Summary of TIMKEN CO - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Introduction
The Timken Company is a leading global manufacturer of highly engineered anti-friction bearings and assemblies, high-quality alloy steels and aerospace power transmission systems, as well as a provider of related products and services. The Company operates under two business groups: the Steel Group and the Bearings and Power Transmission Group. The Bearings and Power Transmission Group is composed of three operating segments: (1) Mobile Industries,
(2) Process Industries and (3) Aerospace and Defense. These three operating segments and the Steel Group comprise the Company's four reportable segments. The Mobile Industries segment provides bearings, power transmission components and related products and services. Customers of the Mobile Industries segment include original equipment manufacturers and suppliers for passenger cars, light trucks, medium and heavy-duty trucks, rail cars, locomotives and agricultural, construction and mining equipment. Customers also include aftermarket distributors of automotive products. The Company's strategy for the Mobile Industries segment is to improve financial performance by allocating assets to serve the most attractive market sectors and restructuring or exiting those businesses where adequate returns cannot be achieved over the long-term. The Process Industries segment provides bearings, power transmission components and related products and services. Customers of the Process Industries segment include original equipment manufacturers of power transmission, energy and heavy industries machinery and equipment, including rolling mills, cement and aggregate processing equipment, paper mills, sawmills, printing presses, cranes, hoists, drawbridges, wind energy turbines, gear drives, drilling equipment, coal conveyors and crushers and food processing equipment. Customers also include aftermarket distributors of products other than those for steel and automotive applications. The Company's strategy for the Process Industries segment is to pursue growth in selected industrial market sectors and in the aftermarket and to achieve a leadership position in Asia. In December 2007, the Company announced the establishment of a joint venture, Timken XEMC (Hunan) Bearings Co., Ltd., in China, to manufacture ultra-large-bore bearings for the growing Chinese wind energy market. In October 2008, the joint venture broke ground on a new wind energy plant to be built in China. Bearings produced at this facility are expected to be available in 2010. In April 2008, the Process Industries segment began shipping product from its new industrial bearing plant in Chennai, India. In October 2008, the Company announced that it would expand production at its Tyger River facility in Union, South Carolina to make ultra-large-bore bearings to serve wind-turbine manufacturers in North America. The Aerospace and Defense segment manufactures bearings, helicopter transmission systems, rotor head assemblies, turbine engine components, gears and other precision flight-critical components for commercial and military aviation applications. The Aerospace and Defense segment also provides aftermarket services, including repair and overhaul of engines, transmissions and fuel controls, as well as aerospace bearing repair and component reconditioning. In addition, the Aerospace and Defense segment also manufactures bearings for original equipment manufacturers of health and positioning control equipment. The Company's strategy for the Aerospace and Defense segment is to: (1) grow by adding power transmission parts, assemblies and services, utilizing a platform approach; (2) develop new aftermarket channels; and (3) add core bearing capacity through manufacturing initiatives in North America and China. In April 2008, the Company opened a new aerospace precision products manufacturing facility in China. In November 2008, the Company completed the acquisition of the assets of EXTEX Ltd. (EXTEX), located in Gilbert, Arizona. EXTEX is a leading designer and marketer of high-quality replacement engine parts for the aerospace aftermarket. The Steel segment manufactures more than 450 grades of carbon and alloy steel, which are produced in both solid and tubular sections with a variety of lengths and finishes. The Steel segment also manufactures custom-made steel products for both industrial and automotive applications. The Company's strategy for the Steel segment is to focus on opportunities where the Company can offer differentiated capabilities while driving profitable growth. In November 2008, the Company opened a new $60 million small-bar steel rolling mill to expand its portfolio of differentiated steel products. The new mill enables the Company to competitively produce steel bars down to 1-inch diameter for use in power transmission and friction management applications for a variety of customers, including foreign automakers. In February 2008, the Company completed the acquisition of the assets of Boring Specialties, Inc. (BSI), a provider of a wide range of precision deep-hole oil and gas drilling and extraction products and services. In addition to specific segment initiatives, the Company has been making strategic investments in business processes and systems. Project O.N.E. is a multi-year program, which began in 2005, designed to improve the Company's business processes and systems. The Company expects to invest approximately $210 million to $220 million, which includes internal and external costs, to implement Project O.N.E. As of March 31, 2009, the Company has incurred costs of approximately $201.7 million, of which approximately $117.0 million have been capitalized to the Consolidated Balance Sheet. During 2008 and 2007, the Company completed the installation of Project O.N.E. for the majority of the Company's domestic operations and a major portion of its European operations. On April 1, 2009, the Company completed the next installation of Project O.N.E. for the majority of the Company's remaining European operations, as well as certain other facilities in North America and India. With the completion of the April 2009 installation of Project O.N.E., approximately 80% of the Bearings and Power Transmission Group's global sales flow through the new system.

Table of Contents

Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)
Financial Overview
Overview

                                                   1Q 2009               1Q 2008             $ Change         % Change

(Dollars in millions, except earnings per
share)
Net sales                                       $      960.4          $    1,434.7          $ (474.3 )          (33.1 )%
Net income attributable to The Timken
Company                                                  0.9                  84.5             (83.6 )          (98.9 )%

Diluted earnings per share                      $       0.01          $       0.88          $  (0.87 )          (98.9 )%
Average number of shares - diluted                96,028,860            95,648,018                 -              0.2 %

The Company reported net sales for the first quarter of 2009 of approximately $0.96 billion, compared to $1.43 billion in the first quarter of 2008, a decrease of 33.1%. Sales were lower across all business segments except for the Aerospace and Defense segment. The decrease in sales was primarily driven by lower volume and lower steel surcharges, partially offset by the favorable impact of pricing. For the first quarter of 2009, earnings per diluted share were $0.01, compared to $0.88 per diluted share for the first quarter of 2008. The Company's first quarter results reflect the deterioration of most market sectors as a result of the current global economic downturn. The impact of lower volume and higher restructuring charges as a result of actions taken to align the Company's businesses with current demand was partially offset by lower raw material costs and lower selling and administrative costs. Additionally, the Company's results for the first quarter of 2008 reflected a pretax gain of $20.2 million on the sale of the Company's former seamless steel tube manufacturing facility located in Desford, England. Outlook
The Company's outlook for 2009 reflects a deteriorating global economic climate that is expected to last throughout the year, impacting most of the Company's market sectors. Lower sales, compared to 2008, are expected in all business segments except for the Aerospace and Defense segment. A significant portion of the decrease in the Steel segment sales is expected to be due to significantly lower surcharges to recover raw material costs, which were at historically high levels during the middle of 2008, but declined significantly towards the end of 2008. The Company's results will reflect lower margins as a result of the lower volume and surcharges, partially offset by improved pricing, lower raw material costs and lower selling, administrative and general expenses. The Company expects to continue to take actions to properly align its business with current market demand. During 2009, the Company announced that it plans to eliminate approximately 400 salaried positions by the end of the fourth quarter of 2009, as well as implement cost savings initiatives that are targeted to save approximately $80 million in annual selling and administrative expenses. The Company expects to continue to generate cash from operations in 2009 as a result of lower working capital levels. In addition, the Company expects to decrease capital expenditures by approximately 40% in 2009, compared to 2008. However, pension contributions are expected to increase to approximately $70 million to $75 million, including $50 million of discretionary U.S. contributions, in 2009, compared to $22 million in 2008, primarily due to negative asset returns in the Company's defined benefit pension plans during 2008.

The Statement of Income
Sales by Segment:

                                                 1Q 2009           1Q 2008           $ Change         % Change

(Dollars in millions, and exclude
intersegment sales)
Mobile Industries                               $ 372.9          $   635.3          $ (262.4 )          (41.3 )%
Process Industries                                242.3              312.2             (69.9 )          (22.4 )%
Aerospace and Defense                             112.6              102.1              10.5             10.3 %
Steel                                             232.6              385.1            (152.5 )          (39.6 )%

Total Company                                   $ 960.4          $ 1,434.7          $ (474.3 )          (33.1 )%

Net sales for the first quarter of 2009 decreased $474.3 million, or 33.1%, compared to the first quarter of 2008, primarily due to lower volume of approximately $400 million across most business segments, except for the Aerospace and Defense segment, lower steel surcharges of $80 million and the effect of currency-rate changes of approximately $75 million, partially offset by improved pricing and favorable sales mix of approximately $80 million.

Table of Contents

Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)
Gross Profit:

                                                 1Q 2009          1Q 2008          $ Change            Change

(Dollars in millions)
Gross profit                                    $ 152.1          $ 311.5          $ (159.4 )          (51.2 )%
Gross profit % to net sales                        15.8 %           21.7 %               -             (590 ) bps
Rationalization expenses included in cost
of products sold                                $   1.2          $   1.4          $   (0.2 )          (14.3 )%

Gross profit margin decreased in the first quarter of 2009, compared to the first quarter of 2008, due to the impact of lower sales volume across most market sectors of approximately $115 million, lower steel surcharges of $80 million and higher manufacturing costs of approximately $100 million, partially offset by lower raw material costs of approximately $50 million, improved pricing and sales mix of approximately $70 million and lower logistics costs of approximately $25 million. The higher manufacturing costs were primarily driven by the Mobile Industries and Steel segments as a result of the underutilization of plant capacity. The lower raw material costs are primarily due to lower scrap steel costs as scrap steel and other raw material costs have fallen in 2009 from historically high levels in 2008.
In the first quarter of 2009, rationalization expenses included in cost of products sold primarily related to the continued rationalization of Process Industries' Canton, Ohio bearing manufacturing facilities. In the first quarter of 2008, rationalization expenses included in cost of products sold primarily related to certain Mobile Industries segment domestic manufacturing facilities, the closure of the Company's seamless steel tube manufacturing operations located in Desford, England and the continued rationalization of Process Industries' Canton, Ohio bearing manufacturing facilities. Rationalization expenses in the first quarter of 2009 and 2008 primarily consisted of accelerated depreciation and relocation of equipment. Selling, Administrative and General Expenses:

                                                 1Q 2009          1Q 2008         $ Change           Change

(Dollars in millions)
Selling, administrative and general
expenses                                        $ 139.0          $ 177.9          $ (38.9 )          (21.9 )%
Selling, administrative and general
expenses % to net sales                            14.5 %           12.4 %              -              210  bps
Rationalization expenses included in
selling, administrative and general
expenses                                        $   0.3          $   0.8          $  (0.5 )          (62.5 )%

The decrease in selling, administrative and general expenses in the first quarter of 2009, compared to the first quarter of 2008, was primarily due to lower performance-based compensation of approximately $18 million and restructuring initiatives and lower discretionary spending on items such as travel and professional fees of approximately $20 million.
In the first quarter of 2009, the rationalization expenses included in selling, administrative and general expenses primarily related to the rationalization of Process Industries' Canton, Ohio bearing facilities. In the first quarter of 2008, the rationalization expenses included in selling, administrative and general expenses primarily related to the rationalization of the Process Industries' Canton, Ohio bearing facilities and costs associated with vacating the Torrington, Connecticut office complex.

Impairment and Restructuring Charges:

                                                1Q 2009     1Q 2008      $ Change

         (Dollars in millions)
         Impairment charges                     $  3.9      $   0.4      $    3.5
         Severance and related benefit costs      10.2          2.1           8.1
         Exit costs                                0.6          0.4           0.2

         Total                                  $ 14.7      $   2.9      $   11.8

In the first quarter of 2009, impairment and restructuring charges were $8.5 million for the Mobile Industries segment, $4.5 million for the Process Industries segment, $0.5 million for the Steel segment and $1.2 million for Corporate. Corporate represents corporate administrative expenses that are not allocated to any of the reportable segments. In the first quarter of 2008, impairment and restructuring charges were $2.4 million for the Mobile Industries segment, $0.2 million for the Process Industries segment and $0.3 million for the Steel segment. The following discussion explains the major impairment and restructuring charges recorded for the periods presented; however, it is not intended to reflect a comprehensive discussion of all amounts in the table above.

Table of Contents

Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Selling and Administrative Reductions
In March 2009, the Company announced the realignment of its organization to improve efficiency and reduce costs. The Company had targeted pretax savings of approximately $30 million to $40 million in annual selling and administrative costs. In light of the Company's revised forecast indicating significantly reduced sales and earnings for the year, the Company is now expanding the target to approximately $80 million. The implementation of these savings began in the first quarter of 2009 and is expected to be significantly completed by the end of the fourth quarter of 2009, with full-year savings expected to be achieved in 2010. As the Company streamlines its operating structure, it expects to cut its salaried workforce by up to 400 positions in 2009, incurring severance costs of approximately $10 million to $20 million. During the first quarter of 2009, the Company recorded $2.2 million of severance and related benefit costs related to this initiative to eliminate approximately 26 associates. Of the $2.2 million charge, $1.2 million related to Corporate, $0.4 million related to the Mobile Industries segment, $0.4 million related to the Steel segment and $0.2 million related to the Process Industries segment. Manufacturing Workforce Reductions
During the first quarter of 2009, the Company recorded $7.4 million in severance and related benefit costs, including a curtailment of pension benefits of $1.8 million, to eliminate approximately 900 associates to properly align its business as a result of the current downturn in the economy and expected market demand. Of the $7.4 million charge, $6.6 million related to the Mobile Industries segment and $0.8 million related to the Process Industries segment. Bearings and Power Transmission Reorganization In August 2007, the Company announced the realignment of its management structure. During the first quarter of 2008, the Company began to operate under two major business groups: the Steel Group and the Bearings and Power Transmission Group. The Bearings and Power Transmission Group includes three reportable segments: Mobile Industries, Process Industries and Aerospace and Defense. The Company realized pretax savings of approximately $18 million in 2008 as a result of these changes. During the first quarter of 2008, the Company recorded $1.1 million of severance and related benefit costs related to this initiative.
Mobile Industries
In March 2007, the Company announced the planned closure of its manufacturing facility in Sao Paulo, Brazil. The closure of this manufacturing facility was subsequently delayed to serve higher customer demand. However, with the current downturn in the economy, the Company believes it will close this facility before the end of 2010. This closure is targeted to deliver annual pretax savings of approximately $5 million, with expected pretax costs of approximately $25 million to $30 million, which includes restructuring costs and rationalization costs recorded in cost of products sold and selling, administrative and general expenses. Due to the delay in the closure of this manufacturing facility, the Company expects to realize the $5 million of annual pretax savings before the end of 2010, once this facility closes. Mobile Industries has incurred cumulative pretax costs of approximately $18.5 million as of March 31, 2009 related to this closure. During the first quarter of 2009 and 2008, the Company recorded $0.6 million and $1.0 million, respectively, of severance and related benefit costs associated with the planned closure of the Company's Sao Paulo, Brazil manufacturing facility.
In addition to the above charges, the Company recorded an impairment charges of $0.9 million during the first quarter of 2009 related to an impairment of fixed assets at two of its facilities in France as a result of the carrying value of these assets exceeding expected future cash flows. During the first quarter of 2008, the Company recorded an impairment charge of $0.3 million related to an impairment of fixed assets at its facility in Spain as a result of the carrying value of these assets exceeding expected future cash flows due to the then-anticipated sale of this facility.
Process Industries
In May 2004, the Company announced plans to rationalize the Company's three bearing plants in Canton, Ohio within the Process Industries segment. This rationalization initiative is expected to deliver annual pretax savings of approximately $20 million through streamlining operations and workforce reductions, with pretax costs of approximately $45 million to $50 million, by the end of 2009.
The Company recorded impairment charges of $3.0 million and exit costs of $0.6 million during the first quarter of 2009 related to Process Industries' rationalization plans. During the first quarter of 2008, the Company recorded impairment charges of $0.1 million and exit costs of $0.1 million as a result of Process Industries' rationalization plans. Including rationalization costs recorded in cost of products sold and selling, administrative and general expenses, the Process Industries segment has incurred cumulative pretax costs of approximately $41.2 million as of March 31, 2009 for these rationalization plans. As of March 31, 2009, the Process Industries segment has realized approximately $15 million in annual pretax savings.

Table of Contents

Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
Steel
In April 2007, the Company completed the closure of its seamless steel tube
manufacturing facility located in Desford, England. The Company recorded
$0.3 million of exit costs during the first quarter of 2008 related to this
action.
Rollforward of Restructuring Accruals:

                                                March 31,     Dec. 31,
                                                  2009          2008

                (Dollars in millions)
                Beginning balance, January 1    $   18.9      $  24.5
                Expense                              9.0         12.6
                Payments                            (6.7 )      (18.2 )

                Ending balance                  $   21.2      $  18.9

The restructuring accrual at March 31, 2009 and December 31, 2008 is included in Accounts payable and other liabilities on the Consolidated Balance Sheet. The restructuring accrual at March 31, 2009 excludes costs related to the curtailment of pension benefit plans of $1.8 million. The accrual at March 31, 2009 includes $14.4 million of severance and related benefits, with the remainder of the balance primarily representing environmental exit costs. Approximately half of the $14.4 million accrual relating to severance and related benefits is expected to be paid by the end of 2009, with the remainder paid before the end of 2010 once the closure of the manufacturing facility in Sao Paulo, Brazil is completed.

Interest Expense and Income:

                                    1Q 2009      1Q 2008     $ Change      % Change

           (Dollars in millions)
           Interest expense         $   8.5      $ 11.0      $   (2.5 )     (22.7 )%
           Interest income          $   0.4      $  1.4      $   (1.0 )     (71.4 )%

Interest expense for the first quarter of 2009 decreased compared to the first quarter of 2008, primarily due to lower average debt outstanding. Interest income for the first quarter of 2009 decreased compared to the same period in the prior year, due to lower interest rates on invested cash balances. Other Income and Expense:

                                                1Q 2009      1Q 2008     $ Change     % Change

(Dollars in millions)
Gain on divestitures of non-strategic assets    $   1.2      $ 20.4      $ (19.2 )     (94.1 )%
Other income (expense)                              6.2        (4.9 )       11.1         NM

Other income (expense), net                     $   7.4      $ 15.5      $  (8.1 )     (52.3 )%

The gain on divestitures of non-strategic assets for the first quarter of 2009 primarily related to the sale of one of the buildings at the Company's former office complex located in Torrington, Connecticut. The gain on divestitures of non-strategic assets for the first quarter of 2008 primarily related to the sale of the Company's former seamless steel tube manufacturing facility located in Desford, England. In February 2008, the Company completed the sale of this facility, resulting in a pretax gain of approximately $20.2 million. For the first quarter of 2009, other income (expense) primarily consisted of $6.9 million of foreign currency exchange gains, $0.7 million of export incentives and $0.5 million of royalty income, partially offset by $1.3 million of losses on the disposal of fixed assets and $0.6 million of losses from equity investments. For the first quarter of 2008, other income (expense) primarily consisted of $2.9 million of losses on the disposal of fixed assets and $1.7 million of foreign currency exchange losses.

Table of Contents

Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)
Income Tax Expense:

                                   1Q 2009      1Q 2008     $ Change        Change

         (Dollars in millions)
         Income tax expense      $    2.8       $ 51.2      $ (48.4 )      (94.5 )%
         Effective tax rate        (127.7 )%      37.5 %          -      (16,520 ) bps

The change in the effective tax rate in the first quarter of 2009, compared to the first quarter of 2008, was primarily due to increased losses at certain foreign subsidiaries where no tax benefit could be recorded and decreased earnings in certain foreign jurisdictions where the effective tax rate is less than 35%. The first quarter of 2009 resulted in $2.8 million of income tax expense, or an effective tax rate of -127.7%. This tax rate was principally driven by the application of the interim period accounting rules for income taxes, as income tax expense on earnings from profitable affiliates exceeded tax benefits that could be recorded on losses from unprofitable affiliates. For the full year of 2009, the Company expects its effective tax rate to be in the range of 25% to 30%.
Net Income (Loss) Attributable to Noncontrolling Interest:

                                                1Q 2009          1Q 2008          $ Change         % Change

(Dollars in millions)
Net income (loss) attributable to
Noncontrolling Interest                         $ (5.9 )        $   0.9          $   (6.8 )           NM

Total                                           $ (5.9 )        $   0.9          $   (6.8 )           NM

On January 1, 2009, the Company implemented SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements." SFAS No. 160 establishes requirements for ownership interests in subsidiaries held by parties other than the Company (sometimes called "minority interests") to be clearly identified, presented, and disclosed in the consolidated statement of financial position . . .