Timken Co (TKR) 2004 Q2 法說會逐字稿

Good afternoon. My name is Christy, and I will be your conference facilitator today. Welcome to the Timken Company second quarter earnings 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 period. If you would like to ask a question during this time, simply press star, then number 1 on your telephone keypad. If you would like to withdraw you question, press star, then the number 2 on your telephone key pad. Thank you. Mr. Beck, you may begin your conference.

Thanks, Christy, and welcome to our second quarter conference call. I'm Kevin Beck, Manager of Investor Relations. With me today are Jim Griffith, President and CEO; Glenn Eisenberg, Executive Vice President of Finance and Administration and CFO, Jacqui 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 afternoon from Jim and Glenn, and will then 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 Web site, www.timken.com. This call is copyrighted by the Timken Company. Any use, recording, or 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 afternoon, everyone. I'd like to make three overall comments before moving into a more detailed review of the quarter. First, we've seen a strong change in our marketplace, with particular strength in heavy truck, mobile industrial, and rail markets. Second, basic supply-and-demand forces have sent raw material prices soaring, particularly those of scrap steel. This is spurring industrial demand, but it also poses major challenges to ourselves and to our customers. We must recover these cost increases in a marketplace which is not attuned to price increases. And finally, as a result of the actions we have taken, and as a compliment to my associates, our business is executing very well.

Our strong results last quarter continued into the second quarter, with earrings per share, excluding special items primarily relating to the Torrington acquisition, of 33 cents a share, 83 percent better than last year and above our previous guidance. This was accomplished in spite of the absorption of an unplanned shutdown at our Faircrest facility, and in the face of soaring raw material costs. Now let me review each of our groups' performance before turning to Glenn for the consolidated financial performance.

Automotive group sales for the quarter of $404m continue to be strong, up 7 percent from last year. Automotive manufacturing execution is on track. Productivity is up, and our European operations have turned a corner. Successful new platforms at Ford and Nissan launched in late 2003 continue to boost sales compared to last year, and North American light truck production was up over last year, while medium and heavy truck production continues to be up very sharply. Automotive EBIT was $7m, comparable to the same quarter last year, but well below the $18m first quarter. Our manufacturing performance is dramatically better than last year, but high raw material costs reduced second quarter profitability. As we discussed in our call last quarter, this had a bigger impact on the second quarter than on the first. We continue to aggressively pursue the recovery of these costs.

Industrial group sales of $438m were strong, up 12 percent from last year. We continue to see increased demand across all segments. We achieved double-digit sales growth in most market segments, with the strongest growth in construction and agriculture, railroad, and power transmission markets. Distribution sales have shown improvement driven by increased industrial demand. Despite these higher sales, distributors continue to reduce their inventories of Torrington-branded products. This inventory reduction is in line with our projections, and we expect this trend to continue over the course of the year.

We are seeing strong demand in most parts of the world, most especially in China. During the quarter, it was exciting to witness the opening of our fourth manufacturing location in China. This plant is a joint venture with NSK [ph], a Japanese bearing manufacturer. The JV is located in the city of Sujyo [ph], in Yangsu [ph] Province. It produces single-row tapered bearings used in both automotive and industrial equipment, and is expected to be at 100 percent capacity by mid-2005.

Industrial group EBIT was $49m, or 11 percent of sales, well above last year. The increase in EBIT was driven by increased volume through our improved cost structure. Since our last call, we announced a plan to begin closing the Canton bearing manufacturing operations here in Canton, Ohio. This consists of three plants, and we expect to ship most of the production to our other U.S. plants over the next two years. More specific information will not be available until after our discussions with the union, including the exact timing of the closure, the magnitude of savings, and the charges for restructuring and implementation. Those discussions formally began this week.

We also completed two acquisitions since our last call, Alcor and SES Technical Group. While both of these are small in size, the strategy is important-growing our business with products and services that complement our base product offerings.

The steel group reported sales of $330m, up 29 percent from last year, with approximately half the growth generated by surcharges and price increases. Sales across most market segments, including both automotive and industrial customers, continue to be strong. While we had record sales for the quarter, unfortunately, we continue to see record-high costs. The steel group EBIT in the quarter was $3m, up from a loss of $3m last year. Productivity improvements, leveraged by the strong volume, enhanced profitability. Raw material costs, especially scrap steel prices, are sharply higher than the prior year. Most major costs, including scrap steel, alloys, and energy, are expected to remain high for the year. The surcharge mechanism and price increases we implemented late last year and throughout the year are recovering a significant portion of these costs.

During the second quarter, our Faircrest facility was shut down for about 10 days to clean up contamination from a low-level radioactive material commonly used for industrial gauging. That material entered our process through our scrap supply. Our system operated as designed and prevented exposure to the environment, to our employees, and to our products. An excellent job was done by all involved to minimize the disruption caused by this event. Their remarkable efforts are symbolic of the dedication of our associates all across the company to excellence and execution.

In summary, we're encouraged by the strong market demand across all of our businesses. We're continuing to see the benefits from the actions we've taken as we leverage this upturn. However, we are still well below peak earnings, and are relentlessly focused on becoming even more competitive in improving our bottom line. Thank you. Now I'll turn it over to Glenn.

Thanks, Jim. My comments, consistent with those by Jim, exclude the impact of special items, which primarily relate to Torrington integration. These special items total $7.6m of pretax expense in the second quarter this year compared to $17.9m of pretax expense in the same period last year. Sales for the quarter were a record $1.1b, 14 percent better than the second quarter last year, with improvement across all three business groups. EBIT for the quarter was $60m, up 61 percent over last year, as EBIT margin of 5.3 percent was up approximately 160 basis points. Both gross profit and SG&A as a percent of sales improved from last year. Margin increases in industrial and steel were realized due to strong sales and operating improvements, while automotive margins were down due to high material costs. With a 38 percent tax rate for both periods, net income for the quarter was $30m, nearly double last year. Average shares outstanding, assuming dilution, increased to 90.6m for the quarter compared to 85.8m last year, driven by the company's 3-1/2m share offering in October of last year.

For the quarter, EPS was 33 cents, 83 percent higher than the second quarter of 2003. This compared favorably to our earnings guidance for the quarter of 27 cents to 32 cents. The company exceeded its guidance despite absorbing the impact of the unplanned 10-day shutdown of our Faircrest steel plant, which was $7.7m pretax, or 5 cents per share. Of this amount, we should recover all but $4m of insurance deductibles. Pretax synergies for the Torrington acquisition were $18m this quarter, or $35m year to date, driven by leveraging our purchasing and reductions in workforce. We are still on track toward our $80m target in 2005.

We ended the quarter with net debt of $784m, or 41 percent of capital, comparable to last quarter's level, but up from 39 percent at year end. This increase was driven by year-to-date cash contributions of $125m to domestic pension plans of the $175m targeted for the year. A $29m tax payment during first quarter related to the sale of our NTC joint venture, for which we received $146m 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 level.

Our earnings per share outlook, excluding special items, is 25 cents to 30 cents for the third quarter, at $1.15 to $1.25 for the year. This is an increase of 15 cents per share from our previous annual estimate of $1.00 to $1.10. We expect all three business groups to show improvement versus 2003. Our automotive group should benefit from slightly higher overall markets and increased market penetration. Our industrial and steel groups should continue to benefit from growing demand in global industrial markets.

Our actions, including the integration of Torrington and other cost-reductions, have positioned us well to leverage the upturn. Scrap steel prices recently spiked again at another record high level, exceeding $300 per ton, and are expected to remain high throughout the year. Surcharges and price increases should mitigate the impact of high material costs. Overall, we continue to be encouraged about the prospects for the company.

This concludes our formal remarks, and now we would be glad to answer any questions that you have.

At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. Please limit your questions to one question and one follow-up question. We'll pause just a moment to compile the Q&A roster. Your first question comes from Bob Chenowsky at Jeffries and Company.

Hi. Actually, this is Monica, on for Bob. I had a quick question on some clarity on that $7.7m of impact and cleanup costs from the business disruption. I do you see some details in your release, but can you break down for us perhaps the different between how much was the exact loss of business, and how much was from maybe less quantifiable business disruption?

Yes. The total, again, was $7.7m during the quarter. And again, to reiterate, all but $4m of all the costs that we'll have will be recouped from insurance proceeds. We have $4m in total in deductibles-$2m for business interruption, and $2m for cleanup. Of the $7.7m, we have around $5m that are related to cleanup, and around $2.7 that are related to business interruption. Of the volume, we lost around $3.9m of revenue as a result of this 10-day shutdown.

And just to clarify also, the recovery will be all from insurance except of the $4m in deductibles-it's not going to be from just recouping some of the volume, maybe, in out quarters?

That's correct-that of the costs that we've incurred right now, we believe that they are real and not recoupable, if you will. As we're shut down, we've missed that volume. So all the costs, if you will, that we incur-that $7.7m, and if there's anything additional-will be recouped through the insurance with our maximum exposure of the $4m deductible to the extent that those costs are directly related to the shutdown.

Thank you very much.

Your next question comes from Wendy Caplan of Wachovia Securities.

Thank you. An auto question: The margin was particularly disappointing in the quarter, and I heard your remarks, Jim, and Glenn, about the steel prices. Jim, you talked about ambitious pursuit of recouping some of those losses. Since Jacqui's there, can you talk about some of the measures you are taking to attempt to cover some of the steel prices?

Wendy, let me take it first, and then I'll let Jacqui follow up. First of all, our customers will recognize that when you see a raw material cost change where it triples-it's a 200 percent increase in the raw material cost-that there has to be recovery at some point in the market. Obviously, in the automotive market, that's not something that happens easily and without friction. We are aggressively pursing that recovery. The timing, obviously, depends on industry segment and customers from all over the country. Now, Jacqui can give you some color, but it's important-- we cannot, at this point, talk about any specific customers or specific negotiations that are going on.

Thanks, Jim. Yeah, Wendy, we are approaching the market and the various customers for full recovery, but we've found that our customers are sensitive to the issue, and we're looking not only for surcharge but other offset mechanisms such as pricing, engineering changes, share impacts where we're dual-sourced, and we've found some other creative mechanisms. Also, our customers are bringing forward ideas as they're hearing this from all of their suppliers.

Wendy Caplan. Thanks very much.

Your next question comes from Andrew Obin, Merrill Lynch.

Andrew Obin. Yes, good afternoon. I have a question on the automotive margin, I think [inaudible]]. What do you think this margin can be for the '05-'06 timeframe assuming production volumes stay relatively flat? How well can this business do, given the car tight pricing environment?

It's a very difficult question to answer from a forecast point of view. Our belief-- I don't like to use "margin," because margin becomes-- is public and deals with the specific relationships with our customer. Our belief, obviously, is that we can bring this business to earning its cost of capital on an independent basis, and that's simply the charge, when Jacqui came on board, that she took as a challenge. And it's in the timeframe that you're talking about.

So you don't think there's anything sort of fundamentally-- there's anything structurally quote-unquote "wrong" in the auto business not to allow this business to recover in the long term.

Obviously, we've done that analysis before we set that objective.

Andrew Obin. OK. The second question is, are you guys finding yourselves constrained, particularly on the industrial side, in terms of sort of delivering on orders or taking new orders in '04, given how high the volumes are for your customers?

Again, an insightful question. Obviously, this market has ticked up very quickly. It has ticked up on the steel side very quickly, on the bearing side very quickly. We are manning-up plants, we are expanding, and our challenge is to keep our customer satisfied. That's-- I wouldn't put that in the same tone as a constraint on accepting orders or accepting business; it has changed very dramatically very quickly, and there's a transition going on in terms of the mix of business and the business volume that we have.

And also, last-- a couple of quarters ago, we had an issue with the level of inventories in the distribution channel on the industrial side in the aftermarket. Has this been-- given how strong the volumes are, should I assume that that's gone?

I'll let Mike talk to that. The straight answer is no, but I'll let Mike answer that question.

Yeah. As we have said before, that issue still remains. The working-through the inventory reduction has actually been very positive. Our sales continue to be up year-on-year in industrial distribution markets; and at the same time, we are bringing down the levels of inventory that are there on the Torrington-branded products. So it actually has been a very positive message with regard to the uptick in the market.

OK, thank you very much.

Your next question comes from Michael Greenwald of EBNT [ph] Capital Market.

Thanks, guys. I just wanted to-- within the segments, I wanted you to quantify the amount of pricing and foreign exchange impacts there were within the revenue growth. I know you went into it with steel, but what about the others?

I'll at least cover-- the foreign exchange was minimal this year; it was around-- or, this quarter. It was around 1 percent of the increase that we had, so it's all organic growth, not impacted by it. With pricing, obviously it depends on the different businesses we have. A lot of the what we call pricing and surcharges clearly attributed to part of the 14 percent top-line growth. For example, on the steel side, we said roughly half of the growth that we experienced there of 29 percent was due to pricing/surcharges relating to the higher costs. Similarly, we would have had price increases and surcharges in both the industrial and the automotive business, but not to that extent.

Are you able to quantify what those essentially were within the two units?

No, other than, again, just to say that a lot of the increases-and Jim mentioned this earlier-in the marketplace, that getting prices has been difficult. We have been able to get a substantial part of the cost increases through pricing and surcharges. Clearly, the most of it would have been realized through our steel business, but also, through both the industrial and the automotive, we were able to recapture a fair amount.

Michael Greenwald. OK, great. Thank you.

Your next question comes from Gary McManus of JP Morgan.

Good afternoon, everyone. I'm looking at your third quarter guidance, and it kind of suggests your EBIT's going to drop $10m or so from the second quarter. And it looks like that's despite the fact you had $7.7m of-- I can just call it nonrecurring in steel. So can you explain-- is it seasonality? It seems like you're suggesting you're going to lose money again in automotive. Can you go through what you expect for the three segments in terms of EBIT in the third quarter?

Gary, as you know, the third quarter seasonally is our lowest period of the year, and we've always tracked that way; and that's even with the inclusion of Torrington in our results. When you look at how we performed in the first half of the year, at call it 31 cents and 33 cents for the first two quarters, the range of guidance that we provided of 25 to 30 is actually probably a higher level of performance in the third quarter relative to what we would have done historically in the first half. So if anything, we believe that we're seeing very good markets, and will be participating in enhanced profitability as a result of it.

Let me just-- let's take steel for a second. You did $3m or so at EBIT, but you really-- I mean, if you x out the business interruption costs and the cleanup, it's, like, $10m. Do you expect that to be down in the third quarter versus the second quarter?

Well, again, what we would categorize, and I think you even made the comment earlier, to lose money, we expect all of our businesses in the third quarter to be profitable. We expect the seasonality to potentially offset some of the momentum that we had in the first half, if you will, but still strong improvements. With steel, we are seeing good markets, we're running full capacity. We do expect shutdown in the plants as we normally would during the third quarter. But there's no reason to feel that we won't continue to see good performance within that business. We'll also be benefiting in the steel numbers, just like we were penalized in the second quarter, from the insurance proceeds that will be positive with that. But with the direct steel question, Tim, you may want to just give an outlook on just steel performance in the first half versus what you're seeing going forward.

Just looking forward at the third and fourth quarter, we're obviously seeing that the volume and the markets stay very strong. There's some speculation out in the fourth quarter about a bit of a fall-off in automotive. Right now, our order book is solid. The big question that we're facing right now is what scrap prices are going to do, and the impact that that will have on surcharge. But from an operational point of view, we'll be running hard through the rest of the year, with the exception of a couple of weeks out later in the year for a shutdown.

OK. Just if I may. On automotive, you would-- I know you probably don't want to talk about the impact of the raw material price increase versus pricing, but would you expect-- the surcharges and price increases you expect in automotive in the third quarter relative to raw material costs to be a negative or a positive relative to what you saw in the second quarter?

Gary, this is Jim Griffith. Let me see if I can answer the question by-- I'll extend a little bit what Tim said. We're expecting strong markets throughout the balance of the year and into next year. That's the basis of the forecast. The uncertainties that are reflected in our guidance are (1) what's going to happen to raw material costs? and (2) the timing of our ability to get recovery from our customers. Now, for us to now talk to you specifically about segments and profitability really gets into the question of which customers and in which markets are we going to get recovery, and that's not something we can do here.

OK. All right, I'll talk off line.

I think you'll get the same response, Gary, but good try!

Again, if you would like to ask a question, please press star, then the number one on your telephone keypad. Your next question comes from Wendy Caplan of Wachovia Securities.

Thank you. The jump in your earnings outlook for this year of 15 cents. You talked some about it, but can you talk specifically about what you're expecting in terms of-- are you assuming that material costs of specifically steel stays-- pricing stays-- scrap pricing stays where it is, or can you kind of-- it was a pretty big jump. Can you talk about what's changed and what you're assuming for the higher number?

Let me let Tim give you some comments, because he's closest to the raw material costs, and then I'll come back to take your overall question.

Just looking forward, obviously we saw a big run-up in the July numbers. Our surcharge mechanism on three-city [ph] average that we saw in July is $308. The model that we've put together would have that ranging anywhere between $300 and $350 by the end of the year, which is an obvious departure from what we were seeing in May and June. Based on the market dynamics, we are less confident that we'll see that back down into a normal range within the next, say, 12-month period. So that's obviously a big issue. We're also seeing alloys stay high as well, as well as energy.

Now, talking about the forecast between what we forecast in the first quarter and what we're seeing now, I'll say, Wendy, there are two changes going on. One is, we have seen our market strengthen significantly. And our confidence that those markets are going to stay strong has increased significantly over that period of time. That just gives us confidence that this will continue. And secondly, our internal performance has been stronger than we had forecast. The organization is performing, the factories are performing, we're delivering to customers-we're delighting customers, if our reading of the marketplace is right-and they're responding to us.

Thanks, Jim. Thank you; helpful.

Your next question comes from Jim Kostell [ph] of [unintelligible] Cuyahoga.

Hi. It's Jim Kostell with Cuyahoga Capital. A couple of questions. First of all, with the cost of steel and scrap bouncing around like this, if I recall, you folks are on LIFO [ph] inventory method here in the States? Is that correct?

Yes.

How are you-- I mean, is there-- how are you positioning and looking at the LIFO charges, and will there be some sort of true-up in the fourth quarter?

Yes, we review our estimate, obviously, during each quarter of the year, and then obviously it's trued-up with the final number in the fourth quarter. So our LIFO expense numbers are going up as the higher material costs are impacting our results. But we believe in each of the quarters that, as best as we can, we're accruing properly, or what we feel is the required number, to put in for LIFO.

Would you feel comfortable sharing with us what your-- kind of, your scrap numbers and your steel cost numbers, what your estimates are?

No, I would not.

If we can turn-- I realize your Canton is sensitive, but could you refresh our memory, in terms of what was in the press release-how long will it be until Canton, and those plants, are shut down? And how-- is there some timeframe that the union negotiation must fit in, secondly? And thirdly, are you seeing any-- since you announced the closure of those three plants, have you seen any change in the productivity of the plants, or-- I mean, is most of the wind-down front-end loaded, or is it back-end loaded?

The announcement that we made was that we didn't give a specific timeframe. We indicated that it would take more than two years. These are big, massive, integrated plants that are linked with the rest of the organization. And beyond that, we're not in a position to talk. As I said, we are engaged formally with negotiations with our union, and the outcome of that negotiation will impact that. The reality is, we're doing this in a very strong market, we're working overtime in those factories, and our employees, our associates, in those factories are doing what they do every day, which is working very productively, trying to serve the customer and delivering product very effectively to the marketplace. Unfortunately, we've done this a number of times around the world in the last three or four years, and 100 percent of the time, Timken associates come through in this kind of a situation, even when faced with adversity.

If I can follow on with that: Are the union employees there-- are the contracts set up in such a way so that, if I work in one of those plants and it's going to be shut down, that I have the option of, if you will, because of my seniority, bumping and taking a job in another one of the plants in the integrated complex?

That is subject to the negotiations that are ongoing with the union at this point-the answer to that.

Thank you very much.

Your next question comes from [unintelligible] Lorenzo of John A. Lean and Company.

Hey, guys, how are you?

Good; how are you?

Good. Just on the insurance part of it-when do you expect to get that payment?

Well, we expect to recoup the money in the third quarter, I would say. We've already recouped some of the money in the second quarter, so the $7.7m is a net number relative to what we've already received. But clearly, for the year, we should have it all recouped, hopefully in the third quarter, and in the guidance that we've provided, we've reflected what we believe we would recoup, which is everything other than the $4m.

OK. What would your margins have been overall if you [inaudible] that?

Well, if you look at the steel business, which is really where it's been impacted, steel reported a margin of .9 percent, and if you back out the impact at Faircrest, they would have had around a 3.2 percent margin. For the overall company, we came in at around a 5.3 percent EBIT margin; and again, if you would have backed in the same amount, I believe you get up to around 6 percent margin.

OK, thank you.

Again, if you would like to ask a question, please press star, then the number one on your telephone keypad. And there are no further questions, sir.

OK, thanks, Christy. I think before we conclude, I'd just like to turn it over to Jim Griffith for some final comments.

We thank you all for coming and sharing this time with us on what is a busy day in the marketplace. In conclusion, we are seeing strong markets across our business and across the globe. That's the good news. They give us the opportunity to leverage changes we've made in the last four years. However, we have a significant challenge-that is to manage the incredibly high costs of raw materials. We must recover these in the marketplace. Let me restate that we are well below peak earnings, and are positioned to leverage the improving economy. We remain focused on creating value for customers and shareholders. Thank you.

Thanks, Jim, and thank you all for attending our call today. If you have further questions, my name is Kevin Beck, and I'm the Manager of Investor Relations. My phone number is 330-471-7181. Thank you.

Thank you for participating in today's teleconference. You may now disconnect.