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Executives

Steve D. Tschiegg - Manager of IR

James W. Griffith - President and CEO

Glenn A. Eisenberg - EVP of Finance and Administration

Michael C. Arnold - EVP and President

Analysts

Eli Lustgarten - Longbow Securities

Martin Pollock - NWQ Management

Mark Parr - Keybanc Capital Markets

Holden Lewis - BB&T

David Raso - CitiGroup

Brian Carlson - Atlantic Investments

The Timken Company (TKR) Q1 FY08 Earnings Call April 30, 2008 11:00 AM ET

Operator

Good morning. My name is Christie and I will be your conference operator today. At this time I would like to welcome everyone to Timken's First Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Mr. Tschiegg, you may begin your conference.

Steve D. Tschiegg - Manager of Investor Relations

Thank you and welcome to our first quarter conference call. I am Steve Tschiegg, Manager of Investor Relations. Thank you for joining us today and after our call should you have further questions, please feel free to contact me at 330-471-7446.

With me today are Jim Griffith, President and CEO; Glenn Eisenberg, Executive Vice President of Finance and Administration and CFO; Mike Arnold, Executive Vice President and President, Bearings and Power Transmission Group; and Sal Miraglia, President of our Steel Group.

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

Before we begin, I'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 in today's press release and in our reports filed with the SEC which are available on our website www.timken.com. Reconciliations between GAAP and non-GAAP financial information are included as part of the press release. This call is copyrighted by The Timken Company any use, recording or transmission of any portion without the express written consent of the company is prohibited.

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

James W. Griffith - President and Chief Executive Officer

Thanks Steve, and good morning. I am pleased to result that Timken began 2008 with record first quarter results. The top line for the quarter was up 12% and our earnings from continuing operations were $84 million. Excluding special items earnings per diluted share of $0.82 increased 24% over last year, exceeding our earnings estimate for the quarter. The changes we're making to our portfolio are working. We are more industrial, more global, and our portfolio is better aligned for consistent profitable growth. We have made critical changes and investments to improve our ability to execute. Our enterprise strategy is clear, to grow targeted parts of our portfolio while optimizing the rest. The first quarter results reflect this progress to structurally transform our business.

Beginning this quarter, we are reporting the results of the company under four business segments. Glenn will take you through the details in a moment. But first, I'd like to review the quarter, in terms of the progress we've achieved to deliver improved performance. Sales and earnings for all three Bearings and Power Transmission segments are up.

In mobile industries, our results reflect the positive impact of pricing efforts as we discussed last quarter, in markets where we are not earning a suitable return. Additionally, we've essentially completed our restructuring and are seeing improved operational performance. The realignment of our bearing and power transmission organization translates into better execution and more effective portfolio decisions. I've been very impressed over the last few weeks at the speed at which our organization is reacted to the customer work stoppage underway in Detroit. Reallocating capacity where possible and taking other actions to mitigate the impacts.

Sales and process industries were up 25% this quarter, driven by strong demand, particularly in energy, the metals industry and distribution sectors. Our investments in capacity to serve these markets are now coming online and have a significant impact on our bottom line which more than doubled for last year in this segment to $60 million in EBIT.

Two weeks ago we celebrated the opening of two new plants in Asia, increasing our manufacturing footprint to seven facilities in the region. Timken is very well positioned in Asia, to achieve accelerated growth and improved profitability in years ahead. The plant in Chennai, India will produce medium size bearings to serve industrial customers, providing much needed capacity in market sectors where we've had backlogs. Our new plant in Chengdu, China will serve global aerospace customers as well as China's rapidly growing commercial aviation industry.

Timken sales in Asia grew over 30% in the quarter, further diversifying our portfolio. Nearly 8% of the company sales now come from this region. Within our aerospace and defense business we began to see the impact of improved execution and additional capacity in our core business. And the Purdy acquisition has already made significant contributions to this business, extending our product offering into complete helicopter gear boxes. In our steel business, we are generating strong results as we continue to grow in differentiated markets.

In February, we completed the acquisition of Boring Specialties, further extending our strong position in the growing market for high performance energy products. We continue to experience rapid increases in the price of raw materials in the quarter which resulted in a significant increase in our LIFO reserve. This month we successfully implemented the third phase of Project O.N.E, a business process and systems improvement initiative. The company now has most of its bearing and power transmission revenue in North America and Europe, flowing through one fully integrated system and we are already seeing improved customer service as a result.

In closing, we expect strong global demand for industrial products to continue. Our results for the quarter illustrates structural transformation and improved execution, driving enhanced performance across the portfolio.

Now, I'll turn it over to Glenn.

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

Thanks Jim. For the first quarter, the company's fully diluted earnings per share from continuing operation were $0.88, excluding special items earnings were $0.82. These special items included $6 million of after-tax income, primarily related to a gain on a real estate divestment, which was partially offset by restructuring and rationalization expense.

In the first quarter of 2007, special items totaled after-tax income of $12 million, and included a favorable adjustment to our tax reserves which was partially offset by restructuring and rationalization expense. The rest of my comments will exclude the impact of special items.

Sales for the first quarter were $1.4 billion, an increase of 12% over 2007. The increase over last year was due to strong demand across the company's broad industrial markets, aided by capacity expansions, any impact of favorable pricing surcharges in currency. The benefit from the Purdy and BSI acquisitions was offset by the divestiture of the Desford 2 Mill early last year.

Gross profit margin for the quarter was 21.8%, an improvement of 90 basis points from last year, reflecting favorable pricing, currency and strong demand, partially offset by higher LIFO expense reflecting the higher cost of purchase scrap within the steel group. The company was also able to leverage SG&A as the margin improved 40 basis points over last year to 12.3%. As a result EBIT for the quarter came in at $113 million or 9.1% of sales, a 110 basis points better than last year.

Net interest expense for the quarter was $10 million, up $2 million from last year due to higher debt levels resulting from the company's acquisitions. The tax rate for the quarter was 34.5% comparable to last year and our prior outlook. As a result income from continuing operations for the quarter was $78.9 million or $0.82 per diluted share, an increase of 24%, compared $0.66 per diluted share last year, and above our previous earnings estimate for the quarter of $0.70 to $0.80.

As Jim mentioned, the company implemented a change to its management structure. It now operates under two business groups, the Steel Group and the Bearings and Power Transmission Group which includes three segments; mobile industries, process industries, and aerospace and defense. Beginning this quarter the company will report its segmented financial results under these new segments which exclude special items and unallocated corporate expenses.

Now, I'll review our business segment performance. Mobile industry sales for the quarter were $635 million, up 4% from a year ago. Increased sales in the off-highway and heavy truck sectors as well as pricing and the favorable impact of currency were partially offset by a lower demand from the North American light vehicle sector, which included the effect of a strike at one of our automotive customers.

For the quarter, mobile industry's EBIT was $27 million, or 4.2% of sales, 80 basis points higher than last year. The benefit of improved pricing, mix, currency and restructuring were partially offset by higher material costs and the effects of strike. We expect to see improved results from this business for 2008, compared to last year as the company benefits from its restructuring, pricing and portfolio management initiatives, which are expected to be partially offset by higher raw material costs and the impact of the strike.

Process industry sales for the quarter were $313 million, up 25% from a year ago, benefiting from pricing, currency and added capacity to serve continued strong demand across our broad industrial markets, with the highest growth coming from the metals and energy sectors. The business also benefited from advanced customer purchases ahead of Project O.N.E. implementation that is expected to reduce demand in the second quarter.

For the quarter, process industries EBIT was $60 million or 19.2% of sales, 830 basis points higher than last year. The impact of strong volume, added capacity, pricing and currency were partially offset by higher manufacturing, logistics and material costs. We expect to see continued improvement in our results throughout 2008, compared to last year. However, the second quarter performance is expected to be lower than the first quarter, due to the timing impact of Project O.N.E. as well as higher raw material costs.

Aerospace and defense sales for the quarter were $102 million, up 39% from a year ago. The increase was primarily driven by the acquisition of Purdy last quarter as well as volume and pricing. Excluding Purdy, organic growth was approximately 10% for the quarter. EBIT for the quarter was $7 million or 7% of sales, 180 basis points lower than last year. The favorable impacts of the Purdy acquisition, pricing and volume were offset by higher material costs as well as manufacturing and logistics costs due to capacity additions and managing strong demand through constrained facilities. Looking forward, we expect the aerospace business to improve profitability and margins throughout the year due to the acquisition of Purdy, strong demand, pricing and better execution.

Steel Group sales for the quarter were $425 million, up 9% from a year ago. The Group benefited from strong demand, primarily in the energy sector which was partially offset by lower automotive related sales. In addition, surcharges and the acquisition of BSI more than offset the decline in volume from the closure of the Desford 2 manufacturing operation.

Excluding the impact of acquisitions and divestitures, sales were up approximately 16%. Steel Group EBIT for the quarter was $53 million or 12.6% of sales, 420 basis points lower than last year. The year-over-year change was primarily due to a LIFO accrual, reflecting the higher cost of purchased scrap. The benefit of strong demand, favorable mix and surcharges in the quarter were offset by higher material manufacturing and logistics costs. Steel Group performance in 2008 is expected to be comparable to the record level achieved last year, despite higher LIFO expense resulting from continued high raw material cost.

Looking at our balance sheet, we ended the quarter with net debt of $805 million, $112 million higher than the end of 2007 due to seasonal working capital requirements and the acquisition of BSI. As a result, the company's leverage of net debt-to-capital increased to 28%, compared to 26.1% at the end of 2007. We expect to generate strong free cash flow for the remainder of the year, providing financial flexibility to pursue strategic investments.

Capital expenditures for the quarter were $52 million, or 3.7% of sales, comparable to depreciation and amortization of $57 million. This spending level will increase over the course of the year as we continue to make investments in support of our growth initiatives. We contributed $12 million to our global pension funds during the quarter. Our full year 2008 contributions are expected to be approximately $20 million, down from roughly $100 million last year.

In summary, we expect demand from our global industrial markets to remain strong, especially in key markets where we've invested for growth, and for the North American automotive market to be down. We expect to see higher profitability and margins for the full year, compared to last year, benefiting from improved pricing, operating performance and portfolio management initiatives. We expect earnings per diluted share for 2008, excluding special items to be in the range of $2.75 to $2.95, a record for the company. And earnings of $0.73 to $0.83 for the second quarter.

From a cash flow standpoint, we expect to see higher free cash flow in 2008 benefiting from earnings growth, better working capital management 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.

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

Question And Answer

Operator

[Operator Instructions]. Your first question comes from the line of Eli Lustgarten of Longbow Securities.

Eli Lustgarten - Longbow Securities

Thank you.

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

Good morning Eli.

Eli Lustgarten - Longbow Securities

Nice quarter, very impressive. A couple of clarifications; one, can you give us the impact of foreign currency, both on top line and bottom line and the actual numbers for the contribution of the various... of the two acquisitions and divestiture?

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

Yes, Eli. Currency for the quarter call it around, it was around $50 million of our revenues. So it accounted for roughly a third of the top line growth. The acquisitions that we had during the quarter of Purdy and BSI are the full impact of the quarter was essentially offset by the decline that we had by exiting our Desford operation. So, the net between the two was effectively zero, so it had no impact on year-over-year on the top line. And as far as bottom line we leveraged reasonably well, the currency we don't give out specific levels within the EBIT number.

Eli Lustgarten - Longbow Securities

But the currency is clearly contributed to the earnings number?

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

It did possibly help them.

Eli Lustgarten - Longbow Securities

Okay. And you indicated the pull forward of some revenue I guess it was the process group in the quarter to the Project O.N.E. for prices coming forward. Can you quantify what that might look like and how much do we give back in the next quarter and so we just had a forecast this?

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

Right. Just from a timing standpoint, again we would say that roughly call it $10 million to $15 million of sales would have been accelerated into the first quarter versus the second. As you may recall, we went through systems implementation last year as well but we did in May. So, we saw similar events. We prepared for the advance of going live on the systems because this was now April 1 the advanced shipments if you will went into first quarter versus the first month of the second quarter.

Eli Lustgarten - Longbow Securities

So that too would have been a couple of pennies a share coming from that?

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

That's correct.

Eli Lustgarten - Longbow Securities

Good. Do you have any quantification what the strike might have cost you in the numbers and whether we see more impact in the second quarter from the automotive strike and the automotive downturn that we saw in the first quarter because it was very impressive what you did given the condition in the auto industry?

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

Sure. Again I'll give you the dollars and again Mike can give you any of the color on there what's going on. But we are viewing it roughly around $15 million plus or minus, call it a month of the revenue impact from the strike, and with leverage of around 20% and so again similar, couple of cents a share, if you well per month of that impact.

Eli Lustgarten - Longbow Securities

And did it get worse in the second quarter since this thing begun?

Michael C. Arnold - Executive Vice President and President

Yes, Eli this is Mike. It really doesn't get worse. It stays at about the same, unless they begin to impact other producers that drives downs to the supply chain. So, the impact that we have seen in the first quarter fundamentally was a March impact. That can run through April and May is almost a monthly impact that we are looking at so.

Eli Lustgarten - Longbow Securities

So we had one month so far and latter in the first quarter we have one months down the second quarter you can say.

Michael C. Arnold - Executive Vice President and President

We had about $15 million in the first quarter as Glenn said, if we look at the second quarter going through is the strike was finalized at the end of this month we probably look at $15 million to $20 million. We just have to see how that actually works out. And as Jim said earlier in his comments our ability to mitigate that from a margin prospective but also try to move some of that product to other markets has been relatively successful.

Eli Lustgarten - Longbow Securities

Okay. I'll get back in queue. I don't want to hung it.

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

Thank you.

Operator

The next question comes from the line of Martin Pollock of NWQ Management.

Martin Pollock - NWQ Management

Very nice results. If I may, this is the first quarter we are seeing the new recasting of the data, but I am most curious is within the segments mobile industries, if you can give us a sense of what the automotive operations did both in the top line and bottom line also, seems aerospace is little surprisingly with a lower then I would expected and wondering if you can describe what the mix issue there in terms of nature of that business? And process clearly phenomenal numbers, can you essence give us little bit more transparency year-over-year, if we had actually maybe seen some of this data without the recasting of the numbers?

Unidentified Company Representative

Yeah, Marty. This is Mike let me walk through all three segments and give you some insights. If we take a look at the mobile as Glenn went through the numbers you'll see mobile as a whole was up 4% on sales about 27% on EBIT. We said in previous quarters that we would try and give you some insight to the automotive pieces that we were still recording in the old automotive group. If we took a look at that sales would have been slightly down which you would have expected out of what we now consider to the light vehicle systems inside the mobile industries. So sales were down about 3%, EBIT was actually improved, quarter-on-quarter so year-on-year. So that was good and that was offered by relatively stronger first quarter for the automotive group last year compared to the reminder of the year.

So that's actually been very good news on the automotive side inside of the mobile piece. So we are making good progress there. If we go to the process industry is just to give you a little bit insight to write the first quarter was a very strong first quarter and as Glenn had talked about some of that is the pre-shipments that we made in March versus April preparing for the implementation of project running and then sharing our customers had the right level of inventories as we took now some of the operations for the implementation.

So there was combination of some volume that was moved in from April. We also have very strong pricing that is continued on as we have discussed over the past couple years. That does continue a very strong markets and strong domain, probably just as important is the volume increase that were getting now from the capacity investments that we've been making over the last several years. So we've talked about those capacity increase as drags on our earnings.

Now we are beginning to see the leverage from that investment and then of course we've gotten some benefits from currency. The good news also is and looking at the first quarter is we've been able to mitigate at least year-to-date the material and some of the logistics cost that we have that are above what we would expect them to be or had expected them to be. But we are able to mitigate that through the strength of the business in our pricing. So, that looks good. We don't expect that margin in the second quarter as Glenn already talked about. But in general that business is running very good and the implementation of Project O.N.E. is not only bringing us improved abilities to serve our customers, but from an on time delivery perspective, inventory in place for our distribution partners across the world is all working out that very well.

A couple of comments on the aerospace, because the aerospace does... this is the first time that we have reported that externally. We walk through that a little bit on the Analyst Day about 6 weeks ago. But if you go through the walk on sales up 39% quarter-on-quarter most of that was from the acquisition of Purdy if you look at just the organic piece of that from a growth perspective they were up about 10% quarter-on-quarter. That 10% breaks down because I know your next question breaks down to about half of that is volume and half of that is price and there is a little bit of foreign exchange in there.

The difference with regards to the actual margins quarter-on-quarter is we would look at the first quarter and say that is going to be our weakest quarter of the year. So we will continue to see gradual improvement in that business. Fourth quarter was a very, very strong quarter and if you go back and kind of look at the 2007 quarter-by-quarter results, you will see that the first quarter although fits relatively well in there, would still be considered to be our weakest quarter for the year going forward.

Martin Pollock - NWQ Management

Yes. If I may just a follow-up, back to the automotive and I guess I don't have last year's quarter, but the sale, coming off the fourth quarter where profits were significantly down. Just give us a little bit of a clarity from what kind of loss did we have in Q1 on automotive and this was pricing actions do you think you've got... the kind of tailwind in the pricing here that suggest things are actually going to get better Q2 and since '04. And the other question on truck, we were clearly in a down cycle here but should we be expecting that any improvement later in the year at least going into '09 on that piece of the business and how big is that exposure to you?

Unidentified Company Representative

Marty, let me take a little bit of a cut from the automotive numbers again, relative to prior periods. First thing and foremost probably is that automotive OEM which is the way we reported that before still accounts for around 60% of the segments. So as Mike said, the changes that you see are truly a reflection in part of what's going on within the automotive business. And as Mike alluded to that sales were slightly down, but from a mix standpoint that was attractive. The sales were down because of the of the strike.

They were down in the light vehicle but we had nice sales improvement on the heavy side. So from a mix and from an earning standpoint that was favorable plus the benefits we continue to get within the pricing as well as the restructuring that we had. And, again there will continue to be the headwinds that we have experienced with regard to material costs and our expectation is that headwind will continue as we go throughout the year and again, Mike alluded to the uncertainty of the strike or how long it will last or be at obviously we are although flow that. It won't be very long lift.

The other thing just to say what's different and how we would have reported the numbers before is the unallocated corporate expense which now comes out, which was effectively a little over 1% of sales to 1.4 varied that would have been pro rata allocated if you will to the businesses. So you can come back to try to get to the same kind of number that we had before by looking at our corporate expenses giving them the pro rata share. What we would tell you though is as best as we can gauge that the old auto OEM group would still be in a loss for the quarter, even with the allocated corporate cost, so identical to what we would have reported before the new segmentation but we would have seen a nice improvement year-over-year in the first quarter and a lot of the improvement within the segment was attributable to the automotive OEM performance.

So as Mike said, it has improved, we expect it to continue to improve but realizing that there is still the challenges ahead with material and with the current markets what's going on with GM and with just the strike that's going on. Hope that gives you a some color on it, but again it's an improved part of our business.

Martin Pollock - NWQ Management

Okay, thank you.

Operator

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

Mark Parr - Keybanc Capital Markets

Hi, good morning.

Unidentified Company Representative

Good morning.

Unidentified Company Representative

Good morning, Mark.

Mark Parr - Keybanc Capital Markets

Great quarter. Holy smokes, stock is up almost 15% today, nice work. I wish... it's nice to see that something else besides steel is driving the company for a change.

Unidentified Company Representative

It's one of those overnight success story that 20 years in counting, right?

Unidentified Company Representative

Marty, I take offence to that.

Mark Parr - Keybanc Capital Markets

Alright sorry Sal. Was that Mike? Mike, great job. Phenomenal results and I just think we are seeing kind of the initial impact of lot of things coming together but at least the early returns on the restructuring appear to be really encouraging. So I just wanted to give that kudo. I did have a question on the steel business, the LIFO charges did have a negative impact and one of the things I would point out is that, the other steel operations that we've seen report first quarter have been able to overcome the higher raw material costs, I am wondering if we should see a reversal of the comparisons in the second quarter or how... given an outlook for flat numbers for the year, again which is the lot more conservative than the rest of the space that I am looking at. How do you see the quarters on full and hope for the balance for the year and are you really just being overly conservative here?

Unidentified Company Representative

Yes. Good morning Mark, it's Sal.

Mark Parr - Keybanc Capital Markets

Hi Sal.

Unidentified Company Representative

Frankly we are little concerned and I think it has more to do with exactly how rapidly these raw material prices actually change. Just to give you some quantification, we took over $17.5 million charge for LIFO in the first quarter. So if you look at that it is, by all measures we had just a bang up first quarter without one exception in terms of total tons and turns of sales dollars and it is that rapid jump that require that we go through and make a modification for what we believe the full year will be. If we don't see a very radical variation in this especially upward variation in raw materials from here, we just go back to even what appear to be crazy last year with decline but some thing on a bit more controlled rate. We expect the year will be very strong. We look to be at least as good as last year maybe even a little stronger and that is even in the phase of relatively weaker automotive market business stands right now. But, what happened last month, $150 a ton jump in the cost of our raw materials, that was just...

Mark Parr - Keybanc Capital Markets

Right.

Unidentified Company Representative

Off everybody's radar screen.

Mark Parr - Keybanc Capital Markets

And Sal based on what we are here at and that will be up at least another 50 bucks this month.

Unidentified Company Representative

Right and we expect that. But, 50 bucks doesn't sound so bad anymore.

Mark Parr - Keybanc Capital Markets

It's a lot. Based on the way your contracts are structured, I mean you are well above 70% contract as far as your overall mix at this point.

Unidentified Company Representative

Yes, that's close. Right.

Mark Parr - Keybanc Capital Markets

Alright. So what sort of lag do you have as far as being able to pass the scrap cost through, you are on a 30 day or 90 day lags, how is that working?

Unidentified Company Representative

Our formula is 30 days. It sets the index for the following month based on the prices published in the American Metal Market this month. So the beginning of the month that's what the index will be for the following month. We are on that, just about 30 day delay for the change in surcharge. We are about... and when it comes to timing, we are 98% covered on this stuff. There is only a few places were we lose little bit on it Mark. So it will make us wait through, it's just a matter of timing.

Mark Parr - Keybanc Capital Markets

Okay, alright. So you see...

Unidentified Company Representative

But the LIFO is a real permanent charge until things start coming back down on some other side of the demand scale.

Mark Parr - Keybanc Capital Markets

Alright. Okay, I hear you. Okay, terrific and thanks for that color guys and congratulations on a great quarter.

Unidentified Company Representative

Thanks Mark.

Unidentified Company Representative

Thanks a lot Mark.

Operator

[Operator Instructions]. Your next question comes from the line Eli Lustgarten of Longbow Securities.

Eli Lustgarten - Longbow Securities

Can you quantify how much incremental capacity will have available in the second half of the year from the new plants or is the next couple of quarters?

Unidentified Company Representative

Do we miss... I think we missed the first part of your question Eli. Would you repeat it please?

Eli Lustgarten - Longbow Securities

My first part I just made a comment so that comment so that everybody must be so impressed that I can ask questions today.

Unidentified Company Representative

We actually heard it. We just wanted you to repeat it.

Eli Lustgarten - Longbow Securities

We sit there almost in all of the quarter, not that we want to pick up the voice of guidance so conservatively beat everybody's estimate by $0.08. Later $0.08 any way but we want to touch that.

Unidentified Company Representative

Yes, Eli let me just see your question was basically how much more capacity would be coming online and how that will leverage the remainder of the year?

Eli Lustgarten - Longbow Securities

Yes, that kind of volume increase will go years in the new capacity how does it go...

Unidentified Company Representative

Yes, we looked at the beginning of the year some places in the neighborhood about $75 million which regards to increase capacity during this year. So there will be that clearly will be coming on, we'll continue to push those new manufacturing facilities for additional product but we know that we will get to that level, you'll begin to see that as you did in the first quarter with regards to volume because if you remember in process industries we are still constrained on many of our product lines. So this new capacity goes right to the market and it gets clear leverage.

Eli Lustgarten - Longbow Securities

Okay, and going back that's... for the first time Sal, I may have to work for living and actually perform that opposed to coasting for last couple of years. We can leverage for the past two of the high material cost that's going to take place. Is that going to offset by the weakness automotive in the second quarter and you really wanted improvement till the second half of the year?

Unidentified Company Representative

I don't believe so Eli. We already saw some weakness in the first half... in the first quarter. And it's all in weakness. So it was about... we probably would have had 3% higher shipments for the quarter if automotive were anything like normal. So all in that was about it and we still had records across the board.

Eli Lustgarten - Longbow Securities

Yes, and I guess I'm looking at the production schedules are weaker in the second quarter and the strike is still going. Strike doesn't disappear very quickly.

Unidentified Company Representative

That's right.

Eli Lustgarten - Longbow Securities

So, just looking at the impact but at this point we should be able to see some of the improvement in margin beginning in the second quarter run out?

Unidentified Company Representative

We believe so, yes.

Eli Lustgarten - Longbow Securities

Okay. The interest charges are going to stay relatively flat at the current level? Is that the expectations?

Unidentified Company Representative

Yes, the interest rates... obviously we're going to envision generating free cash flow, so the debt balances should come down, but the interest rates should remain relatively the same.

Eli Lustgarten - Longbow Securities

Okay. Alright, thank you.

Operator

Your next question comes from the line of Holden Lewis of BB&T.

Holden Lewis - BB&T

Thank you. When you talk about the two items which maybe somewhat trained in nature, does the pull forward of demand and process in the automotive strike, one manages roughly $15 million, one cost roughly $15 million. So really the impact on revenues from those... deal on the Q1. But how should we look at the impact of those two things from an EPS driven from a margin standpoint because it already strikes me that, the process is very profitable and no debt drove some of that. Whereas automotive, assuming this is impacting some of your North American guys the most its not that you made a lot of money on those clients anyway. So you get always neutral revenues. Can you give us a sense of what those transcend items might have had in terms of margin and EPS effect?

Unidentified Company Representative

Holden, we would say frankly that it would be relatively neutral for both. We're probably leveraging it around 20% give or take but again revenues were identical. The bigger impact will be obviously in the second quarter as the T1 shift obviously will negatively impact the revenues and therefore some earnings in the second quarter while the strike continues there'll both be moving in the wrong direction. So you will see the bigger impact in the second but just assume that it was respectively a loss if you are just looking at those items in the first quarter.

Holden Lewis - BB&T

Okay. So there is the benefits that came from the pull forward were largely neutralized by losses from the automotive?

Unidentified Company Representative

Close enough.

Holden Lewis - BB&T

Okay. And then can you... you talked about logistics expenses, in at least three of your segments. You're just referring to energy costs or are there some mismatches in terms of where you have capacity and shipping that sort of thing. Can you just expand on that a bit?

Unidentified Company Representative

Yes, there is two things really going on. Clearly the energy cost on just even surcharges on fuels and the shipping costs etcetera have gotten quite expensive. The second thing is we still are running our plans maximized. We are shipping product to customers across the world and when you are doing that, you are still incurring significant cost probably above what we would expect long term as we get our manufacturing base very much created across the world and a better sense that product being produced in Asia is being sold in Asia similar currencies, lower logistics costs overall versus moving a lot of product especially the large product going into the process industries across the world.

Holden Lewis - BB&T

Okay. And then lastly you also sort of referenced, better portfolio decisions in auto and particular. Obviously there were no high visibility portfolio decisions that were made. Can you just expand on some of the stuff that, to which you are referring in that statement?

Unidentified Company Representative

Well let met just give you a little glimpse of maybe the mobile group and the mix of the sales and the impact in the changes of that mix. If you look at what we call the light vehicle systems which basically as the passenger car side of the business, first quarter, quarter-on-quarter comparing back to '07 was down 8%. The heavy truck piece of our business was up 25% and our after-market piece was up about 14%. So what you'll begin to see and whether you look at it, first quarter of '08 versus fourth quarter of '07 or looking back into quarter one of '07, we are fundamentally driving a mix of our sales much more towards the markets that we believe that we can be the most profitable end. Obviously we get impacted by things like the strike in American Axle and the shut down of the General Motor's plants and that impacts it. But this is a fundamental direction that we are driving our capacity home.

Holden Lewis - BB&T

Okay, thank you.

Unidentified Company Representative

Okay.

Operator

Your next question comes from the line of Martin Pollock of NWQ Management.

Martin Pollock - NWQ Management

Yes. I am looking at last year's quarter. The first quarter that you indicated that automotive had a life and not grow the issues of life, what was the cost I don't know, if that would be material to that was but could you mention that LIFO was is an expense for, in this release for the steel segment. I am just wondering if you can effectively describe is... are you... what's your reserve action on policies on LIFO? Are you effectively doing it on under quarter-by basis, do you have an estimate for the year and then you are essentially working with about which could change. So essentially is LIFO some thing that's higher or in line with your original expectations and maybe by segment were in LIFO seems to your comment here in steel as where you saw the LIFO hit. I don't see that comp material automotive which is with... where the fourth quarter was?

Unidentified Company Representative

Alright Martin, I guess with regard to LIFO maybe cover the last part first which is our expectation. I think Sal have made a reference. But we had no expectation that LIFO expense would be as large as it did because it's very directly correlated to the high price of the scrap that we're seeing again we did envision seeing. So clearly we are managing through an environment of higher LIFO expense then what we would have thought coming in to the year even the quarter. What we did always we do look out for the full year and what our expectations will be and therefore and then we bring it back into each of the quarters by building up the reserve. So, effectively when you look at the guidance that we had out there the reaffirming of the full year and obviously the first time we have met the new guidance or... outlook for the second quarter that reflects now what our current expectation of material cost will be. LIFO does effect all of our business that clearly the biggest piece is in the steel business that Sal alluded to you and frankly within the bearings side the biggest keys would be in the automotive keys of that to your point earlier. But year-over-year fourth quarter to first quarter, the number you've quoted for auto would probably be pretty comparable to what they would had for an expense in the first quarter.

Martin Pollock - NWQ Management

Okay. If I may on the steel just back to the steel, at this point, is really the performance of steel is a little bit unfavorable. Is it still lagging on your pricing actions at this point lagging, in terms of those results that affect you, not yet picked fully implemented those price actions?

Unidentified Company Representative

No, Martin our price actions have been implemented. Our surcharging mechanisms are renewed in our contracts. We have a timing issue of... made for these things of through to the marketplace but it probably the quickest of all the timing within any of our businesses. Frankly it's almost exclusively that LIFO impact in our first quarter.

Martin Pollock - NWQ Management

But that suggested Q2 could see the bigger benefit there?

Unidentified Company Representative

Correct. Yes.

Martin Pollock - NWQ Management

Okay and last CapEx running fairly high well above depreciation, are you at a point if you can decide whether CapEx is it, is at a level where we are seeing maximum level for this year and what would normalized CapEx be in fact what would be normalized maintenance if they are realized, there is normalized growth in your expectations. So that effectively CapEx will still be fairly high?

Unidentified Company Representative

Mart, we would say if you will that, normalize that will be... that's a tough thing to say because obviously when you invest in capacity or in continuous improvement initiatives you are getting good returns on it. So you don't mind allocating your capital that way. But clearly we would target longer term I think we have said before around 4% of sales is probably on more normalized level. We currently have depreciation and amortization of around 230ish to 40ish million a year. So clearly we are spending above that level although we spend at that level for the first quarter but it will grow. So we'll spend roughly what we did last year again the biggest piece of that spending is on the new capacity additions that we're doing the Project O.N.E. implementation that we are putting in. So key strategic initiatives of the company as were that capital is going. From our maintenance standpoint again that will fluctuate around the bit that we probably think so that been in the past that is roughly around $80 million give or take of maintenance within the business on that depreciation and amortization level of that call it 235. So it's higher than normal, but it's clearly funding key strategies of the company.

Martin Pollock - NWQ Management

Okay, thank you.

Operator

[Operator Instructions]. Your next question comes from the line of David Raso of CitiGroup.

David Raso - CitiGroup

Quick question, I was trying to back into the non-auto part of mobile. In a way you were at the year-over-year profit improvement in auto or essentially what are the exact number year ago first quarter because of the MRO now include it. But essentially if the loss was less in the first quarter just reported than a year ago... trying to back into the non-auto business implies the margins were down year-over-year in the non-auto part of mobile. Is that a correct statement?

Unidentified Company Representative

Well Dave, I think it's close to that. Again we're not... we will not be breaking down the margin side of the various pieces of mobile. But what we set out to do was essentially focused very much on improving those underperforming areas of the business which was a lot of the old automotive and that's where we've seen the improvement and through the period of time now where we are seeing material pricing escalating, logistics cost etcetera and we are completing out some of these plans, maintaining those margins and what are actually attractive parts of the mobile industry was really that Raso. So, what you are seeing in the first quarter is an example of that.

David Raso - CitiGroup

The duct in auto given the biggest piece of mobile that's obviously, the biggest positive swing back, better improve that then show little improvement in non-auto...

Unidentified Company Representative

That's correct.

David Raso - CitiGroup

It was just interesting that, the non-auto was down at least the way I am on the numbers down that's not a best slot. Can you give us some color on going forward? How should we think about that or is that a classic volumes that are still very good. Because the volumes were up pretty darn big year-over-year, if I am doing it right. That for the profits to be flat to down is that simply an input cost issue and how we are handling that on price going forward?

Unidentified Company Representative

Yes, a couple of things. I think that as we look going forward through out the year you are going to see some of that swing back as we see improvements in the other side of the mobile business. But remember the mobile business is made up of basically the pass car which... this is an area that we have to focus on what we are doing at both through mix meaning, we are getting out of some business that is in fact not attractive moving prices where it can be and we are still in that process of doing that. But is like said earlier our sales quarter-on-quarter '07 versus '08 is actually down.

The remainder of that segment remember there is a heavy truck segment that actually was part of automotive and that has been an area we are in fact we've decided to continue our participation certainly in that industry and a scenario where the sales have been up significantly going into '08. We expect the strong year for that and in addition pricing has been strong, so that's been a big piece of not only the automotive fix but also how we look at mobile. And then the other pieces are our highway which remains strong both from the prospective of sales and margin, rail we are seeing some drop from late '07, so that is impacting us on downside. That has been a very attractive of market for us so from a mix prospective actually coming out of '07 into '08 is slightly down. And then the other is our automotive aftermarket which is an area where we do see improvements throughout the year. So, I think you'll see that mix begin to change in the last three quarters.

David Raso - CitiGroup

And for clarification that down 8% on passenger vehicle, I'll call it generically auto that include auto aftermarket but does not include the heavy truck right? That's total auto OEM and aftermarket.

Unidentified Company Representative

No, that down 8% is just sales to original equipment manufacturers.

David Raso - CitiGroup

Okay. That's helpful. And quickly in the aerospace you mentioned that hopefully that's the lowest quarter margin that we'll see. How quickly should we expect the margins to get up to where you would started the business as a solid, low double-digit margin business?

Unidentified Company Representative

I think you should be looking towards the third and forth quarter. We'll still some a little bit weakness on those earnings in the second quarter. They are seeing a lot of material impact from the marketplace etcetera. So, I think you will begin to see interesting jump third quarters.

David Raso - CitiGroup

Okay. Thank you very much.

Unidentified Company Representative

You bet.

Operator

Your next question comes from the line of Brian Carlson of Atlantic Investments.

Brian Carlson - Atlantic Investments

Hi guys. Thank you for taking my call. And I wondered if you could just clarify couple of good points. PASCAR revenue down 8% to OEMs, that's globally right?

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

That's correct.

Brian Carlson - Atlantic Investments

Okay. And then you mentioned that the LIFO charge in steel was $17.5 million, the LIFO in auto will be similar to Q4, is that correct?

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

That's right, figure around $4 million is with that in order.

Brian Carlson - Atlantic Investments

And with this embedded in the current guidance would be, what kind of expectations I mean with the guidance expects scraps deal to rise by another $50, say and to sort of stay at that level? Would it include continued increases of small amounts or is any there moderation expected in it?

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

Yes. We would say at least what's again we obviously provide guidance with a range and the range is the uncertainties and things that we can't control which is exactly what the scrap prices are. But our general assumption would be that we would expect that prices scrap would come down throughout the year, maybe not significantly but at least the trend shouldn't be a sustained. So it may go up before it goes down but as it goes through the year, we wouldn't think that they would stay at this high of a level. It may, but again that's our current excuse.

Brian Carlson - Atlantic Investments

Okay. And is it possible for Mike for you to give us an update on the sort of negotiations you have had in terms of pricing with the contracts and so what percentage of the contracts were opened and sort of I think that at the Analyst Day you were suggesting that things are going a little bit better than you originally expected, is that still the case?

Michael C. Arnold - Executive Vice President and President

I think the progress is going very well. Obviously, we have completed all of the '08 contracts and I think they have been good for both us and our customers with regards to certainly the value we would provide in the marketplace, we have opened many of the 2009 contracts from the perspective of those discussions or happening. Clearly, we are making sure that as part of those discussions, these significant material price issues are dealt within those contracts or in fact, we will decide that we will exit some of that business. So, I would tell you that compared to a quarter ago when we've talked about this that this effort is progressing very positively, and I think both from the perspective of the mix of our business and how much of that we actually do want to be in the automotive industry, but also with regards to the price levels and you are already seeing the impact in the first quarter our margins for the old automotive group.

Brian Carlson - Atlantic Investments

It seems to be progressing well.

Michael C. Arnold - Executive Vice President and President

Yes.

Brian Carlson - Atlantic Investments

And can you give us any update in terms of Timken's expectations for North American auto production?

Michael C. Arnold - Executive Vice President and President

Well, we are still sticking with the I think the industry number of $14.3 million is what we are still using. However, we talk last quarter about two things that could impact a lot of that. One is just the strength of the recession in North America but also $4 a gallon gas and I think it's the time we talked about $4 of gallon gas and it's kind of chuckled and we're 361 now. So, I think that's a concern, we are we have model that and so we to the best of our ability are already beginning to manage with regards to that and I think you have seen the recent announcement from General Motors that is taking their expectations with regards to production down for '08. But probably more importantly there are bigger percentage drops in the areas such as light trucks and SUVs which is an area in which we participate heavily. So, the macro number of 14.3 or 14.2 isn't as important to us, it's actually the light truck and SUV numbers and that's what we watch very, very carefully.

Brian Carlson - Atlantic Investments

Okay. And then the last question I had was just as regard to steel. I know that the automotive demand was probably a little bit less than perhaps you guys had anticipated. But my impression was that if there is any weakness on the auto side that demand from the energy sector was such that there were a clearly customers looking for that steel, and than that you have a positive mix shift in that you can take an auto, piece of auto steel or take I don't know some capacity there and reallocate it. Sal, can you just comment on that? I mean if you would had more auto sales in the quarter, even if been higher?

Unidentified Company Representative

Actually would have been because we have made shifts where the shifting is appropriate. But then there are some areas and some sizes and ranges and grade, where they really isn't an alternative. It is just pretty much automotive related and those weaknesses in shipments are among that category. That would have been purely automotive. So, had not there been a strike our results this quarter would have been even better.

Brian Carlson - Atlantic Investments

Can you give us a sense of the percentage of the steel capacity which would be solely tight to auto?

Unidentified Company Representative

No. I really can't give you that number because it may not just be auto. Its areas that used that sort of size range, but for the most one I can tell you that much of the automotive product is in the smaller size ranges, in the smaller SPQ arenas. So in the up to 3 and 4 inch down to 1, 0.5 inch size ranges in general, that is probably 65% automotive best in throughout the whole of the industry.

Brian Carlson - Atlantic Investments

Okay.

Unidentified Company Representative

And that's our the strength of our size range. We are there but not with the extreme capacity quantities.

Brian Carlson - Atlantic Investments

And just as a general comment, very happy to see some of the capacity expansions starting to bear some fruit. Good job. Look forward to seeing more of that.

Thanks Brain.

Brian Carlson - Atlantic Investments

Thank you.

Operator

Your next question comes the line of Mark Parr of Keybanc Capital Markets.

Mark Parr - Keybanc Capital Markets

Yes. Just, I hate to keep pounding on this LIFO thing in steel. But I think I understand now is that, the LIFO charge that you took is in excess of what you actually realize in the first quarter, because of your full year expectations for scrap cost. Is that fair Glenn?

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

That is.

Mark Parr - Keybanc Capital Markets

Okay, terrific. That really helps clarify the situation and thanks very much.

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

Thanks Mark.

Operator

There are no remaining questions at this time. I will now turn the call Jim Griffith for any closing remarks.

James W. Griffith - President and Chief Executive Officer

All right. Thank you again for your interest in the Timken Company. I am pleased to see that you all took Eli's challenge and came up with the full hours with the questions for us. To reiterate the message we are seeing strong global demand, especially from those industrial markets involved and helping build the Asian infrastructure and we are taking advantage of that to improve our portfolio. There are plenty of challenges in the market today, but we are tackling on the head on with the goal of driving improved performance for our shareholders. Thank you.

Operator

Thank you for participating in today's Timken's first quarter 2007 earnings release conference call. You may now disconnect.

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Source: The Timken Co. Q1 2008 Earnings Call Transcript
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