Timken Co (TKR) 2011 Q1 法說會逐字稿

Good morning, my name is Wendy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Timken's earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (Operator Instructions) Thank you.

Mr. Tschiegg, you may begin your conference.

Thank you, and welcome to our first-quarter 2011 conference call. I am Steve Tschiegg, Director of Capital Markets and Investor Relations. Thank you for joining us today, and after our call should you have any further questions please feel free to contact me at 330-471-7446.

With me today are Jim Griffith, President and CEO; Glenn Eisenberg, Executive Vice President of Finance and Administration, and CFO; Rich Kyle, President of our Mobile and Aerospace and Defense businesses; Chris Coughlin, President of Process Industries; and Sal Miraglia, President of our Steel Group. We have remarks this morning from Jim and Glenn, and then we'll 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 would like to remind you that during our conversation today you may hear forward-looking statements related to future financial results, plans, and business operations. Actual results may differ materially from those projected or implied due to a variety of factors. These factors are described in greater detail in today's press release and in our reports filed with the SEC, which are available on our website, www.timken.com.

Reconciliations between GAAP and non-GAAP financial information are included as a part of the press release. This call is copyrighted by the Timken Company. Any use, recording, or transmission of any portion without the expressed written consent of the Company is prohibited.

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

Thanks, Steve. As you saw in the earnings report we issued this morning, the first quarter of 2011 was exceptionally strong for the Timken Company. With brisk demand across our industrial sectors, we achieved an increase in sales of 37%, and set a first-quarter earnings record of $1.13 per diluted share. These results exceeded our expectations. They reflect the combination of a continued modest economic recovery and the impact of the strategic changes we've made to improve our performance. These results put Timken on pace to set a new earnings records this year.

Our strategy is working. We've optimized the Company's performance with stronger execution and diversification. We are steadily expanding our presence and our market share in attractive areas.

When you consider the leverage we are achieving in this upturn, it's clear that the Timken Company of 2011 is a very different company from that of only a few years ago. We are more agile and more productive. Our portfolio is more balanced across markets and channels. And it's bolstered by new products that are selling very well. We are growing and we're investing in demand-driven expansion to keep place.

I'd like to share some first-quarter highlights that demonstrate the extent to which we've repositioned our Company. Our mobile segment again showed remarkable earning power, starting off the year stronger than ever. Our ability to respond rapidly to the improving market conditions is being recognized by customers who are offering us new opportunities, offsetting much of the turnover we've cautioned about in the light vehicle sector.

Process industry sales rebounded sharply in the quarter, as our ability to maintain strong customer service levels despite a rapid run up in demand was rewarded by strong orders from industrial distribution. New product offerings including industrial bearings in Asia and mounted bearings associated with our recent QM acquisition also contributed to process growth.

Our steel business is seeing record levels of demand for this point in the business cycle, and has a backlog that extends throughout most of the rest of the year. This is led by demand from the energy sector where capabilities gained in our 2007 acquisition of Boring Specialties are opening doors for us to the rapidly growing market for drilling for natural gas in shale deposits in North America.

In a number of product lines, we are experiencing a need to increase our capacity, both for industrial bearing and steel products. While capital spending will be up for this year, we changed our capital productivity to generate significantly greater sales per unit of investment than was historically the case.

In addition, especially for bearing products, these investments continue expanding our geographic footprint. The capabilities developed through our project ONE business systems investments have resulted in strong levels of customer service in our bearing business, as well as tight control of working capital. The combination of improved supply-chain management and efficient capital spending has generated stronger than expected cash flow, a much appreciated characteristic of the new Timken Company.

The exception to our positive story is our aerospace business. Specific issues associated with the destocking of the supply chain on the military side, and our exposure to the after market segment of business aviation, have caused a deeper and longer reduction in shipment levels in this segment of our business. Nevertheless, we have seen an uptick in orders from commercial aviation, and expect to see shipments ramp as the year progresses. Combined with the benefit our cost reduction activities, this should lead to a return to solid levels of profitability by year-end. Our momentum, along with our understanding of the success of the actions we've taken, gives us increased confidence, which leads to the upward revision of our 2011 earnings estimate.

The first quarter brought a number of shocks to the global economy. These in turn have created a great deal of uncertainty in the minds of many investors. At this point, those issues have not had a significant impact on Timken, and we retain a positive outlook for 2011.

Let me explain. The earthquake and tsunami in Japan were both a human and an economic catastrophe. Fortunately, Timken has very little direct exposure to the Japanese market, and the slowdown has not impacted us. We have strong supply-chain partners in Japan whose operations were not severely impacted by the disaster. Our Company and our people have contributed to the efforts to alleviate the human suffering in Japan, but we are not seeing an impact on our business.

A second shock is the effect of raising commodity prices driven by demand from growing Asian economies and the recent events in the Middle East, which impacts our raw material costs. We have put in place pricing structures to manage this risk. You can observe that directly in the revenue increase in our steel business, a part of which results from increased surcharges to offset raw material costs. Moreover, extractive industries, industries like energy, mining, and agriculture are core markets for Timken. As prices rise, capital spending and operating levels follow, creating stronger demand for our products.

Finally, in Asia the actions taken by the Chinese government to rein in inflation threatens to slow its growth. Despite these actions, we are continuing to see double-digit growth in demand in China. In addition, our market diversification efforts are being rewarded with growth in India and Southeast Asia.

Let me sum up with a simple observation that our performance in the first quarter reinforces that our strategy is working. It gives us confidence in our prospects, and firmly places us on track to make 2011 a record year for the Timken Company.

At this point, I'll turn the call over to Glenn for a more thorough review of our results and financial outlook.

Thanks Jim. Sales for the first quarter were $1.3 billion, an increase of 37% over 2010. The increase was due to stronger volume across most of the Company's end markets, higher surcharges, and pricing. These benefits were partially offset by weaker demand in the aerospace and defense markets. From a geographic perspective, the increase in sales came primarily from North America and Asia, although European sales were also up.

Gross profit of $333 million was up $111 million from a year ago. Gross margin for the quarter was 26.6%, up 220 basis points from last year. The improvement was driven by higher volume, mix, surcharges, and pricing, partially offset by higher material costs.

For the quarter, SG&A was $150 million, up $17 million from last year, primarily reflecting higher variable incentive compensation and wages. SG&A as a percent of sales for the quarter improved 260 basis points over last year to 12%. As a result, EBIT for the quarter came in at $180 million or 14.3% of sales, 520 basis points better than last year. Net interest expense for the quarter was $8 million, down $1 million from last year, reflecting interest income earned on higher average cash balances.

The tax rate for the quarter was 33.5%, compared to 61.5% a year ago. The tax rate for the quarter of 2010 reflected a one-time non-cash charge of $22 million resulting from the US Healthcare legislation. This charge was mostly reversed in the fourth quarter following the Company's establishment of a VIVA trust. As a result, income from continuing operations for the quarter was $112.7 million or $1.13 per share compared to $0.29 per share last year.

Now I'll review our business segment performance. Mobile industry sales for the quarter were $443 million, up 21% from a year ago. The increase was driven by higher demand across all of the segments' end markets, led by off-highway and rail. From an earnings perspective, the mobile segment achieved strong profitability, with EBIT of $68 million or 15.3% of sales compared to $40 million and a margin of 10.8% last year. The improvement was driven by increased demand and manufacturing utilization.

Given the strong demand we saw in the first quarter, coupled with an increased outlook for the balance of the year, we are now projecting mobile industry sales for 2011 to be up 10% to 15%. Increased demand led by the off-highway, rail, and heavy truck sectors is expected to be constrained by exited light vehicle business resulting from prior pricing initiatives.

Process industry sales for the first quarter were $285 million, up 38% from a year ago. Demand from global industrial distribution, growth in Asia, and new products accounted for the increase.

For the quarter, process industry's EBIT was $67 million or 23.4% of sales, up from $24 million and 11.7% of sales last year. EBIT benefited from higher volume, price, and mix. We are increasing process industry sales outlook for the full year to be up 20% to 25%. This growth is driven by better than expected first-quarter performance, increased global industrial distribution demand, growth in Asia, and sales from new products.

Aerospace and defense sales for the first quarter were $79 million, down 14% from a year ago. The decline was driven by weak demand in the defense sector. EBIT for the quarter was $2 million or 2.8% of sales, down from $12 million or 12.9% last year. The decline in profitability was driven by lower demand and manufacturing capacity underutilization. We continue to expect aerospace and defense sales for 2011 to be up 5% to 10%, driven by strengthening commercial aerospace, and health and positioning control markets, while defense markets are expected to remain relatively weak.

Steel sales of $482 million for the quarter were up 78% over last year. The increase was driven by stronger demand across all end markets, led by the oil and gas, and industrial sectors. In addition, surcharges were up $75 million for the quarter due to higher raw material prices and overall demand. EBIT for the quarter was $60 million or 12.5% of sales, compared to $20 million or 7.4% of sales last year. The increase resulted from higher volume, mix, price, and raw material surcharges, which were partially offset by higher material costs.

The Company now expects steel segment sales for 2011 to be up between 30% and 35%. This increase reflects steel's strong first-quarter performance, initiatives to increase capacity and response to strong end market demand, as well as surcharges.

Looking at our balance sheet, we ended the quarter with cash of $638 million, or $115 million in excess of debt. This compares to a net cash position of $363 million at the end of last year. Free cash flow for the quarter was a use of $238 million. Cash generation from earnings were more than offset by increased working capital requirements of $175 million, as well as discretionary pension contributions of $150 million. For the full year, free cash flow is expected to be around $100 million after dividends of $70 million, capital expenditures of $220 million, and discretionary pension contributions of $150 million.

Our outlook for sales is expected to now be up 15% to 20% over 2010, an increase from our previous estimate of 10% to 15%. We expect our 2011 earnings per diluted share to be $3.80 to $4.10, an increase of roughly 40% to 50% from $2.73 per share in 2010. Our improved outlook for 2011 is reflective of the solid financial performance achieved in the first quarter, and stronger demand across several key end markets.

This ends our formal remarks, and we'll now be happy to answer any questions. Operator?

(Operator Instructions). Your first question comes from the line of EliLustgarten.

Good morning, it's nice see you got a quarter right for a change.

Good morning a lie.

Anyway, very nice quarter. You improve the outlook and volume you talk about the outlook for, you know, operating profitability for margins at various segments. You know, 15.4% in global and 53 as good a mobile. But you still worried about losing some business is that still going to happen and what do you see profitability? We would love to see 23% stay in the process that -- whether that's been ongoing. You talk about the profitability businesses based on the new volume outlook that you give us.

Yes, Eli. this is Rich. On the mobile side, we expect to roughly sustain those margins through the rest of the year with the exception of the fourth quarter seasonality which typically brings us down a few points due to plant shutdowns and a general reduction of volume.

On the lost business side, we still expect the lost business to be in the $50 million to $100 million range that we talked about last quarter. However, I would also say a fair amount of that lost business is already reflected in the first quarter run rate. An example of that four of our five markets within mobile were up double digits year-over-year in the first quarter. Exception of that was light vehicle which was only up in the low single digits. And if you look at the markets that we serve light truck and European passenger car and North American passenger car. We would expected that to have been up of the lost business probably in the 9% to 12% type range. So again, some of that $100 million is already reflected in the first quarter run rate for business that was lost the latter part of last year. I will let Chris talk about process.

Yes. On process. I mean obviously the first quarter was very good. There were three primary drivers of this margin change. First of all, the distribution mix relative to the original equipment mix was favorable. There's three things driving that distribution mix one is strong global markets. A number two new products are doing very well in the distribution area. And then number three, we have very good service levels, very good profitability. The bearing markets are relatively tight and thus we are doing very well in the after markets due to that high service level.

The second primary driver is the leveraging of the Asia manufacturing. We've talked about this a lot in the past and some of you will remember, you know, three or four years ago this was a major drag on margins. Well now the opposite has happening. We are through the major portions of the ramp-up for us. We are getting very good cost leverage out of that asset base as we ramp those outputs.

The third primary driver the first quarter is just general excellent cost control. You'll see the leveraging of the SG&A as a percentage of sales. Very tight control of head counts which we intend to sustain. So you know, that's pretty favorable. We had very good management of raw material costs. I'll come back to the point here at second. But just generally speaking, very good tight management of costs.

So moving forward on this, to your point Eli, you know, we expect to have a very, very good year, very, very strong margins relative to any historical numbers we've hit areas we clearly might come off the 23% a little. Two drivers of that, one we expect to see some of the mix shift back to the original equipment in the balance of the year we have major OE applications coming online. This is still very, very good business very important to the long-term health of our after market but those -- that business is at a lower margin relative to the distribution business.

And then the last point you know there is pressure on raw material costs. We are recovering all of that via price. There is a little bit a favorable timing influence in the first quarter. It's not a huge number but we would expect to see some of that favorability you know, tightening up on us as we move deeper into the year. Not a major issue for us but clearly we, we do have some cost pressure on the raw material side.

Expected to stay over point percent for the year it sounds like.

Yes, I would say that a fair statement.

And you know we can't let get away without doing anything, right?

What's your question, Eli?

You know, only 12.4% with this kind of volume, I mean you have cost ramp issues but can you talk about what profitability can go in the effect that we saw the rest of the year?

Eli, if you factor out the surcharge which we passed through directly with no benefit to us. That has the effect of diluting our EBIT margins. If you use that $75 million number that Glenn talked about that would boost that to about 15% EBIT margins. So, structurally I think we are operating there. You're going to see a little bit of dilution just because of the mechanisms we have in place to protect us from any escalation of the raw material prices while we maintained our base pricing increases.

Now one follow-up question Jim talked about the problems in Japan. Enormous base globally in bearing capacity in Japan which is going to be somewhat problematic. Affecting the a lot of companies outside of it. Can you tell by any sign of global bearing availability tightening up or you know, strengthening the market place or anything like that going on?

Yes Eli, this is s Rich again. I'll take it since it's predominantly a mobile market. The assessment at this point in time is no. There have been several spot queries that we may have picked up a little bit of business somewhere along the line through our after markets and channels. But the assessment is that the airing competitors are operating they lost a little bit of production but they also lost the same time all of domestic demand during that timeframe. So we are not seeing or expecting any significant competitive issues positive or negative on the bearing side as a result of it at this point.

Okay thank you.

Your next question comes from the line of David Rasso.

Yes, Good morning. Just a simple question on the balance sheet going forward. Can you take us through your thoughts obviously the cash flow guidance increase was you know even the larger percentage than increase the EPS when you back out the pension contribution. Can you take us through update us on your thoughts on the use of the balance sheet?

Yes, David. Again the balance sheet continues to be strong. Obviously we used cash in the first quarter but for the full year we expect to generate very good cash flow. The uses of the cash as we talked about before were still dealing with still underfunded pension and post-retiree medical obligations. We obviously have a sizable capital spending. For good projects and initiatives underway but that's obviously encumbered within the free cash flow number. We obviously continue to look at that our dividends and share repurchase programs. As well as obviously the strategic acquisitions we are doing. So between a combination of those that's how we use our capital and we are pretty encourage on all those products that we will be able to redeploy it pretty well.

And if you were a little more specific on things we should be expecting this year at all any further color you can provide on at least the priority or how the M&A environment is looking?

Well again I think from a standpoint of the priorities, you know, first of all organic opportunities to capital spending that we have on projects. We talked about some of the capacity additions we're doing to meet the strong very profitable depend that is out there. We talked about the pension and which we control we know where the liabilities are. We made progress in dealing with those issues. Again the deals with obviously the dividends of the share repurchase programs that we have. But then finally on the acquisition side that you're talking about, we are seeing flow picking up just as a general comment obviously the economy is improving the credit markets are improving. So we are seeing more companies looking to unties their assets now than probably they have over the last couple of years. So we are very encouraged that we can find. Good strategic acquisitions for the Company over the first evil future. But nothing imminent and we would talk about.

Okay and regarding mobile if you look at the guidance and the comment that most of the contract laws have already occurred. It looks like you are implying the rest of the year mobile growth of only 10%. And maybe I'm missing something or doing the math wrong but especially seeing if you don't have the contract law as much of a drag you would think it just seems like another contract laws should still not there on a year-over-year basis it just seems 10% is a little modest given some of your comments of those markets, the backlog. Is it more of an issue of capacity constraint that we -- I am trying to square that up.

We are not capacity constraint at this point it's not an issue of capacity. I'd clarify a wouldn't say most of the loss businesses occurred instead of significant amount of it as it has. We don't expect it to second and third quarter due to the timing of our contracts but we do have taken another -- another reduction in the fourth quarter of this year. The other thing I would point out is that our year-over-year comp's significantly more challenging starting in the second quarter in that our mobile business ramped up significantly in the fourth quarter of 09 and the first quarter of 10. We would be hard-pressed to see numbers in the 20% range going forward across all of those markets particularly when white vehicle as the basis segment closer to flat for us.

Okay that's helpful I appreciated thank you.

(Operator Instructions). Your next question comes from the line of the of Theodore O'Neill.

Thank you, Wunderlich Securities. I was wondering if you could give us a little more color on what you're seeing in China. I know that in particular the wind turbines spaces seem to be pricing pressure they are from suppliers of other components into that and I was wondering if you could comment about China in general and then specifically if you are seeing any change in growth demand on the wind turbines side other with China or China manufacturers to go after the export market?

Yes, this is Chris. On China in general, first of all, we are seeing very strong revenue growth in the first quarter. And to everything we can see moving forward, so far it looks it looks to be continuing on that path.

Now that said we are closely watching the tightening that the government is undertaking and watching that closely. We haven't seen any impact of that yet but it is clearly potentially at risk of moving into the future. Specifically on wind, our wind business in China continues to grow. Continues to do very well.

That said, we do see evidence of around competitiveness in the market and you know there is some price cutting going on in the -- in the wind turbine space. Some aggressive -- that has really not translated back. Bearings are a very technical component of that wind turbine. So, so far, it is okay. Obviously, what the future holds, can't really comment at this point in time. What to see.

Thank you.

(Operator Instructions). There are no remaining questions at this time. Sir do you have any final comments or remarks?

Thank you. Again thanks for your interest in the Timken Company. Our first quarter performance highlights the step change that we have made. In our Company. If you take one point away from our call this morning, it should be that we left little question that we have raised the performance capability of our Company. Thank you.

Thank you for participating in today's Timken's fourth quarter 2011, I'm sorry Timken's first quarter 2011 earning's release conference call you may now disconnect .

Excuse me. This is Steve with the Timken Company. We do see that there is potentially other calls for the Timken we would like to take those.

Absolutely Sir. Absolutely. (Operator Instructions). Your next question comes from the line of Tom Mullarkey.

Hi guys. Question on the CapEx guidance. I see that it stayed the same from the call that you had in January even though you announced recently that expansion of your steel capacity. I was wondering why the CapEx guidance is still staying into 20.

This is Sal. Maybe I can help you appreciate that. The increase in capacity that we announced really is a consequence of investments we made in 2007 and 2008. In the addition of rolling mills to our Harrison still operations.

You may, if you are on prior calls remember our announcing that we had finished it and began commissioning just as we entered the recession at the end of 2008 in 2009. So we had very well opportunity to test the capabilities as we began ramping up in 2010, we had some peripheral difficulties with supporting mechanical equipment. We had a wreck that caused a fire that sort of put a handicap in our ability to commission it appropriately.

We've overcome those things. The first three months of this year, we are operating at about 10,000 tons per month higher than the capacity we had planned for. We had that kind of opacity at our Harrison plant given that we were running only three turns five days a week.

So we had begun bringing crews to move to a four crew seven operation. That should be accomplished by the end of May. We will have a starter up period as we bring those new people on. But essentially, the capacity is in place to handle it. And we will see it begin to come on stream over the second half of the year as customers validate approved it, and we need the demand for that we've got affectively with the capital already in place. So we needed to do very little additional once we saw that we had far better capacity capabilities then we originally planned.

Great to here thanks, guys.

Absolutely.

Your next question comes from the line of Wendy Caplan. Wendy your line is open. Ms. Kaplan, your line is open.

This is Wendy Gooseman in for Wendy Caplan. Just had a quick question regards to the follow-up in that capacity expansion in the steel business. What is the total capacity for this steel business?

This raises our capacity about 10%.

Okay then what are the competitors doing relative to capacity?

There are modest increases that have been announced by several of our competitors over the course of the last eight months or so. All of it seems to be fairly reasonable in terms of adding to existing assets as opposed to major initiatives such as new greenfield sites or anything of that sort. Quite frankly, it's sort of needed right now. The demand in the special part quality arena is very high. But it seems to be in the process of being that as we speak.

Okay. You don't see any need to increase capacity any further this year?

Well 10% increase is pretty healthy. Over the point in time. Frankly, anything that's bigger than that would take probably a three or four year. To make that happen anyway. Those are masses investments programs.

Just a reminder to both of the last two questions. Recall that we raised our capital budget for 2011. To roughly double what was in 2010. So we were already anticipating the recovery of the market and the investments were already an hour -- in our forecast to deal with that in all parts of the business.

Maybe to elaborate a hair more to that point. One of the investments that we made comments about earlier, will come on stream in early 2013. And that will add another 8% to 10% capacity at one of our other steel plants. In the pipeline, there is, there is a stream of active projects that will bring relatively modest increases but useful increases to the market space in due time.

Okay thank you very much.

Your next question is a follow-up from the line of David Rasso

Yes I apologize. Clarification I apologize if I missed this. The aerospace margins for the year. How are you thinking about that and as part of the revenue improved in the back half of the year that we have expect in knowing technologies by the end of the second quarter to stop the destocking, you know, will be done with their destocking on the Apache and Blackhawk?

Dave, first let me say that the first quarter was not a big surprise for as we expected to get off to a slow start this year. So while we were at the lower end of our range for both revenue, and a EBIT we were within our range. And I would say that there's really been no change in the guidance we provided at the end of -- at the end of last year and that is that we do expect to see sequential quarter to quarter improvement in revenue, EBIT and EBIT margins , each of the next three quarters as we progress through the year with a target of getting back the double digits by -- EBIT margins by the end of the year. Were we do have visibility to the order book, we see that still developing and our order book for the second, third quarter is improved from a way that it been able to see if the three or four months

But the improvement, is it more clarification on the ceasing of the key stocking by -- or is it more on the commercial side can you help us push that out it's a pretty good deal to going down 14 to up budgeted six in the back half of the year.

Yes. The situation I commented on mobile. The year-over-year comp's get markedly lower starting this quarter within -- within the aerospace group. So it's not -- it's not quite as high of a bar as it may appears based on the 14% decline in the first quarter. I would say it is less on destocking and over more on market recovering is what we would -- and penetration is what we'll be seeing in the coming quarters.

Is that commercial or --

Commercial.

Commercial. Okay. I appreciated thank you.

There are no further questions at this time.

Thanks again for your interest I won't repeat by combing -- closing comments this was a great quarter for Timken we look forward to your continued interest in our Company.

Thank you for participating in today's Timken's first quarter 2011 earnings release conference call. You may now disconnect. [ Event Concluded ]