Timken Co (TKR) 2011 Q2 法說會逐字稿

Good morning. My name is Paula, and I will be your conference operator today. At this time, I would like to welcome everyone to Timken's second quarter earnings release conference call. All lines have been place on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. Thank you. I would now like to turn the call over to Mr. Tschiegg. You may begin your conference. Sir, you may begin your conference. (Operator Instructions). Thank you. I would now like to turn the call over to Mr. Tschiegg. You may begin your conference. Sir, you may begin your conference.

Good morning, this is Steve Tschiegg from The Timken Company. Can everyone hear us okay? Operator?

Yes, we're good. Yes, sir, I can hear you.

Okay. Thank you. Thank you, and welcome to our second quarter 2011 conference call. I'm Steve Tschiegg, Director of Capital Markets and Investor Relations. Thank you for joining us today. And should you have further questions after our call, 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; 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 will 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 our reports filed with the SEC, which are available on our website at 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, and the 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.

Good morning. As you saw in our release today, Timken had another excellent quarter. Top-line growth was solid. We are seeing broad-based strength in the industrial areas we've targeted for expansion. We set a new record for second quarter earnings of 49% from a year ago. Timken's performance stands in stark contrast to the overall economy, at least as you hear it reported in the media. Before Glenn takes you through the details of our performance, I would like to put the economy in which Timken competes in the proper context to build your confidence in our ability to sustain this higher level of performance.

The US and the European economies on the whole continue to recover slowly, stymied by government debt crises and a lack of consumer confidence. This tepid economic growth and the unemployment that accompanies it dominate the headlines. Fortunately, although not reported as broadly, there is another stronger economy creating real market opportunities. This more vibrant economy is driven by developing countries, where an ascending middle class is generating new demands for energy, transportation, and infrastructure. While there is much concern about the credit tightening in China, even in a bad year the economy will grow 6% to 8%. On top of that, India's GDP grew 8.5%, Brazil by over 5%, and Indonesia by almost 6.5%. Timken has positioned itself well to serve the demands created by this growth. This growth has also led to unprecedented demand for commodities including copper, iron ore, coal, gold, and silver, as well as agricultural commodities such as corn and wheat. The mining and farming industries are expanding globally to meet this demand. Mining equipment shipments are at all-time record levels.

Wherever they expand, whether operating or repairing older equipment which is fueling the growth of the business or creating today's record demand for new machinery there is ripe opportunity for Timken. This is reflected by the fact that the demand in our off-highway sector is up about 50% year-over-year. Opportunity also comes in the form of new technology, which is unlocking natural gas from shale deposits.

Horizontal drilling is growing rapidly around the world. For example, in Poland it offers a potential solution to their energy dependence on local coal and the gas they import from Russia. New Timken capabilities acquired when we purchased Boring Specialties in 2007 gives us a unique position in the market and contributes to the unprecedented demand for Timken's specialty steel products. Clearly there are elements of the global economy that defy the prevailing tone of the popular press.

Timken's transformation over the past few years enables us to participate in these markets and to benefit from them. We also continue investing to expand our capabilities. Our most recent acquisition of Philadelphia Gear moves us solidly into these attractive markets. Their technically oriented aftermarket services are a perfect complement to our core capabilities with excellent margins on par with those of our existing process industry segment. We expect the new business to contribute $100 million in sales in its first full year with Timken and because its end markets are so complementary to ours we intend to expend this business around the world.

Adding to our confidence is the fact that our traditional markets--Heavy truck, rail, American light truck, commercial aerospace, et cetera--are in the very early stages of their recovery. As they strengthen, they should contribute additional opportunities to improve our performance. The combination of the current strength in Asia and commodities as well as the recovery of our traditional markets convinces us that 2011 will be a record year on both the top and bottom lines for Timken and that we have the potential to deliver even stronger performance in the years to come. With that, I will turn it over to Glenn to walk through the details of our performance.

Thanks, Jim. Sales for the second quarter were $1.3 billion, an increase of 31% over 2010. The increase was due to strong volume across the company's broad markets with the exception of our defense business. The top-line also benefited from higher surcharges, pricing, and currency. From a geographic perspective, we posted solid gains in all major regions, North America, Europe, and Asia. Gross profit of $351 million was up $82 million from a year ago. The improvement was driven by higher volume and mix while surcharges and pricing offset the impact of higher material costs. The gross margin of 26.4% for the quarter was down 10 basis points from a year ago.

The effective higher surcharges of recover material costs had a dampening effect on the margin. For the quarter, SG&A was $154 million, up $13 million from last year primarily reflecting higher variable incentive compensation and wages. As a percentage of sales, the margin improved 230 basis points over last year to 11.6% as we continue to leverage our cost structure well. As a result, EBIT for the quarter came in at $192 million or 14.4% of sales, 160 basis points better than last year and a record for the company.

Net interest expense of $8 million for the quarter was down $1 million from last year. The decrease was primarily due to lower financing costs associated with the company's new $500 million senior credit facility and lower interest rates. The tax rate for the quarter was 33.4%, compared to 31.8% a year ago. The current rate was in line with our expectations while the prior year rate benefited from favorable adjustments to our reserves related to pre-2010 tax years.

As a result, income from continuing operations for the quarter was $121.5 million, or $1.22 per share compared to $0.84 per share last year. Now, I will review our business segment performance. Mobile industry sales for the quarter were $465 million, up 16% from a year ago. The increase was driven by higher demand led by off-highway, heavy truck, and rail markets. In addition, the top-line benefited from currency. The mobile segment had EBIT of $67 million or 14.4% of sales. Compared to last year, EBIT was down $2 million due to a $5 million charge related to a previously announced plant closure in Brazil.

The benefit of volume was partially offset by increased material and logistics costs. Mobile industry sales for 2011 are expected to be up 10% to 15% for the year. We continue to see improved demand particularly in the off-highway, rail, and heavy truck sectors.

Process industry sales for the second quarter were $308 million up 46% from a year ago. Demand from industrial distribution and growth in Asia including wind energy accounted for the increase. Pricing mix and currency also contributed to the improvement. For the quarter, process industries EBIT was $70 million or 22.8% of sales, up from $28 million and 13.4% of sales last year. EBIT benefited from higher volume, price and mix which more than offset higher material costs.

Process industry sales for 2011 are expected to be up 30% to 35% for the year, driven by improved demand for industrial distribution and the benefit of the Philadelphia Gear acquisition. Aerospace and defense sales for the second quarter were $84 million, up 1% from a year ago. Increased commercial aerospace demand was largely offset by lower demand in our defense business. EBIT for the quarter was $3 million or 4% of sales, down from $6 million or 6.1% of sales a year ago. The decline in profitability resulted from a $3 million inventory write-down taken during the quarter to reflect the market value of certain non-core aftermarket parts held for disposition.

We expect aerospace and defense sales to be up modestly for the year, driven by stronger commercial demand, partially offset by continued weakness in our defense business. We believe the first quarter was the trough for this later cycle business and expect sales and profitability to increase sequentially through the remainder of the year. Steel sales of $505 million for the quarter were up 49% 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 approximately $50 million for the quarter due to higher raw material prices and overall demand. EBIT for the quarter was $72 million or 14.3% of sales compared to $43 million or 4.7% of sales last year. The increase resulted from higher volume, mix, surcharges, and price, which were partially offset by higher material costs. Steel segment sales for 2011 are expected to be up 40% to 45%, driven by improved demand across its end markets, surcharges, and pricing. The segment is benefiting from capacity being brought online to satisfy the strong demand.

Looking at our balance sheet, we ended the quarter with cash of $638 million, or $117 million in excess of debt. This compares to a net cash position of $363 million at the end of the last year. Free cash flow for the quarter was a use of $24 million. Cash generated from earnings was more than offset by discretionary pension and VEBA Trust contributions of $95 million net of tax, and increased working capital of $56 million to support the company's higher sales. Free cash flow excluding the discretionary contributions totaled $71 million.

Our outlook for sales is now projected to be up 25% to 30% over 2010, an increase from our previous estimate of 20% to 25%. This increase is driven by the company's strong first half performance and an improved outlook for the second half as well as the addition of Philadelphia gear. As a result, we expect 2011 earnings per diluted share to be $4.30 to $4.50, an improvement from our prior outlook range of $3.80 to $4.10. For the year, the company expects cash from operating activities to be $275 million and free cash flow a use of $10 million after capital expenditures of $210 million and dividends of $76 million. Excluding discretionary pension and VEBA Trust contributions made in the first half of 2011, totaling $193 million net of tax, free cash flow is expected to be $180 million.

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

(Operator Instructions). And at this time, your first question comes from Steve Volkmann of Jefferies.

Good morning, gentlemen.

Good morning.

Good morning.

Was -- I was interested in your opening comments, Jim, certainly what we are seeing across the industrial space -- and yet as I kind of try to square that up with what I think you are telling me vis-a-vis your outlook, it looks to me like your second half revenue growth probably has to slow a little bit to kind of stay within your targets, and your margins may come in a little bit as well. So I wonder if there is a bit of a disconnect there. Are you being a little conservative? Is this sort of just the new seasonality we should expect or what is the right way to think about that?

Steve, this is Glenn. I think it is more of the latter part of our comment. As you know, the second half for Timken historically is seasonally lower than the first half. So the markets that we are seeing aren't changing, if you will. It's just we do expect to see slightly lower second half than first with a couple of exceptions. Within process, you will see that our expectations are for stronger second half in part because of the Philadelphia Gear acquisition.

Were it not for that, we would have seen the seasonality -- similar, mobile, we see it. The two exceptions to that are in both the aero and steel. Aero just because again -- later cycle. It's coming off of a low base, but we do expect to see it sequentially progress throughout the year, so it will be higher. And also in steel and the issue in steel is we are running full so effectively the improved outlook we have for the second half is more of a function of the surcharges expected to up pricing and mix. But as far as the first half, second half -- the economy, at least as we see it, continues to be strong and it's just more seasonal issues.

Okay. Good, good. Can I -- I don't want to put words in your mouth, but can I say that you are not seeing any signs of your end markets kind of slowing as you went through the quarter into sort of June/July time frame?

From my standpoint, that is correct. I think Chris, Sal, and Rich can obviously speak to the outlook for the businesses as we go through the questions.

Steve, let me take the first stab at that. This is Sal. We have not seen any weakening. We might have -- we might be detecting finally the completion of the restoration of stock in some supply chains, so that it's not as frenetic as it had been as we all were trying to catch back to where we were. We're certainly getting no signals from our customers about anything back and, of course, it has been in the news. We are probably the only ones officially there, but in our business we're on allocation across every one of our product lines, so we have fair visibility through the end of the year as it stands.

We may have a little bit of margin weakening. As you know, we are making our major maintenance outages in the third quarter and some of those costs may roll into the fourth quarter, and there are likely to be seasonal holiday issues that might put a little bit of damper on the endpoints of the year, but from a market demand point of view, we have yet to detect any softening for those markets that we are serving.

This is Chris. Our global distribution business is still very strong. The growth rate of it has leveled off but at a very good business level. So, looking forward that looks pretty good. It obviously, though, is subject to the seasonality point that Glenn brought up. The only areas where we see a little bit of issues -- we are seeing a little bit of a slowdown in growth in China. But I would term that a slowdown in growth, it is not an issue of, you know, the market being bad or anything of that nature. But we are clearly seeing the impact a little bit of some of the credit tightening from the government there.

This is Rich. I'll just the add that mobile is the biggest contributor to the second half being softer than the first, and that is really just seasonality as Glenn talked about. If you go back to the pre-recession years of 2005, 2006, 2007, the second quarter for mobile is consistently the highest revenue quarter, and we expect that to be the case again this year as we get back to a more normal seasonality.

And your next question comes from the line of Eli Lustgarten of Longbow Securities.

I got called a lot of things in my life, I guess.

Good morning, Eli.

The question is what do you do for an encore? Terrific quarter. Can we go through a little bit of the outlook on business. I mean, you started doing it but in steel you are on allocation and sold out for the year. If you could talk a little bit about how much capacity is coming on between now and end of 2012. If anything goes, it has to come from the capacity scenario. I think you indicated margins would be a little soft in the second half and the first half. Same thing in mobile. There is seasonality. Do you still expect to lose $50 million to $100 million worth of auto business this year? How is that allocated or has gone by the board because of the Japanese problem, and the profitability and process, that is probably the most spectacular. Is that sustainable on the second half growth or does it back off a little bit because you include Philadelphia Gear acquisition costs will drop it?

Let me start, Eli, you asked about steel to begin with. We have brought all of the capacity online that there is to come online between now and the end of 2012, so there won't be much growth in the way of volume under -- in that time period. The capacity additions that we have announced; for example, the Faircrest, in-line crest which will become operational the end of 2012 into the first quarter of 2013 will not be -- will not be available until 2013. So we are kind of at that limit at the current time, but we brought with the fourth crew at Harrison Avenue, we brought 120,000 tons of additional capacity on this year. It was -- it was brought on during the latter part of the first quarter and into the second quarter and will be operating at that pace in the latter half of the year and throughout all of 2012 assuming we don't see some kind of other global economic of some sort.

Year-over-year you will have some modest addition.

Some modest additions and whatever will come in from the way of pricing.

And profitability, am I right, second half a little lower than the first half?

Ever so slightly because of equipment outages. Yes, that's right.

This is Rich. I will take the question on the lost business in mobile. The lost business through the rest of the year is not a factor in the second half decline as I said earlier, it is really just the seasonality. We said that we expected the lost business to be around $100 million. Most of that is all of it materially has been in the run rate really for since early in the year and it was an issue of contracts expiring at the end of last year and beginning of this year that were not extended. So we expect no material decline through the second half of the year. We do have some contracts at the end of this year that we expect not to be renewed, and that has been in our long-term guidance and in the 2012 forecast that we provided at the beginning of the year.

And operating profitability will -- you know, every quarter we saw it was going to go down a bit. Is it going to stay relatively stable at this rate? Is that the expectation?

We expect a little bit of a decline in the third and fourth quarter in the guidance due to the seasonality of the volume reduction. But the -- we are within the target range and maybe a little on the high end of it.

Okay. Thank you. And process?

Yeah, you know, the margin story is the same as the first quarter. We have a very good distribution mix, good service levels. That is helping a lot. We continue to leverage the manufacturing costs ramp in Asia and just general excellent cost control on S&A and things of that nature. Those are the primary drivers of the margin. Moving forward, you know, start with we expect to have a very, very good year but -- and also on that, we believe we have taken our margins to a new structural level versus anything we have had in history. That said, though, you know, we do expect to see an increase in our OE mix moving forward.

That's very good business for us, important to the long-term aftermarket, but it is at lower margin than some of our core distribution business and then, you know, we also then have the seasonality issue where -- with the third quarter is a weaker quarter and we have outages in plants and things of that nature. We certainly are going to see some dampening effect from those factors.

And Philadelphia Gear itself would come in at the same margins or a little lower?

Just a tad lower but not relevant to the total really. It is still a pretty good story inside that mix.

And that is $50 million a quarter at this point, I would expect?

No, that is -- $50 million a quarter in sales?

$25 million a quarter, I'm sorry.

Yes, roughly.

All right. Thank you.

Your next question comes from the line of Theodore O'Neill of Wunderlich Securities.

Thanks. Eli has covered just about everything. But I had to jump on for a second. How much capacity are you going to add on the steel side and are you going have to take down any of the mills in the third quarter for maintenance?

Yeah, let me see if I can handle that, Theodore. During the first part of this year, we brought on at an annual run rate about 120,000 tons of capacity, which is now in our -- on our books. We are operating with it, and it is in our projections. That was bringing one of our melt shops up to full 24 hour a day, 7 day a week operating status. Indeed, in the third quarter and a little bit into the fourth quarter, we have a number of our mills scheduled for maintenance outages, which is why we will have a little bit of weakening from a margin point of view in the third quarter and a little bit of that cost may run into the fourth quarter.

And then the end of the year, we always run into the holiday seasonality and mostly that is from a customer shipment acceptance point of view more than anything else but not much different than what we have seen before, so it is actually will be a very good second half just with those seasonal characteristics associated with it,.

We are basically operating at our capacity and will for the rest of this year and through 2012 at the levels that we have today.

Okay. And then in the defense segment, the parts that -- the parts write-down of $3 million, is there any chance that you can sell those parts sometime in the future?

Those parts were a non-strategic part of an acquisition that we made a few years ago. We stayed in the business for a few years. We made the decision to exit that part of the business, and we wrote the assets down to what we -- the inventory down to what we would estimate as a liquidation value, and we expect to liquidate them over the course of the next few months. So, yeah, we would get the cash from them, but it is not expected to be another EBIT impact associated with that.

And the plant closure in Brazil -- can you give us a little more color on that?

The plant's actually been closed for going on a year.

Okay.

And that was a combination of two items that we made a reserve adjustment for. One is associated with settling labor claims that are common in operating in Brazil after a plant closure, and the other is associated with an environmental reserve to prepare the facility for sale in 2012.

Great. Thanks very much.

And your next question comes from the line of Gary Farber of CL King.

Good morning. Can you discuss your updated thoughts on the market for acquisitions or interested acquisitions, and then in regards to Philadelphia Gear, can you talk about any opportunities to export that overseas?

Let me cover first just the market for acquisitions and then have Chris talk about the opportunities or synergies with Philly Gear. We think right now the deal activity is clearly picking up. You could call it a seller's market. Obviously, the uncertainty of the future -- you've got a good year this year. You've got a lot of companies and private equity sitting on a lot of cash. Banks are borrowing or lending money again. Interest rates continue to be very low.

So it's clearly a prescription for companies that want to monetize their assets to be in the market. We are seeing more of that happening. So we continue to evaluate the deals that we feel are strategic to the company and are encouraged that over time we will continue to be able to grow and complement our organic growth through acquisitions. But obviously we won't speak to any of that until an acquisition would come around, but the deal activity is there as far as the opportunities to take Philly Gear internationally. Chris?

Yes. Our primary interest in Philadelphia Gear is around, you know, bringing more value and mechanical power transmission at end users, which is a very important aspect of our global distribution business. The strength that we bring, they have a very strong brand and a very strong presence in North America, so to your point, we will take our infrastructure globally and extend that model throughout the global infrastructure of Timken.

Okay. Thanks.

(Operator Instructions). And there are no questions in queue at this time.

Thank you. This is Steve. Before we conclude today, I would like to turn the call over to Jim for closing comments, and after our call if you should have any further questions please feel free to call me at 330-417-7446.

I would simply like to thank you for your interest in The Timken Company. As we discussed, our strong second quarter reflects a new structural level of Timken performance. We look forward to discussing it with you again in the future.

This concludes today's conference. You may now disconnect.