Timken Co (TKR) 2007 Q1 法說會逐字稿

Good morning. My name is Courtney, and I will be your conference operator today. At this time, I would like to welcome everyone to the Timken's first quarter 2007 earnings release call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Thank you.

Mr. Tschiegg, you may begin your conference.

Thank you, and welcome to our first quarter conference call. I'm Steve Tschiegg, Manager, Investor Relation. 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 & Administration and CFO, Mike Arnold, President of our Industrial Group, Jackie Dedo, President of our Automotive Group, and Sal Miraglia, President of our Steel Group. We have remarks this morning from Jim and Glenn, and will 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 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 a report filed with the SEC, which are available on our Website, www.timken.com. Reconciliation between GAAP and non-GAAP financial information is included as part of our 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.

Thanks, Steve, and good morning. I'm pleased to report Timken began the year with record first-quarter sales, and a significant earnings improvement over the third and fourth quarters, 2006. Glenn will take you through the numbers in a moment. First, I'd like to review the quarter with regard to progress made in structurally transforming our business to accelerate profitable growth. During this quarter, we invested heavily in additional capacity for targeted industrial products. We advanced construction on new facilities in Chani, India and Chengdu and Wushe, China, to keep pace with the rapid growth in Asia, where our sales grew by 17% for the quarter. Completed the expansion of our plant in Asheboro, North Carolina. They are already beginning to benefit from that increased capacity. As these facilities ramp up to full utilization, expect to see gradual improvement, margins of our industrial business.

We continue to make investments in our aerospace business, where sales grew nearly 40% for the quarter. Expanded capability to produce precision after-market components at our new facility in Mesa, Arizona, represents a significant broadening of our after-market product and service portfolio. In our steel business, we were able to take advantage of weaker automotive demand and convert production to increase penetration, service sector, and energy sectors. This favorable shift and mix contributed to record steel results for the quarter. We also announced the $60 million investment in our rolling mill capabilities that will give Timken the broadest range of forging bar sizes in North America. This allows us to vary our mix with the market and improve the consistency of our profitability throughout the cycle. Actions in the first quarter also included the announcement of a plan to close our bearing production facility in Sao Paulo, Brazil. This is part of our global restructuring program to right-size our auto business. That program continues to be on schedule.

And finally, next month we will implement the second phase of our initiative to improve business processes systems across the company, called Project One. With the installation of a major portion ERP system in the United States, following the 2006 pilot program in Canada. In short, we're pleased with our progress on strategic initiatives and that our results rebounded so strongly in the first quarter. Looking ahead into the rest of the year, we anticipate continued strength in key industrial markets. We will leverage our investments in additional capacity, take advantage of this strong demand. Strong industrial markets should also support strong steel performance throughout the year. Add to that the benefits of our auto restructuring program, and overall, we expect full-year results to approach or exceed record levels for the company. Now I'll turn it over to Glenn for a more detailed review of Timken's first quarter performance.

Thanks, Jim. For the first quarter, the company's fully diluted earnings per share from continuing operations was $0.44. Excluding special items, earnings per diluted share was $0.66. These special items included $27 million of pre-tax expense primarily related to the restructuring and rationalization of our automotive and industrial groups, and the closure of our steel tube operation in the U.K.. In the first quarter of 2006, special items totalled pre-tax expense of $5 million, principally related to manufacturing restructuring and rationalization. Rest of my comments will exclude the impact of special items.

Sales for the first quarter were $1.3 billion, an increase of 2.4% over 2006. Strong demand across the Company's strong industrial markets was partially offset by declines in automotive demand from North American customers, and the sale of the Company's automotive steering business in the end of 2006. Gross profit margin for the quarter was 21%, 80 basis points lower than last year, due primarily to the underutilization of automotive capacity and higher manufacturing costs associated with the company's industrial capacity expansion. Offsetting the decline in gross margin was an improvement in SG&A expense. SG&A was 12.7% of sales, 90 basis points favorable compared to last year, primarily reflecting lower costs, due to the company's restructuring and workforce reduction initiatives, as well as lower incentive compensation and automotive bad debt expense.

As a result, EBIT for the quarter came in at $103 million or 8% of sales, an improvement of 20 basis points compared to a year ago. Net interest expense for the quarter was $8 million, down $4 million from last year, primarily due to lower net debt levels, which were reduced by the proceeds from the Latrobe specialty steel divestiture in the fourth quarter of 2006. The tax rate for the quarter was 34.2%, compared to 32.4% last year, due to the company having a smaller percentage of its earnings in lower tax rate foreign jurisdiction. As a result, income from continuing operations for the quarter was $62 million or $0.66 per diluted share. E P S was up 6% over last year's results and compared favorably to our previous earnings estimate for the quarter of $0.50 to $0.60.

During the quarter, the company adopted FASB Interpretation Number 48 or FIN 48, which resulted in a $2 million direct reduction in retained earnings and no impact to income. However, the company is awaiting the issuance of a final FASB staff position related to FIN 48. When issued, we expect to record, as special items, the benefit of a $33 million reduction in income tax expense, and a $7 million direct increase to retained earnings. If issued prior to the filing of our Form 10-Q, the Company will record the necessary entries into its first -quarter results.

Now I'll review our business group performance. Industrial Group sales for the quarter were $544 million, up 8% from a year ago, benefiting from pricing and strong demand across its broad industrial markets, with the highest growth coming from aerospace and heavy industry. Industrial EBIT was $49 million, or 9% of sales, 10 basis points lower than last year. The impact of favorable pricing and demands was offset by higher manufacturing costs related to the ramp-up of capacity additions, as well as higher raw material and logistics costs. Looking forward, we continue to expect strong industrial markets with improved margins for the year, as we better leverage our top line growth through operating improvement.

Automotive Group sales for the quarter were $388 million, down 8% from a year ago, primarily due to the sale of the steering business at the end of 2006 and lower demand from North American customers. For the quarter, the group reported a loss before interest and taxes of $7 million, compared to a loss of $3 million last year. The net benefits associated with restructuring initiatives, including reductions in SG&A costs, were more than offset by the underutilization of manufacturing capacity. The Automotive Group is demonstrating improved performance due to its restructuring initiatives, as evidenced by its improvement over the second half of last year. We expect the Auto Group to return to profitability in 2008.

Steel Group sales for the quarter were $390 million, up 4% from a year ago. The group benefited from increased pricing and strong demand in the service center and energy sectors, which was partially offset by lower automotive demand. Steel Group EBIT for the quarter was $62 million or 15.8% of sales, 60 basis points higher than last year. The improvement reflects favorable pricing and mix, as well as plant utilization and labor productivity. We continue to expect strong results for the 2000 year from our Steel Group, comparable to last year's level.

Looking at our balance sheet, we ended the quarter with net debt of $568 million, roughly $70 million higher than the end of 2006, due to seasonal working capital requirements. The company's leverage of net debt to capital increased to 27.2%, compared to 25.2% at the end of 2006. We expect to generate free cash flow for the year, providing additional financial flexibility to pursue strategic investments. Capital expenditures for the quarter were $61 million or 4.7% of sales above depreciation and amortization of $55 million. The spending level will increase over the course of the year, as we continue to make investments in support of our business and growth initiatives. We contributed approximately $38 million to our global pension plans during the first quarter. Our full-year 2007 contributions are expected to be approximately $100 million, compared to roughly $265 million last year. As with last year, we will consider making additional contributions, based on our pension funding status and financial leverage.

In summary, we expect global industrial markets to remain strong and automotive demands to stabilize. We expect to see higher profitability and margins for the full year, driven by improved operating performance, with earnings per diluted share, excluding special items, to be in the range of $2.55 to $2.70, compared to $2.13 from last year. For the second quarter, we anticipate earnings per share, excluding special items, to be $0.65 to $0.75, compared to $0.80 for the same period last year. The company expects second-quarter results to be constrained compared to the prior year period, as we implement Project One, continue restructuring activities in automotive, add capacity and industrial, and anticipate narrowing of material cost spreads in steel.

However, we continue to expect improved results from our businesses for the full year, compared to last year. From a cash flow standpoint, we expect to see higher free cash flow in 2007, benefiting from earnings growth, better working capital management, and lower pension contributions. Capital expenditures should remain about the same as last year, as we continue to invest in growth initiatives, while cash taxes are expected to increase, due to higher earnings and estimated tax rate of 34%, and having utilized all of our U.S. tax loss carry forwards in 2006. We remained focused on our key objectives, including Asian growth, capacity additions, restructuring, strategic acquisitions, and the continued implementation of Project One. This ends our formal remarks. And now, we'll be happy to answer any questions that you have. Operator.

At this time, (OPERATOR INSTRUCTIONS). We'll pause for just a moment to compile the Q&A roster. And our first question comes from the line of Andrew Obin with Merrill Lynch.

Yes, hi, can you hear me?

Yes, Andrew. Good morning.

Hi. Good morning. Just a question on the second quarter. I just want to understand a little bit when you said, "Expect constraints in the second quarter. Can you give us granularity by (inaudible)? Does it mean we might see sequential deterioration in margin, or what exactly does it mean?

Well again, it's relative to the period of a year ago, which was a good quarter for the company, but if you looked at it by the segments as you've asked, Automotive is tracking at relatively the rate they had in the first quarter. So that the improvement will really be because of the seasonality we would expect the second half to be down, theyll be able to maintain the current level. But when you look at the performance compared to the second quarter of a year ago, that was before we saw the significant reductions in North American volumes that we're going to see, you know, a decline in automotive profitability, if you will, second quarter year-over-year, albeit, again, improved for the full year -- year-over-year.

Similarly, within the Industrial side, very strong quarter for them, hitting 12% operating margins last year. So we expect that in the second quarter of this year, we'll see that down, but improved over the margins that we had in the first quarter. And again, as well, Industrial -- the expectation is that we'll see that improved for the full year compared to the full year a year ago. So, again, some of it is timing related, but from a comparative purpose, compared to the second quarter, we would expect that. And then finally -- finally, one last with -- Andrew, with the steel side, we had a very good first quarter above a year-ago's results. We expect for the full year Steel will be comparable, so that we do expect some decline relative year-over-year for the remainder of the year, as we do see some narrowing of the material cost spread.

And I just want to understand for Industrial, I'm interested. Historically we've had a nice step up from first quarter to second quarter in margin just seasonally. So should we continue to see similar pattern in '07?

That's right. As I said earlier, we do expect to see margins in Industrial improve in the second quarter, which would seasonably be the case. Albeit, we'll be down a little bit from last year. I think the big difference, though, is we would normally see that then come down in the second half, off a peak in the second quarter, but our expectations are that we should be able to see continued margin improvement throughout the year, such that for the full year, we'll be up year-over-year.

That would be great. Just another question. I just got back from BOMA in Munich. And it's the first time in a couple of years that we are hearing about capacity constraints on the bearing side, not only from you but also from your Japanese competitors. I was wondering if that creates pricing opportunities for the industrial business in the second half of the year?

Andrew, this is Mike Arnold. It's actually created pricing opportunities for the last couple of years, and there is constraint on the size of product that is required in those industries that you would have seen at the BOMA show. So that capacity constraint in the industry and the demands of the energy market, construction input and et cetera, will provide opportunities for a good margins on that business forward.

And just a final question. I will let you go. Just given these capacity constraints, and given the fact you're sort of talking about potential increase in production volumes in the second half of the year, do you think you guys have the capacity to meet that demand?

We continue -- and this is the discussion that we've had now over sort of the last year and a half, Andrew. We continue to install new capacity, new facilities. We have three new facilities in Asia that are either finished and ramping up their capacity or under construction at this point. And I think as Jim mentioned in his opening comments, completion of our expansion at our Asheboro, North Carolina facility, which produces product in the size ranges that are used by that industry.

Okay. Thank you very much. I really appreciate it.

Hello, operator? Your next question comes from Mark Parr with KeyBanc Capital market.

Thanks very much. Can you hear me?

Yes, Mark. Good morning.

Good morning. Hey, congratulations. Nice quarter. A couple of questions. I was wondering if we could get an update on the program mix on the automotive side and what are you realizing, as far as base pricing momentum, '07 versus '06 for automotive bearings?

Good morning, Mark. Jackie.

Hey, Jackie.

On the program mix, '06 to '07, we're continuing with our portfolio management. We exited about $70 million worth of programs. We've brought in about $55 million worth of new programs, and we're continuing with our goals of customer diversification in alignment with the markets and on track to be at about a 50/50, non- Big Three to Other, at the middle of '09. In '07, that percentage continues versus '06. We've seen about -- the mixture on the new programs was a little over 50% non- Big Three. On pricing, we are not seeing positive pricing at this stage in the first quarter of '06 versus '07. It's slightly up. But not significantly up.

Okay. All right. So as far as the restructuring, I mean, what we're going to see on automotive is basically a cost reduction this year, as opposed to any kind of pricing leverage. Is that fair?

That's fair. You're going to see cost reduction due to the restructuring, both with the facilities and the S&A, and you're going to see some leverage due to the mix of programs coming in. But it's disproportionate on the restructuring side.

Okay. Terrific. That's very helpful. I was wondering, Glenn, have you talked about the timing for the commissioning of the capital upgrade in the steel business. Just wondering if I could get an update on that?

Good morning, Mark. This is Sal Miraglia. We have not commented on it, so we will be operational in the second half of next year. So are ground breaking phases now -- (inaudible) and some major (inaudible)

Sal, you're breaking up. I'm sorry, I can't hear you.

Sorry about that. I'll see if we can get a little closer. Is that better?

Yeah, that's better.

We have let most of the contracts -- we will start major groundwork for the installation in the second half of this year, and we expect to be operational by the third quarter of 2008.

Okay. Third quarter of '08. Okay. That's helpful. Also, I have one last question. Did did Timken have any LIFO impacts in the first quarter that were worth mentioning?

No, Mark.

Okay. Terrific. Well, hey, congratulations on the progress. It's nice to see the automotive restructuring starting to take hold, and good luck with the balance of the year.

Thanks, Mark.

Your next question comes from Marty Pollack.

Hi. Hi. Nice, nice quarter. Certainly nice recovery and on automotive -- staying on the automotive side -- I'm just wondering on last year, clearly we had -- it seems that losses were quite minimal. So in a sense, I just want to get the risk of a second half development the way we saw it this year, I mean, in '06. In a sense that I don't know whether you would expect lower builds in the second half, but clearly the comps should be easier. The question is, directionally will we be seeing the losses coming down the first, let's say half? And how much of that is effectively due to restructuring efforts? So, where this year you're obviously prepared for a different environment. Last year, it seems that you weren't.

Good morning, Marty. Jackie Dedo. Let me try to add some color to that question. In terms of -- as Glenn said, we achieved loss of $7 million this quarter versus a much more significant loss last quarter, as you said, due to unanticipated structural declines from our North American customers. We've now added additional restructuring. We announced last quarter to work on that. The first quarter, quite honestly, came in stronger than we had anticipated, due to a little bit better market than we had planned for.

So at this stage, I would expect the profitability performance to continue through the year, given our market expectations. We think we're planned for the right structure of the market, don't expect to see a second half additional decline over last year. We are planning for it to be slightly lower than last year because we think we'll see it for the full second half, whereas you know last year, it feathered in over the second half.

Okay. With regard to share, I'm just wondering if you were to exclude the steering sales, what's implied in terms of overall market share, U.S. and North America? Because clearly the build rate is still very low in '07. It seems that when you have back steering, if you make -- if you compare apples to apples, are you effectively doing better than the industry here?

Marty, could you restate the question?

Yeah. I'm saying with the steering sales effectively suggesting lower -- at this point, the steering sales are not in Q1, but last year they were your numbers. So ex the steering sales, are you performing better, in terms of market share in automotive year-over-year? Eventually with the build rate very low still this year, just wondering where you -- where might you be doing better?

Marty, I think the straight answer to your question is that there not a significant change in share -- on our market share in the automotive. The focus is the profitability.

Again as Jackie said, we are seeing a shift, and so overall the share will remain, but we're seeing a shift in our customer base.

Yeah, but within the North American business, is your share more or less the same, or are you seeing any better results?

No significant.

I think you're breaking up here as well. Okay. I'll come back to cue.

Next question comes from the line of Peter Jacobs.

Good morning, gentlemen, and ladies. The first question is just basically a housekeeping question, and when I'm looking at the P&L and the adjusted statement of income, we have an EBIT of basically $102.6 million. But when I look on the following page where the business segments are broken out, when I add that up, I get $103.8 million. So basically a difference of a little bit over $1 million. Could you just clarify where that difference comes from?

Yes, Peter. I mean, it's just a small amount of eliminations between the businesses.

Okay. Yep. Hey, and secondly, I think I was distracted earlier when you were talking about the automotive business. But could you just refresh your memories on, if you didn't already say this, on basically the percentage of sales you're seeing into the traditional OEM's versus the transplants here in North America?

Our current mix has come down from the beginning of last year to about 75%. Right now we're somewhere in the mid 60s.

Okay. Thank you.

Your next question comes from the line of [Elliott Arlin], stockholder.

Yeah, my question is that we did -- we made profits of $62 million, and I heard the figure of $0.47. And last year we made $57 million, and we made $0.71. Is there something I don't understand?

Yeah, if you look at the accompanying financials that we provided, I think you're getting the income from continuing operating company with $62 million, which translates to $0.66 a share --

How much a share?

$0.66 a share.

Oh, I see.

And that last year, comparing it to the same period a year ago, we did roughly $58 million, translated into $0.62.

Right. All right. Then my next question is, has the company repurchased any shares in the market during this quarter?

We have not.

You have not. Okay. Then my next question is, last year we had a big loss on sale of assets of $65 million. Is there anything expected this year of that magnitude?

Again, the only thing as far as -- we have not disclosed any (inaudible) or divestitures and what impact that would have on a net basis. We've had a loss on last year. We do have restructuring costs, but not relating to any assets.

Fine. That's all I have.

Thank you.

All right. Thank you.

Your next question comes from the line of Mark Bishop with Boston Company.

Alright, I have a few questions. First, your -- how much cash restructuring costs do you still have to do for the rest of this year, and how much did you do in the first quarter, and do you have more to do in '08?

We did, roughly -- if you looked at our unusual items or special items that totaled around $27 million for the quarter, including that was around $10 million for our (inaudible) shut down. So the remaining 15, you could say, is probably a reasonable run rate for the rest of the year.

$15 million total?

No, the 15 per quarter of the non-Desford, because Desford effectively will have a small amount in the second quarter and then go away.

$15 million per quarter rest of '07?

That's right.

And then there is none in '08?

Well, again, not at the level that we've had. You never say never, right now. But our automotive restructuring should be completed by the end of this year, and that's been the bulk of it. Our industrial restructuring, which again has been the smallest component could have some left into 2008, but, again, on a relative basis, it will be much smaller than what we've expected this year.

Okay. And then the saving -- the cost cuts in auto, the savings are supposed to be how much from the whole restructuring? And do you realize the full amount in '08, and have you realized any of it yet?

Yeah, the targeted savings from our automotive savings and head count reduction initiatives is targeted for around $75 million, to be realized in 2008.

For the full year?

For the full year. And obviously we're incurring some of the savings currently, but part of those savings are being eroded, if you will, by the cost of our restructuring program from just operating issues. So, that's why when we say that auto is going to see improved performance in 2007, but still at a loss for the year, we expect to regain profitability in '08, in part, based upon the benefits from the restructuring.

Is that savings versus the 2006 level?

Yeah, the 75 -- if I understand your question, the 75 will be realized in full in '08. Some of that, not all of that, has been realized in '06, but, again, we had counterbalancing costs in '06 as well.

Okay. So I'm just, I just -- so it's $75 million savings versus what level? Versus -- so you can't add 75 to the 2006, because some of it actually showed through already in '06? Is that right?

Well, again, on a net basis, you're not seeing a lot of the benefits, if you will, because we have the costs associated with it. So as we ramp up in 2007, we'll start to see now a positive delta between the savings and the costs to achieve it, and when we get to '08, those costs should be, for most part, out, and we'll realize the full $75 million benefit dropping to the bottom line.

Okay. I'm sorry. I'm not expressing this well. The 2006 numbers that you published by segment on a -- are those -- do you have the proforma numbers with the restructuring costs taken out, or are there some costs included in the EBIT numbers by that segment for auto that's kind of not really -- you know, that includes some of these restructuring costs? You know --

There is costs. Again, this is not -- there are costs -- call them two sets of costs we show. One is our restructuring costs, which we do take out as special items. That could be severance related or impairment issues, whatever. We also have the cost of actually implementing the restructuring, the consolidation of facilities and there are costs associated with that, moving equipment, learning curves, training and so forth. So as we're realizing the benefits of the restructuring program, we're also incurring costs, included in our as adjusted numbers, what you see in those segment results. So those two are netting against each other.

As we get to 2008, we'll see a nice improvement, because we'll now be getting the full benefit of the restructuring program with -- now without the costs of that restructuring, whether it be in our special items or in our normal operating items, barring just some inefficiencies as we're ramping up that capacity at the new facilities.

Let me restate, make sure I got it. So the '06 numbers had -- might have shown some benefit from a $75 million, but also had -- were offset by some costs that you did not break out, in addition to restructuring costs that you did break out? So you really didn't show any benefit in '06. And so you ought to get $75 million more in '08, according to plan, versus what you did in '06 in auto.

I think directionally, that's a fair statement. I won't say that there wasn't any net benefit of the restructuring, but clearly the magnitude of the savings that we expect, a lot of that, as we had in '06 or even in '07 is being diluted by those costs, not necessarily dollar for dollar. But we do expect a nice ramp-up in profitability in '08, if that's what you're getting at, due to realizing the full potential or the full benefits from the restructuring.

Okay. Let me just ask a couple of quick ones, and then I'll get back. Is there a working capital forecast for the year overall for the company?

What we've said is that, at least from working capital management, so you're working capital per sales dollar, that we do expect to maintain or see improvements in that metrics. So depending upon what sales does this year, we do expect to see the performance of our working capital improve.

Working capital per dollar sales, okay. And then what is the pension and OPEB liability as of the end of the year?

We had roughly around, I believe on the balance sheet, it will show you roughly a number of -- call it close to around $1 billion between pension costs and post-retirement benefits, as of the end of March.

Okay, thank you.

Thank you.

At this time, I would like to turn the call over to Jim Griffith.

Hello? Hello?

Yes, operator, if you wouldn't mind to see if there are any additional questions before we have our wrap up.

There are no further questions.

All right. Thank you. In conclusion, strong markets, followed execution, (inaudible) Thanks again for your interest and your investment.

Thank you for joining us today. If you have any further questions, please feel free to give me a call, Steve Tschiegg at 330-471-7446. This concludes our call. Thank you.