understood it?

Eli Lustgarten - Longbow Research

Right, I just wanted to make sure that the implications, you take $150 million, your number then is about $40 million lower in the first quarter.

Glenn Eisenberg

That’s correct. Roughly $40 million each quarter if you look at it year over year.

Eli Lustgarten - Longbow Research

That’s why I asked the question. And what we see in the process industry, across people who are supplying the industry is a wide expectation for double digit growth in some markets. It’s probably the thing that’s going to carry Emerson's Process business and the whole company and Honeywell, and then across the board. Is double digit – you are implying a sort of a growth rate almost half that in your guidance. If things work out, I understand the Europe and Asian problem but is a double digit growth reasonable in the process market? We are talking ex the acquisitions, based on current bookings if the fears don’t work out that we’re seeing a much stronger process market than you sort of indicated?

Chris Coughlin

And anything is possible and clearly if markets run with us we could see a good growth. The issue that we would see right now, Eli,is in Asia in particularly China, we are looking relatively flattish kinds of first quarter numbers. The growth rate has clearly stopped quite frankly. So we are looking at relatively flat revenue numbers early in the year. Now we are cautiously optimistic that we are at a bottom at least in terms of growth rate and if that growth will resume in the latter part of the year, but depending on how that plays out and everybody can have their own assumptions on that. Those are the issues we are looking at when we are looking at our guidance on the revenue rate.

Obviously if those prove to be too pessimistic that that will be good for us because we are right in the middle of those markets. And as you know, one other point, win in particular in China is challenged. It is part of our portfolio in that market space. And so we do have a couple of market sectors which in total are not a huge consequence in terms of the performance of the group but when you start getting to a point here or a point there of growth rate, those market segments can have an impact as well.

Eli Lustgarten - Longbow Research

Okay. The one final question, I know the mobile business, there is a debate of how strong it will be, well the numbers, are you seeing any change in order pattern from your – the construction equipment, the farm or truck, or rail or some of the heavier companies as you look into 2012 order book in the mobile business, so is business still strong, is it flattened out on a quarter to quarter basis, if we get some idea of what’s going on in the marketplace?

Rich Kyle

From a mobile perspective, we are still growing year over year and sequentially. The rail market is strong, the off-highway market is strong led by mining. Construction is okay as well but mining is the real driver there. Heavy truck has been flattening out and that depends on – I’d say globally our mix is flattening out, some softness in Europe still some strengthened in North America. But overall our first quarter order book is pretty solid.

Operator

Thank you. And our next question is from the line of Samuel Eisner with William Blair & Company. Please go ahead.

Samuel Eisner - William Blair & Company

You mentioned before when you were talking about CapEx guidance that you were capacity constrained. Can you talk about where you are seeing those constraints? I presume that they are in steel but maybe if you can talk to that a little bit further.

Jim Griffith

Sam, this is Jim. If you look across the company, go back to my opening comments, the strength in the oil and gas industry and the strength in the mining industries are driving our capital program. And that is across the company. So certainly we are capacity constrained, we’re on allocation on the steel side and that explains a little bit of the growth numbers for 2012. There are investment plans to address the oil and gas capacity as well as the mining capacity on both the bearing business and the steel business.

Rich Kyle

On the bearing side, we are generally not capacity constrained. There would be some very small product areas that would be tight but we have – the markets are stronger, we have room to capitalize on that.

Samuel Eisner - William Blair & Company

Then I guess just to head on to that, can you maybe talk about utilization rates within I guess the three separate bearing businesses?

Glenn Eisenberg

Overall, capacity as Jim talked about within steel, we are probably running around, call it 85 percentage which is effectively full for us. On the mobile side, and give you kind of rounded numbers around 70% process, around 75% and on aero around 60%. So as Rich said, while from a segment standpoint, we have additional capacity. There are still certain markets within those segments that could be more constrained than others, such as the rail segment, if you will, within the mobile market.

Samuel Eisner - William Blair & Company

That’s definitely helpful, thanks. Regarding the pension, obviously you are now about 84% funded, I think last year, or the beginning of last year, you were about 90%. Can you maybe talk about whether the deltas are in your guidance, maybe how much on a year over year basis, you would increase your ongoing pension expense and how that flows through in your guidance assumption?

Glenn Eisenberg

No, we’ve always said, at least for the most part plus or minus $100 million of expense for pension and OPEB is a reasonable number. It does fluctuate every year. But the magnitude is normally not that great because of averaging and so forth. But as you know we’ve contributed a fair amount into the plan this year, only to see the contributions we made be offset because of having a lower discount rate as well as asset returns. In fact, our asset returns came in around 4.5% this year versus 8.5% expectation if you will and the discount rate dropped fairly dramatically at the end of the year, and we are discounting it around 5% which were 75 basis points lower.

So, again, the funding status remains at 84%. We were at 86% at the same period a year ago. We actually had that percentage improved as we went through the year but again, on the year end valuations back to around 80% and we’ve talked in our guidance of cash flows for next year we will put in around $150 million net of tax, or call it 250-ish pre-tax into those plans in both the pension and the OPEB, or our post retiree medical. On that front, we did see an improvement in the post retiree medical by around $135 million. Again, this is a discretionary plan that we are not required to fund and at the end of 2011 we were around 27% funded in that plan as well. So that gives us a flexibility going forward on cash flows as well.

But we always say rates can’t go any lower and they do. But our strategy is to continue to fund and these are discretionary. So we will evaluate where we are on the balance sheet relative to other opportunities to invest but clearly we’ve also talked about at least on the pension side going through and trying to address the liability now as much as the asset side by looking at potentially going out with lump sum payments, annuitizations and so forth so that we can lessen that liability that we have.

Samuel Eisner - William Blair & Company

And then just lastly obviously you highlighted your $1.3 billion of liquidity and your strong cash position. I mean, can you maybe just talk about priorities for cash and maybe acquisitions as well, are you still targeting expanding further into process and aerospace or is there something else that you would be maybe looking at from an acquisition standpoint?

Glenn Eisenberg

Again, with the exception, take acquisitions maybe last, but clearly the $345 million that we are talking about on CapEx is a large amount for us, more than our normal amount. So clearly what you heard from Jim and the others, we see a lot of good growth opportunities from that respect. We’ve talked about 100, call it $150 million net of tax into the pension and post retiree will be a form of that investment. Obviously we have a dividend and a share repurchase program that we will continue to be active in.

And then on the acquisition front, we continue to look for strategic acquisitions across the businesses. There were two that we did this past year, and we continue that we will use some of our liquidity to continue to pursue our strategic growth in acquisitions in a lot of different areas but obviously what you’ve seen is kind of growth outside of our traditional product offerings more into a broader expansion into the power transmission, mechanical power transmission space.

Operator

Thank you. And our next question is from the line of Steve Barger with KeyBanc Capital Markets. Please go ahead.

Steve Barger - KeyBanc Capital Markets

For the steel segment, thinking about the 5% and 10% revenue forecast, can you break that out for me between volume and price?

Salvatore Miraglia

Steve, it’s all mix and price. We will be about flat on volume for 2012, operating close to a capacity level, not actually there, depending on what product mix might come through weeks, maybe able to get little more up but predominantly we are talking about mix and price that affects that, yeah.

Steve Barger - KeyBanc Capital Markets

And so in terms of margin, I mean, if you are getting all that on – if a lot of that is coming from price, you should have a really solid incremental margin in that segment right?

Salvatore Miraglia

I kind of signaled little earlier that we’d expect to maintain that low to mid-teens EBIT margin level up from where we were, a year or a year and half ago, which was just about 10% or thereabouts.

Steve Barger - KeyBanc Capital Markets

Can you tell us what maintenance costs in the quarter were for steel?

Salvatore Miraglia

For the fourth quarter we were probably around $30 million to $35 million of maintenance for the quarter. We did a lot of work in that particular period of time because of the holiday period.

Steve Barger - KeyBanc Capital Markets

And what’s the – how should I think about a run rate for that kind of in ’12 on a quarterly basis?

Salvatore Miraglia

Similar to what we had before about $20 million to $30 million a quarter.

Steve Barger - KeyBanc Capital Markets

Okay. And switching gears for a second to process, the release mentioned that the segment that you benefitted from a really strong mix of distribution. Can you tell me the margin differential between distribution and OE, and how should I think about what that mix is on percentage basis going forward?

Chris Coughlin

That varies considerably and I don’t think we are going to provide that kind of data. That said, our distribution mix, primarily meaning aftermarkets, is running 65% on norm, been running a little closer to 70% in 2011. But there is clearly distinctly a margin differential between the two. And the reason, I’d be greatly generalizing because of the OE side of that business and even the distribution side. The mix can fluctuate or the margin can fluctuate quite a bit depending on the product line and other details around which specific segment we are talking about.

Steve Barger - KeyBanc Capital Markets

Generally speak though, is it 100 basis points?

Chris Coughlin

Yes.

Operator

Thank you. And our next question is from the line of Tom Mullarkey with Morningstar. Please go ahead.

Tom Mullarkey – Morningstar

Okay. My first question, since a lot of them have been answered, deals with the last February at your investor day, you spoke about the opportunities in Asia, and you talked about the market softening a little bit. I was wondering if you can get into maybe specifically in China and India, what you saw in 2011 and if any of your forward looking thoughts have changed around the wind, aerospace, power transmission and rail sectors in that region?

Chris Coughlin

Yeah, I will start. This is Chris. The first nine months in Asia were pretty much the way they have been. We were cliffing off 30% growth rate kind of number. So the first nine months of the year were very, very good. In the fourth quarter, as a result of significant tightening from the government in the mid of 2011, basically the growth disappeared for argument sake, we could debate the numbers. So the governments are reining in inflation, this is also happening in India as well.

So what has happened is the growth rate has sort of disappeared and I use that term because it’s not the market collapse or anything, it’s just that the 20%, 30% kind of growth rate is not there. And we will not see that in the first quarter. Now the government has begun loosening credit again, and I think as I pointed in previous call, this is my third experience with this. In the previous two experiences, six, nine months after the government has done that, we see the market return to growth. So we are cautiously optimistic that we will see the resumption of growth in the China market in the balance of the year as we move deeper into this year.

We have not seen as bigger problem in the greater Asian area, meaning Indonesia and countries like Vet (ph). So and we still got some pretty decent growth there. So that’s really the geographic look at it.

In terms of the markets, most of the markets in China continue to do very, very well. I would put wind off on the side, it’s a little bit of a special case. It’s a market that’s definitely struggling and you will hear that from a number of people I am sure. But rail, mining, infrastructure, metals, these markets are still pretty robust within the region.

Tom Mullarkey – Morningstar

Fantastic, thanks. And I guess, my next question is looking at your Philadelphia Gear acquisition, it’s been under your belt now for about six months, is the integration going as planned? And I think the business is primarily North American, have you been able to roll it out the solutions into any international markets?

Chris Coughlin

Yes. Two things, one is going extremely well. And I think you can see that just by looking at the margins and process industries, we brought that segment in. So you can see for yourself that it’s performing very, very well in terms of profitability and everything we expected. We are in the process of taking that platform globally and so there is a lot of work going on, India, China and throughout the greater world to globalize the platform, which is our primary synergy per your point that they're very strong in North America already.

Operator

Thank you. And our next question is from the line of Gary Farber with CL King. Please go ahead.

Gary Farber - CL King

Just a couple of questions. Can you talk about – you talked about at the beginning of the call the trends in North America, Europe the turmoil, Asia the credit situation, can you discuss the competitive environment you are seeing? How are competitors responding in those different geographies? Do you think there is opportunities for market share?

Jim Griffith

Let me take that question and talk about it sort of at the corporate level. And then if you want to dive into a particular market, you can. The focus of Timken, go back to my original comments, the focus of Timken is to focus on specific markets where we have unique capabilities in the marketplace. And our goal in those is to focus on markets that are growing and to grow disproportionately into those markets which there in your terms means we will gain share in those. I think – but you have to step back, you can’t define that as either bearings or SBQ steel markets. You have to define them specifically in markets like oil and gas on the steel side, mining, infrastructure, rail road et cetera on the bearing side, and certainly the industrial aftermarket on the bearing side.

Rich Kyle

From a mobile perspective, add a little more color, I’ve not seen anything unusual from a competitive landscape globally as a result of European economic issues or other issues. Looking back in our rail, off-highway and our aftermarket businesses within mobile, we certainly held our own or gained penetration through the course of 2011. On automotive, we’ve already talked about that. We strategically lost share there and heavy truck probably held our own. Always pricing pressure but general pricing went up, we were little behind covering the material within mobile. But we expect to cover that in 2012.

Gary Farber - CL King

There has been a fair amount of movement in raw material costs over the last quarter or so. Can you discuss if that’s having any impact on your business at all?

Salvatore Miraglia

Let me take the first stab at that, Gary. This is Sal. As we’ve described earlier, we have had operatives since 2004 as a surcharging mechanism for scraped alloy. At one time energy but energy is looking pretty good right now. So it’s not as operative for us nor as problematic, the fact, it’s a positive. So other than slight variations month to month, we essentially have passed the volatility and cost escalations of raw materials down to supply chain. So we are pretty immune from that in steel right now.

Glenn Eisenberg

Just as a general comment too for the company. As Sal said, within the steel group the mechanism of surcharges recovering our material cost has been very effective. And as we go into 2012, we really have true pricing power given the constrained markets. Within the bearing and power transmission again, we have the ability to pass on those for the most part through price increases. So as a net impact of higher raw material costs on the company between the pricing and the surcharges, we would expect as we did this year to meet or exceed through pricing beyond the cost of those materials.

Operator

Thank you. And our next question is from the line of Holden Lewis with BB&T. Please go ahead.

Holden Lewis - BB&T Capital Markets

So where steel is concerned, I certainly understand that your capacity constraints of the volumes aren’t going to go up that much. But to the extent that price is a big source of growth and in fact, drives double digit growth. I mean, shouldn’t that drop to a greater degree right to the bottom line? And so if you achieved sort of 15% margin in Q4 in steel, why wouldn’t we assume that with a big pricing piece coming through that you wouldn’t build on that 15%?

Salvatore Miraglia

You are thinking about it perfectly correctly, Holden. But just remember that we also moved pricing in 2011. So there is one on top of the other that we are seeing for the two years. And in addition, where we have the opportunity, again because we are practically at our capacity right now, we are shifting when possible to more profitable product lines, when that opportunity makes itself available. So I mean, I can’t argue with your logic. We agree with that.

Jim Griffith

Holden, just little bit of color, though. I mean, if you follow your logic, you’d say 10%, 15% price increase means those dollars fall right to the bottom line. There are some cost headwinds in steel, some particular inputs that we are seeing very aggressive that, inflation, carbon-based kinds of things, and that offsets it. So it tempers the profitability impact of that pricing to some degree.

Holden Lewis - BB&T Capital Markets

That’s helped by surcharges right?

Jim Griffith

No, that’s raw materials but if you look at things such as refractory and electrodes where there are similar global capacity constraints, there is opportunity there for those suppliers to push their prices and they are.

Holden Lewis - BB&T Capital Markets

And then you made reference I guess to sort of the margins in Q4 being adversely impacted by accounting adjustments. Can you give some sense and that would obviously be the mobile and process, can you give some sense of how much that margin impact was, because that should be relatively temporary and be gone through most of 2012, right?

Glenn Eisenberg

Yeah, I guess the only things that I can think of that would have negative impact our performance that were unusual would be I guess, tier 1, some purchase price accounting issues, with regard to Drives, but again not a significant issue, probably in the $1 million to $2 million issue. And then the Brazil if you will the restructuring as we closed our facility and are looking to exit that we have some costs just going through that primarily environmental and that’s probably to the tune of around, call it $6 million. So overall you are looking at – those would be the only two that I would identify as, call it unusual.

Holden Lewis - BB&T Capital Markets

And then lastly, if I am kind of doing this math correctly in your mobile business, I think automotive is roughly 40% of mobile and you can certainly update the number. But -- and if that’s right, then your automotive business in mobile is about $700 million. And if you are losing $150 million of that, I mean that’s like a 20% reduction in your overall automotive business. I guess I am kind of curious – I mean, is that going to necessitate more fixed cost restructuring, because that's a meaningful decline in the overall size of that, that operation?

Rich Kyle

Your numbers are close to right. It is about a 20% reduction in the size of that business. But no, we have taken the fixed cost reductions at this point over the last couple of years and we’ve made some variable cost reductions in the fourth quarter of last year, and are comfortable with where we are at from a cost perspective getting into the year.

Holden Lewis - BB&T Capital Markets

And then given that is the $14.5 million in restructuring charges that you incurred in 2011, are we sort of – I know you embed them now rather than strip them out. Are we going to see light numbers in 2012 or are we kind of done with that $14.5 million, that $0.10?

Rich Kyle

No, we would see a similar type of number in 2012 in terms of repositioning our portfolio and investing in our competitiveness of our manufacturing operation. So a relatively small number in comparison to our revenue.

Jim Griffith

Holden, just again to put that in little perspective, and I think we said this to you before, when we can go in and project changes like we have with the pricing program we went through in 2008 and 2009, we can handle those adjustments with relatively small restructuring charges. And the change in accounting method that we made, what two years ago, this year, was intended to signal that the big restructuring is behind us. But I think just any business like ours just operating on a global basis will continue to have small restructuring charges to the kind of tune of $10 million to $20 million a year on an ongoing basis.

Operator

Thank you. That is all the time we have for questions today. At this time, I would like to return the conference over to Jim Griffith for any final remarks. Sir?

Jim Griffith

Well, again thank you for your interest and thank you for the robust questions. Obviously we are excited that 2011 was the best year in our history and the more exciting part is as we look at 2012, we believe we have the capability to take the company up to a new level of performance. Thanks again for your interest.

Operator

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

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