Timken Co (TKR) 2004 Q1 法說會逐字稿

Good morning, my name is Mandy and I will be your conference operator. At this time, I would like to welcome everyone to the Timken first quarter 2004.Release conference.

(OPERATOR INSTRUCTIONS)

Thank you, Mr. Beck. You may begin your conference.

Thank you, Mandy and welcome to our first quarter conference call. I'm Kevin Beck, Manager, Investor Relations with me are Jim Griffith, President and CEO, Glenn Eisenberg, EVP of Finance Administration and CFO, Jackie Dedo, President of our automotive group.

Mike Arnold, President of our Industrial group and Tim Timken President of our Steel group. We have remarks this morning from Jim Griffith and will then be available for Q and A. After 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 would like to remind you that during your conversation, 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 the reports filed with the SEC, which are available on our Web site www.timken.com. This call is copyrighted by the Timken Company.

Any use regarding our transmission of any portion of this conference call without the express written consent of the company is prohibited.

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

Thanks, Kevin and good morning, everyone. As Kevin mentioned, we have all three-business presidents presence on the phone with us this morning and I encourage you to take advantage of the presidents during the Q and A.

I'd like to welcome Jackie Dedo, our new president of our automotive business who joined the company on March 1st. It is a pleasure to be here this morning. Earnings per share excluding special items were 31 cents or 63% better than last year and slightly above our previous guidance.

We saw a broad based improvement across the company faster than we expect when we spoke last January. Improvement was driven by two things, first a fundamental improvement in our operating profitability as the actions we took in 2003 took hold.

And secondly, leveraging the increased volumes resulting from improved market conditions through an improved cost structure. 2003 was a year of remarkable change and challenge for the Timken Company. The challenges we faced last year are the opportunities in 2004.

Industrial markets are and I'll say finally improving. Industrial -- or changes to our steel surcharge mechanism that we put in place in the fourth quarter have allowed us to begin recovering the historically high raw material increases we experienced in 2003.

Automotive productivity improvements, which we achieved at the end of 2003 are hitting the bottom line and will continue. And we're benefiting from the integration cost savings from the acquisition of Torrington in February of last year. We are a changed company in 2004.

We are stronger, we are faster, we're bigger as evidenced by last week's inclusion in the Fortune 500. Now let's take a look at the individual groups before turning to Glenn for consolidated financial performance picture. Our automotive group had sales of $416 million, which continue to be strong up 39% from last year or 8% if we include pro forma results for Torrington in 2003.

The increase in sales was propelled by strong North America light truck production up about 3% and heavy or heavy medium truck production up almost 36%. Recent successful new platform launches including the Nissan titan and Ford F150 launched in late 2003 also boosted first quarter sales.

March sales of taper roller bearing products to the U.S. auto industry were at record levels. EBIT of $18 million was 4.4% of sales compared with a margin of 3% last year. We leveraged strong volume with the benefits of our actions hitting the bottom line.

These include improved productivity resulting from the reduction of over 750 people during the second half of last year, improved output from our eastern European plants and the Czech republic to improve performance and Poland as a result of an expansion completed during 2003.

Integration savings from combining the purchasing activities of Timken and Torrington and lower costs from our material conversion process moving from internally produced tubing to green rings either purchased or produced in joint ventures as we now have stabilized the external supply issues. Industrial group sales of $411 million were strong up 35% from last year or 11% including pro forma results from Torrington.

We had improved demand in many key segments as well as favorable foreign currency translation. We will achieve double-digit sales growth in most market segments with the strongest growth in highway, rail and heavy industry. Distribution sales have shown improvement driven by increased industrial demand.

Despite these higher sales distributors reduced their inventory of Torrington branded products we expect this continue over the course of the year. Industrial group EBIT was $36 million or 8.7% of sales compared with 5.8% in the first quarter of last year. This improved in EBIT was driven by leveraging increase volume to an improved cost structure. Integration savings of combining Timken and Torrington in addition to the completed cost reduction and rationalization actions have positioned us well to leverage the upturn in the market.

Steel group reported record sales of $309 million up 12% from last year surcharges account for about half of the increase. But first quarter bar shipments were at record levels and March saw a record high melt tonnage in our alloy steel operations.

Sales to automotive customers continue to be strong and shipments to bearing and general industrial customers were up almost 25%. Sales of tool steal, and aerospace steals, which have been the most depressed segments also showed double-digit increase from last year.

While we had record sales for the quarter unfortunately we saw record high cost. Steel group EBIT in the quarter was $3 million, about half of last year.

About this was the first profitable quarter since the second quarter of 2003. Raw material costs especially scrap steel prices are sharply higher than the prior year. The new surcharge mechanism and price increases we implemented last year are recovering a significant portion of these costs. While scrap prices have fallen recently from their historically high levels they are expected to settle at high levels for the balance of the year.

Additionally high volume and labor productivity contributed positively to earnings. In summary we're encouraged by the market up turns across all of our businesses. We are beginning to see the benefits from the actions we're taken as we leverage this upturn and expect to deliver much stronger performance than we did in 2003. Thank you. Now I'll turn the mic over to Glenn.

Thanks, Jim. My comment consistent with those by Jim exclude the impact of special items, these special items totaled $700,000 of pre-tax income in the first quarter this year with a $7.7 million CDO receipt mostly offset by integration expenses relating to Torrington. In the first quarter of 2003, these special items totaled $3.6 million of pre-tax expense.

Sales for the quarter were a record $1.1 billion, 31% better than first quarter last year on a pro-forma basis as if Torrington were part of Timken on January 1, 2003, sales would have been up a 11%, of which 4% was due to foreign currency translation. Both gross margin and SG&A as a percent of sales improved from last year. Margin increases in industrial and automotive were realized due to strong sales, and operating improvements while steel margins were down due to higher material costs.

EBIT for the quarter was $56 million or 5.1% of sales, approximately 130 basis points better than last year. With a 38% tax rate for both periods, net income for the quarter was $28 million, double last year. Our average shares outstanding, assuming dilution increased to 90 million for the quarter, compared to 75 million last year, which only had a partial quarter of the 22 million shares issued to finance Torrington.

The current share total also includes 3.5 million shares issued last October. For the quarter EPS was 31 cents, 63% higher than first quarter of 2003, this compared favorably to our earnings guidance for the quarter of 25 cents to 30 cents. Pre-tax synergies for the Torrington acquisition were $17 million this quarter, driven by leveraging our combined purchasing and workforce reductions.

We are still on track towards our $80 million target by the end of 2005. We ended the quarter with total debt of $812 million or 42% of capital, compared to $735 million or 40% of capital at year-end 2003. This increase was driven by cash contributions of $63 million to domestic pension plans this quarter, of the $175 million targeted for the year.

A $29 million tax payment related to the sale of our NTC joint venture for which we received a $146 million in cash during the third quarter last year and seasonally higher working capital levels. The company continues to be committed to a strong balance sheet and expects to reduce its leverage by the end of the year to below last year's ending level. Our earnings per share guidance excluding special items are 27 cents to 32 cents for the second quarter and $1 to a $1.10 for the year.

We expect all three segments to show improvement versus 2003. Our automotive group outlook is driven by improved operating performance in only slightly higher overall markets. Our industrial and steel groups should benefit from growing demand in industrial markets.

Our actions including the integration of Torrington, and other cost reductions have positioned us well to leverage the upturn.

Scrap steel prices are currently falling from unprecedented high levels, while we expect prices will continue to come down, we believe they will remain at historically high levels. Steel profitability is expected to continue to be challenged with these and other high material costs.

Actions such as surcharges and price increases will mitigate the impact and we expect the group to be profitable for the year. Overall we continue to be encouraged about the prospects for the company for the rest of the year. This concludes our formal remarks and now we'd be happy to answer any questions that you have.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Wendy Caplan with Wachovia Securities.

Good morning. About three weeks ago you pre-announced that you expected your first quarter to be higher than you had earlier expected. And yet you three weeks later beat that number. Can you talk about what happened, you know, why you were -- were you just being conservative? And how should we think about your assumptions for Q2 and the balance of the year?

Specifically since your current the guidance that you have just given us would suggest that 60% of earnings roughly are in first half versus second. I know auto is an issue in the second half. But can you kind of address those issues, please.

Wendy, two good questions. The first obviously we're a little embarrassed when we give guidance 3 weeks ago and we didn't meet the guidance, although we prefer being above it to being below it. What really happened at the end of the March we ended up with a - ended the month with a flurry of sales that we hadn't seen happen.

We ended up about 5% higher in March then we thought we would broadly across all three businesses and that was enough to push us up a couple of cents from what our internal forecast were at that time. Pure and simple, that's what happened. As we look at the year, traditionally in the Timken Company our seasonality is such that we do earn 60% or 65% of the year's earnings in the first half of the year.

That's a traditional year. In an up market like this, sometimes the second half of the year comes in stronger than that and obviously absent everything else we would be hoping that would happen. What we have is everything else is we are in a mode at this point of doing some hiring in some of our plants so we'll see some training expenses over the course of the year.

And then we've got this issue of the overhang of the Torrington inventory and industrial distribution that we believe will depress sales a bit in the second half of the year and that balances it out. So, you know as I look at the year at this point, we believe it will follow traditional cyclicality 60, 65% first half and then the balance in the second half.

Thanks, Jim.

Your next question comes from the line of Mark Parr with Key McDonald.

Good morning, guys.

Good morning.

And a lady who I haven't met yet. So I'll apologize for that one.

Good morning.

Good morning. I'd like to just address the same question to each of the three sector presidents. And, you know, I guess my sense is that with the momentum that's been established in the first quarter, particularly the momentum that we saw in March, what makes you think that overall performance in the second quarter is going to be no more than equal to the first quarter?

And where is the potential delta for positive surprise or negative surprise? Or maybe I'm missing something and Glenn, you may want to try to address this. Maybe we've got something as far as higher tax rate, higher interest costs, some sort of non-operating issue that may impact the second quarter. So, I'll leave the floor open to you guys and, you know, try to help us in looking at the business on a sequential basis as we move into the seasonally strongest period of the year.

Mark, let me start and then I'll pass the baton around to Tim, Mike and Jackie. If you look at it generally, the big factor that is in addition to this Torrington thing that Mike -- Torrington inventory thing that Mike can address, the other factor that you got to look at is raw material costs and the way they factor through the supply chain.

When they actually get to hitting the bottom line. And the difference by the different businesses where their purchasing patterns are and that sort of thing. And that's kind of the overriding driver that would get it. But it's the impact is different in the three different businesses and I'll let Tim respond first.

Hi, Mark. How are doing?

Good, Tim. Good morning.

Let me answer your question in kind of two different ways. If you look at the wail our year is laying out right now, obviously we had the big run up of scrap costs in the first quarter.

We were able to get our surcharge mechanisms in place we were able to move some prices in the spot market. So, we have been able to cover the run up. Now, if you wanted - if you talk about positives and negative deltas, obviously the scrap and alloy is going to continue to be a big issue.

We've seen scrap pull off a little bit in the last couple of months but we're actually forecasting it coming back up during the tail end of the year.

And if you look at the mechanisms of the surcharge it tends to lag by about a month. So, you'll have a big amount of impact late in the year as that comes back up with just basic seasonality of scrap pricing. We are predicting that volume will stay healthy through the year.

We have cut down so one in July one in August that obviously impacts the numbers and then also we get holiday questions later in the year. So, when you balance the two out, I think for the most part, the year looks to be pretty consistent across the quarters with a bit of a downside in the fourth quarter, as you get into, you know, the holidays. I think that's about all I've got, Mark, unless you have a specific question about that.

Yes. Just as I follow-up on the steel side, you know, given some of the delay effects of getting the surcharges in place, and given the unusually strong demand that's out there in the market right now, would you think that the ability to achieve effective surcharges -- as a proportion of your total business be the same in the second quarter? Or, you know, you'd think at least conceptually it might increase a bit?

It should be better. Should be depending on what happens with scrap pricing in the steel business.-- The auto and industrial will talk about their own issue on that. We've got a management dynamic to keep with all the speakers. I'd like to let Mike and Jackie to go through quickly.

Sorry. Thank you.

Center an industrial perspective I'll make it relatively quick. We expect the stay strong in the second quarter consistent with the first quarter but as you know we serve many different industries and we have some industries very strong that Jim mentioned earlier off highway rail and heavy industry while others like commercial air craft are significantly down.

So it is a balance looking forward in the second quarter as to how the various industries will perform. The issue around Torrington branded product inventory is actually a good issue as we move forward with regards to our sales still being up across distribution on a global basis. But that inventory in fact being managed down through the first quarter and we would expect that to continue in the second quarter, which obviously will have an impact on the mix of our product sales.

Would you expect distribution inventory reductions to accelerate to Q2 versus 1Q or stay the same?

We expect it will be very similar.

OK. Thanks, Mike.

Good morning, Mark, Jackie.

Hi Jackie.

Hi. We are in the second quarter we expect sales to continue to be strong. Of course, at the end of the second quarter, we start to see the model year transition with our customers as they go from current product to next model year and that causes us not to consider continued ramp up. On the raw material prices, being further down in the food chain or further up in the food chain, we see the raw material impact actually hitting us stronger and having more to overcome in the second quarter than we do in the first quarter.

And that's when we'll find out exactly how effective our mechanisms are. Saying that, we're getting positive feedback from our customers who understand our situation. On your question in terms of positive or negative opportunity to that, I'd say on the positive side, if we see a larger lift in heavy and medium, than we're currently projecting -- we're already projecting up market, as Jim mentioned -- that could cause it to be stronger than our projected.

On the flip side, if we see a higher model year inventory burn off from our light vehicle customers as they transition to their new models that could cause it to be lower. And right now I would judge those two positive and negative impacts to be potentially balanced.

OK. Thank you very much.

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

Good morning. Thank you. I'd like to address I guess the distribution question I guess the note or the comment in your release was a little bit confusing to me commenting on how many, you know, sales were up but people were reducing the inventories. Should I just read that? The Timken brand product was selling up and Torrington was selling down.

And how does that normally distribution tends to be a higher margin piece of the mix is that still the case, you know, if you are sort of net up between those two?

There is two issues with regards to selling, Holden. One, it depends on if you're talking about how that product is actually selling to the end user or how that product is selling from us to our distribution channels. Let me deal with the distribution channels.

Our sales are actually up year on year about 12% on the distribution side. Now remember we have a global distribution business. The issues around the Torrington branded product and those inventory levels in fact continued to be aggressively managed downward.

So the dynamics of is yes to one of your questions, are Timken branded products up in distribution, yes, and consistent with the market. In those areas on the Torrington branded product, where in fact the inventory reductions need to take place, in some cases the sales are still up as that inventory reduction takes place.

OK. Fair enough. And then in your steel business, is there any inventory impact or inventory benefit? Is that a contributor to the better numbers?

What do you mean by inventory? Are you talking about pricing of inventory?

Are you selling through like lower cost products or I guess moving through lower cost, you know, materials before getting to higher costs down the road?

No effectively we operate with something less than 30 days of raw material inventory in the system. So for argument sake, you can assume current scrap prices get reflected almost immediately in the cost of sales.

OK. Great, Thank you.

Your next question comes from the line of Barry Haimes with Sage Asset Management.

Hi. Back on the Torrington distribution inventory issue, do you have any rough sense or range of how much inventory, you know, what the goal is in terms of reducing that inventory for the year? Will that process -- do you think then balance by the end of the year or will it extend into next year? And will that pattern of inventory reduction, you know, be equal as we go through the year? Or will it be some uneven pattern as we go through the year? Thanks.

Let me take that first, Barry, as Jim Griffith. You have to be careful in asking those questions of us. It puts us on uncomfortable territory because you're asking us what we think our customers are going to be doing and how they are going to be dealing in the marketplace.

And I think it's importantly and, you know, these customers are public companies. You can ask the same questions to them. So just as we're dancing a little bit on eggs, we're trying to tell you without getting crosswise with key customers in the marketplace. With that I'll let Mike respond.

The inventory reduction actually will take place in a very managed fashion over a period of at least one year, up to two years, unless obviously the market continues to strengthen. And you all know as well as I do that this is an issue of purely the difference between what is actually sold into the end user market and what is sold into the distribution channel.

And that is being managed very closely. It will be relatively consistent quarter on quarter but going back to Jim's comments, depending upon the actual dynamics in the market and the behaviors clearly of our customers, it will change those numbers.

You'll recall in the fourth quarter of last year we did our customers came in and made a much bigger year-end by then we had anticipated. And that's, you know -- we're just forecasting what we think they are going to do as we talk to you.

OK. Could you give some sort of -- let me put it this way. From your point of view, without putting words in their mouths, could you give us some broad range just bigger than a bread box idea of, you know, what the desired inventory reduction would be?

I think you are now asking us to get into their financial situation and I don't think it's appropriate for us to share our own forecasts on that.

OK. Thanks.

(OPERATOR INSTRUCTIONS)

You do have a follow-up question from Holden Lewis, with BB&T.

On the P&L sort of below the operating line there's that other category which was actually down I think almost 9 million I guess I was under the impression that involved a lot of like the you know the JV's the green machines and things like that, and then even though those costs were pretty heavy in 2003 that you probably going to be getting on top of them and perhaps that negative would become less so I mean opposed to more so during 2004.

Can you give us some sense of what's in that line item and how we are going to expect to see that trend?

Yes, Holden. I mean you are right of what's in there, obviously non-operating expenses or income and when you look at it relative to the same period a year ago we actually had some favorable occurrences in there that showed that number as only a very small negative number.

But there's different categories that would be in there obviously our foreign currency obviously having the biggest swing, in that area losses on any JV's that we would have first potentially any write-downs associated to the material conversion that we're going through that would benefit the company.

But, overall the number was probably a little higher than what we would normally see for a quarter's worth of a year. But the delta between year-over-year was more of a function of we had some favorable numbers in the first quarter of last year, but again you are still speaking of a very small number for the total P&L.

But the JV side have been particular, we made progress sort of stemming some of the losses on the JV's or are those kind of running at the same levels that they have been?

Holden, we've talked specifically about our AJC, joint venture the green machine in joint venture down when Winchester Kentucky and also the new plant which will be opening this month - next month in Suzhua, China.

The answer to your question is yes, both of those are on solid ramp up in control and the issues that we were having at least as a mark on wood at this point we feel they are under control and we will continue to see improvement in those, particularly the material conversion program. We had some early supply chain problems that's now flowing reasonably well and absent major changes in the steel marketplace, we would anticipate they would be positive. Most of those reflect in the automotive business financials.

OK. And then just lastly, the Torrington savings that you commented on 17 million in the quarter, I mean does that suggest a $68 million run rate, you know, through the year? Or is there going to be some seasonality applied to that as we go through as well? Where does that put us from a savings standpoint by year-end?

I think it's obviously fair to just annualize the number. We're continuing to take additional actions that should make that number continue to increase as we move towards the target that we have set at to $80 million by next year.

I mean if you make progress, you pretty much get near that 80 million by the end of this year don't you?

Again we're striving to do that but obviously we have to take continued actions in order to hit that target.

Well done. All right. Thanks.

Your next follow-up question comes from the line of Mark Parr with Key McDonald.

Hello. Thank you very much. Two questions. First of all, on the steel business, what was the magnitude of base price increases that were realized in the first quarter and what is the outlook for further price base price increases in the second quarter?

We moved prices in the spot market by roughly 20% in the first quarter. That was on top of some moves that we did at the end of last year. We're looking daily at the market to figure out whether we can push more on the spot side and on the contract side we're sticking with the surcharge mechanism.

Mark to put a little color around what Tim said, in my prepared remarks, I noted that the steel sales were up about 12% and about half of that had to do with surcharges. That is surcharges and price increases. And as we deal with that you have to deal with both of those. And surcharges will go up and down with the raw material prices.

OK. So the half of the growth was a combination of scrap pass through and base price increases?

That's correct. Obviously the vast majority of our business is under contract so the surcharges are the more important piece, maybe not the one that we have the most leverage on but the most important piece.

OK. Good. And just one other question on the industrial business. You know, that business on a pro-forma basis I believe you had indicated was up by a 11% versus last year. And yet it sounds like all the various pieces you're talking about are up, you know, significantly more than that almost.

So, even aerospace was up double-digits, distribution was up 12% despite inventory reductions with the customers and then, you know, your strongest areas of heavy industry off highway and rail must have been up significantly more than 11% or 12%. If you talk about the areas, Mike, that are significantly weaker than the norm or maybe those numbers you're talking about weren't pro forma. I'm just -- I want to make sure I'm talking apples and apples here.

Well, the first comment I would make is to I think correct one of the earlier comments you made is aerospace and defense side of business was actually down year-on-year.

OK.

If I can explain the difference, Mike or Mark. I made a comment about aerospace being up significantly, but it was aerospace specialty steel sales, not aerospace -- not sales into bearing products.

OK. All right. That helps then. That helps clarify it because I had misunderstood. Thank you very much.

There are no further questions at this time, sir.

OK. Thank you, Mandy. Before we conclude our call, I'd like to turn it over to Jim Griffith for some final comments.

Well, thank you for your interest. It's refreshing to have questions about positive results, rather than trying to probe what's wrong. As you can see, that this year the acquisition of Torrington after the rationalization efforts over the last several years have positioned us for a very positive year in 2004 with the economy finally improving. Bottom line, we said what we were -- we did what we said we were going to do and we're beginning to see it in the results.

And while we've made progress, we believe that the earnings level that we earned in the first quarter of this year, while better, is well below the target levels for the Timken Company and will continue to take aggressive actions to see that performance improve. Thank you.

Thanks, Jim. That concludes our call. If you have any further questions, my name is Kevin Beck and my phone number is 330-471-7181. That concludes our call.

Thank you for participating in today's conference.

You may now disconnect.