Steve Tschiegg - Director of Capital Markets & Investor Relations James W. Griffith - Chief Executive Officer, President and Director Richard G. Kyle - Chief Operating Officer of Bearings & Power Transmission and Director Ward J. Timken - Chairman Philip D. Fracassa - Chief Financial Officer Christopher A.

Coughlin - Group President of Mobile and Process Industries Segments.

Eli S. Lustgarten - Longbow Research LLC David Raso - ISI Group Inc., Research Division Ross P. Gilardi - BofA Merrill Lynch, Research Division Stephen E. Volkmann - Jefferies LLC, Research Division Steve Barger - KeyBanc Capital Markets Inc., Research Division.

Good afternoon, and welcome to the Timken's First Quarter Earnings Release Conference Call. Today's call is being recorded. [Operator Instructions] Mr. Tschiegg, you may begin your conference..

Thank you, and welcome to our first quarter 2014 earnings conference call. I'm Steve Tschiegg, the company's Director of Capital Markets and Investor Relations. We appreciate you joining us today. If after our call you have further questions, please feel free to contact me at (330) 471-7446.

Before we begin our remarks this morning, I want to point out that we posted on the company's website presentation materials that supplement today's review of the quarterly results. You can also access this material through the download feature on the earnings call webcast link.

With me today are Jim Griffith, President and CEO; Tim Timken, Chairman of the Board of Directors; Rich Kyle, Chief Operating Officer, Bearings and Power Transmission; Phil Fracassa, Chief Financial Officer; and Chris Coughlin, Group President of Mobile and Process Industries.

This morning, Jim will begin with some opening remarks followed by Rich and Tim, who will give an update on their respective businesses. Phil will provide additional commentary on the financials before we open the call up for your questions.

[Operator Instructions] Before I turn the call over to Jim, I'd like to remind you that 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.

We describe these factors in greater detail on today's press release and in our reports filed with the SEC, which are available on the www.timken.com website. Reconciliations between non-GAAP financial information and its GAAP equivalent are included in the press release. Today's 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. In our earnings announcement earlier today, we reported first quarter sales of $1.1 billion, with earnings of $0.90 per diluted share. The company is tracking well against our plan with particularly strong momentum in our Steel business.

For the quarter, I also want to point out that we returned a total of $141 million in capital to shareholders. In February, the Timken Board of Directors declared a 9% increase to the company's quarterly cash dividend, raising the dividend to $0.25 per share.

Share repurchases for the quarter totaled 2 million shares, and we have another 2 million shares remaining under the current board-approved repurchase program. The work on our planned separation of TimkenSteel from The Timken Company is going well, and we remain on track to complete the transaction by June 30.

Since we last spoke in January, TimkenSteel Corporation filed its initial Form 10 with the SEC, as well as 1 subsequent amendment. We now believe that the total cost for separation will be $95 million, less than we originally estimated.

The combination of solid business performance and better-than-expected progress on the separation is a credit to the Timken team and I would like to personally congratulate them.

With a view toward the upcoming separation, we will have Rich and Tim now report individually about the performance of the Bearings and Power Transmission and Steel businesses. Then, we will turn it over to Phil Fracassa for more detail on the numbers.

Tim? Or Rich?.

Thanks, Jim. In our Bearings and Power Transmission business, the quarter was in line with our expectations. We expected moderate sequential growth through the year and we are seeing demand improving to support that.

We reduced manufacturing cost proportionally with demand, which allowed us to sustain profitability at the gross margin level, and we look to expand margins further through the course of the year with increasing volume and the impact of our ongoing cost-reduction initiatives.

In Process Industries, revenues were up 9% year-over-year, 3% of which was from acquisitions. We are seeing positive trends in a number of markets and geographies. Our wind energy business, as an example, is up significantly as we gained traction in the market with the product manufacturing investments that we've made in recent years.

The inventory correction, which we have talked a lot about recently, appears to be behind us across Process Industries channels and markets. Margins for Process were on the low end of our targeted range, but we experienced an adverse impact from currency in the quarter and volumes remain well off previous peak.

So we remain comfortable with the profit levels and the plans that we have projected for the full year. In Mobile Industries, sales were down 13%, primarily from the year-over-year impact of the automotive platforms that we wrapped up in late 2013. Without the impact of that exited business, Mobile sales were approximately flat.

Our automotive business repositioning is behind us, and while it will affect our year-over-year growth rates through the rest of 2014, we do not anticipate further sequential impacts. So as we look at the Mobile business going forward sequentially from the first quarter run rate, we expect to see the business grow in line with the markets.

Similar to Process, we believe the inventory correction across the Mobile markets and channels is behind us. Mobile margins, excluding the gain from the land sale and the offsetting onetime charges, were at the low end of our targeted margin range, but given the volume reduction, was in line with our expectations.

In Aerospace, we had a disappointing quarter, with sales flat year-over-year and margins at 8% below the low end of our targeted range. We are still expecting that Aerospace margins will return above 10% by the second half of the year from a combination of execution, cost and volume improvements.

Across the business, we are focused on successfully completing the separation of TimkenSteel, increasing organic growth in our targeted markets and improving our margins through a combination of growth and cost initiatives. Let me now turn the conversation over to Tim to report in more detail on the performance of TimkenSteel..

Thanks, Rich. I'm proud to say that TimkenSteel got off to a solid start in 2014, in line with our expectations. We saw stronger demand in both the industrial and energy sectors, which delivered 13% growth in sales over the first quarter of 2013.

We also posted improvements in EBIT versus prior year, with strong manufacturing efficiencies more than offsetting the $4 million of costs we saw related to the severe weather that we had in the first quarter.

We marked our 1 year anniversary of the launch of our in-line forge press and the intermediate steel tube finishing line, which have further strengthened our ability to provide differentiated products for the energy, industrial and automotive sectors.

Both of these assets have also delivered operational efficiencies and customer service improvements, contributing to our strong manufacturing performance in the quarter. The net result is a 65% reduction in cycle times and a 50% improvement in labor productivity.

As we've said in previous calls, we'll commission our jumbo vertical continuous caster late in the third quarter of this year and plan to ramp up in the first half of 2015.

The caster is really a one-of-a-kind piece of equipment for North America, coupled with our in-line forge press that expands our large-bar capabilities, providing even more customized and flexible steel solutions for our customers.

The caster is a key element of our multiyear investment program and further strengthens both our product and service leadership, as well as our operational performance. As Jim mentioned, the Steel business is progressing well towards operating as an independent company by midyear.

That work included the launch of a new TimkenSteel brand this quarter, which has been well received both internally and externally. We look forward to sharing more about our unique business model in our upcoming Investor Day scheduled for June 19. At this point, I'd like to hand it off to Phil..

onetime separation costs related to the spinoff of TimkenSteel of $0.50 and charges related to cost reduction and plant rationalization initiatives of $0.15. Partially offsetting these costs is the gain on the sale of land in Brazil of $0.20. Excluding these items, we expect adjusted earnings per share to range from $3.60 to $3.90 per share.

That's up $0.10 from the estimate we provided in January. For 2014, we expect cash from operating activities to be approximately $500 million. Free cash flow is expected to be $110 million. That's after CapEx of $300 million and after dividends of $90 million.

The change in our estimate of free cash flow from January is primarily due to higher anticipated cash taxes. As Jim commented, the separation of our Steel business is progressing. In advance of the spinoff, we will hold 2 Investor events in New York City on June 19. The morning session will feature Timken, followed by TimkenSteel in the afternoon.

This will provide an opportunity for each company and management team to outline their long-term vision, strategies and business and financial outlooks going forward. Both events will be webcast, so please mark your calendars. This ends our formal remarks, and we'll now open it up for questions.

Operator?.

[Operator Instructions] We'll hear first from Eli Lustgarten of Longbow Securities..

One clarification. The drop in cash -- operating cash flow from $560 million to $500 million, is that all due to higher cash tax? That's a big change..

Yes, Eli, this is Phil. It's primarily due to higher cash taxes. Earnings moving up a touch; working capital up a touch, but mostly cash taxes. And it's really attributable to the 2 things -- we've got an audit settlement that we anticipate will happen this year that will require our cash payment.

And as we finalize the calculations on the 2013 taxes for purposes of preparing our estimate -- for our extension, excuse me, we found that we owed more in 2013 than we anticipated. So the increased amount are all related to prior years..

I guess -- can we talk a little bit about operating profitability in the segments? I mean, the one -- the first one, obviously, is in process where you have a Venezuela exposure that has also FX.

Is there anything you have to do in Venezuela? Are you taking a write-down? Are you changing -- changing their assumption on how they record it? Can you give us some color on what's going on there and what should we expect for Venezuela for the rest -- for Process through the rest of the year? Do we go up to close to 20%? And might Mike will take us through the other segments..

This is Chris. Directly on Venezuela, this is almost 80%, 90% of our exposure we took care of this quarter. We have made the $0.5 million of exposure moving forward for the balance of the year. We made some changes there over a year ago that mitigated any future issues.

This is directly related to our accounting policy of receivables being over 1 year old. So -- but the issue's pretty much behind us for argument's sake, moving forward..

So I mean, should we expect that. You got 70% in Process, the adjusted number will be 19%.

So we expect as the year goes on that we approach the 20% level in there? And can you talk about the profitability in the rest of the Bearings businesses as well as Steel?.

So on Process, yes, we were disappointed with the 16.7% in particular because of the issues we just talked about. So yes, on a structural basis, we still are targeting an 18% to 20% range across the total cycle. And we have a number of initiatives going where we believe we will see increasing higher margins through the balance of the year.

On the Mobile, I think it's pretty much -- you see where we're at on that. The issue of the current margins, the decrement from a year ago period was all-around volume.

We have a -- once again, we have a number of cost reduction initiatives in place, but we expect to, once again, maintain a low double-digit kind of margins in the Mobile Industries across the cycle..

And you indicated Aerospace will go back to 10% by the second half of the year.

Is the Steel margin sustainable where we are for the rest of the year?.

Eli, this is Tim. I think 14% is a pretty good representation of where we are in the cycle. I will say, though, that we traditionally have some maintenance cost and the impact of LIFO in the second half of the year. If you take those into account, though, 14% feels about right..

And we'll hear next from David Raso of ISI..

First, housekeeping question and then a question on Process margin.

For the first quarter and really the first half, I thought we used to speak of the tax rate was going to be 40% and the back half, 30%? Was there a reason for that change? Or is it just how you're going to be able to set it up for a certain quarter across the year? But it seems like it can help the quarter about $0.08, so I'm just trying to make sure I have that correctly..

Yes, David, this is Phil. Yes, on the tax rate, we initially anticipated it was going to be a bit more lumpy during the year. But as we pulled through the calculation of taxes for the first quarter, the GAAP rate came in at 36%.

That may be a little lumpy throughout the year, but as we pulled the special items out, which really caused most of the volatility in the rate, the rate came in at 34% on an adjusted basis. And we would expect it to be at that level for the remainder of 2014..

Okay.

And then on the other side of the coin, the Venezuela situation seem to cost you, if I heard you correctly, a number that's about $0.03 for the quarter?.

Probably a little less than that..

Okay. If I adjust for that fact, getting to my Process margin question, it does suggest the margins and process were already -- end up north of 18% for the quarter.

And I'm just trying to figure, with the mix going forward, is the OEM strength that you're seeing -- should we think of that as a headwind for the margins? Or the incremental margin from the OE business is going to make it easy to get to the 18%, 19% of the revenue show up? I'm just trying to make sure I understand the mix.

Because obviously last year, some of the destock on the distribution side, you would think that could be a nice balance for the rest of the year. So I'm just trying to figure out how much, if we're already at 18-plus percent, not saying 18% is not good, but why is it 18% when 20% is relatively easy for the mix..

Okay, David. Let me walk you through it. First of all, mix in the quarter was actually a negative to us. To your point, the OE mix versus the distribution mix was more towards the OE, which operates at a lower margin on our distribution business. So from a pure mix basis, it was a negative to us in the first quarter.

However, we -- as we've mentioned previously, we have been working very hard with some very aggressive cost reduction activities that you are now very clearly seeing the result of those activities. Those are around labor productivity, they're around material specifications and other things we've been doing down in our manufacturing facilities.

Those improvements offset that negative mix from the first quarter. So we expect to yield further benefits off of those moving forward.

And then to your last point, depending on what you believe about the global industrial distribution markets, to the extent that those markets continue to recover, and we are seeing early signs of recovery there, yes, we will see a favorable tailwind with regards to mix if the global distribution business comes back with any kind of strength..

Just to the question, you already are seeing some of the distribution improvement that we were lacking in the back part of last year?.

Yes. So I mean, let we comment on distribution, then, directly. It's a mixed story. Very clearly, we've seen distinct movement demand in Europe and in Asia Pacific. So we have clearly seen coming off the bottom there. However, if you look at North America in the first quarter, we were essentially flat.

And what the issue is there is your exposure to coal mining and metals in North America continues to be a drag on our North American business. Now all that said, we have very clearly seen an improvement in our incoming order trends, we're cautiously optimistic and our backlogs are beginning to build within the global distribution business..

And last 2 quick questions, on truck. Obviously, I know you have a lot of European exposure there relative to maybe just generic thought, it's North America. So I understand why you were down in the quarter in truck.

But as European builds recover a bit, as Europe moves further away from the post pre-buy issue, should the on-highway truck business start to turn positive for you year-over-year as soon as 2Q or is it 3Q? I'm just trying to get a sense of how much can I get Process improving mix, as well as on-highway trucks at the same time?.

Yes. I would say we're less certain of the truck situation, and there's a couple of reasons. We've been pruning our portfolio within the heavy truck market. So you've got that working against market forces. We don't talk about that in terms of providing the numbers on that.

But the truck business, as you pointed out in the first quarter, was not great for us. We're sort of cautiously watching the developments, but we very clearly don't see a lot of indications of a strong moving truck yet, at least with regards to our position in the market..

And last question, with the June meeting coming up, would you care to share a little bit with -- some level of expectations we should have going in, of what will be addressed, what are some of the key themes that we should be thinking about?.

Sure, David. This is Phil.

We will, as I indicated in my remarks, I mean each company will come in with their management team and go through the strategies, including capital allocation, booking strategies, long-term vision and also provide some color around the business and financial outlooks for the remainder of the year and even directionally, probably, slightly beyond that.

And I think from there, you should be in a really good position to understand how each company is positioned coming out of the chute..

Will it be quantified? Do you feel there be a Bearings target, a Steel target when it comes to cash flow, EPS whatever it might be on a multi-year look?.

Yes, I think it's really up to each team in each company, but I could tell you for Timken, we will update our guidance for 2014, excluding Steel. We'll provide directional guidance, if you will, relative to '15. And then also provide some color around how we anticipate putting the balance sheet to work and that sort of thing..

[Operator Instructions] We'll hear next from Ross Gilardi of Bank of America Merrill Lynch..

In Mobile, you talked about anticipated improvement in rail and off-highway. How much of that have you actually seen at this point? And what's driving the improvement in rail? And then I just have a follow-up question to that..

So in rail, yes. We are clearly seeing it. We see that in our order rates, and so we are pretty optimistic on rail for the balance of the year.

Quite frankly, what's driving it is we've had success on a number of platforms primarily outside the United States, which has been very good for us, particularly in China and Latin America, Australia and some other markets like that. So that's what's really driving the rail business. The off-highway business is a little bit of a mixed bag.

We're coming off a pretty low base situation given what's happened in the global mining markets. We've clearly come off the bottom and we are beginning to see, I would say, gradual upticks in that market space, nothing fabulous yet at this point.

But once again, clearly, off bottom and clearly beginning to enter a recovery stage, for lack of a better term..

Are you saying you're clearly coming off the bottom in mining or in off-highway in general? Or is that more of a construction-related comment?.

Well, our exposure in off-highway is heavily against agriculture and mining. So in mining, yes, we're seeing a little bit of improvement, but that's really because of inventory. The inventory burns in the dealer networks appear to be over. So we're now matched against demand. So it's more of that issue, I would say.

Although, the capital equipment side of mining is still very weak. Agriculture, there's some weakness in the ag business that we participate in right now. But if you sum all that up in total, we are seeing a gradual improvement within the off-highway space..

Got you.

And then on Steel, could you elaborate on how you made out with that price increase that you had announced I think a couple of months ago on the noncontractual business? And just broadly, do you think operating rates are supportive of stable pricing? I'm realizing you've got -- most of your pricing is on an annual basis, but in support of a stable pricing, do you think at least through next year given some of the new capacity that's come online?.

Yes, this is Tim. You got to put the 30% per ton price increase in perspective. It is for bar products under 6 inches on a spot basis. So if you look at our total products we take to market, it's a relatively small amount. I will say, though, that we have locked, keeping that into the marketplace.

And as we've looked at our order book going forward and the conditions that we see in our end markets, we would assume that quarter-over-quarter, we will see our utilization rates improve. So I think market conditions will support it going forward..

So you're optimistic on it but it hasn't been fully implemented at this point?.

Well, it's announced and in the market..

And our next question comes from Stephen Volkmann of Jefferies..

Nice to see you guys starting to use the balance sheet a little bit here. And I guess I just wanted to dig into that a little bit, given that you have the separation and these meetings coming up.

Would you anticipate that you'll probably wait to do anything else meaningful with the balance sheet until we get past those things? Or are there other opportunities, I guess, obviously I'm thinking about M&A and additional share repurchases that could happen between now and then?.

Sure, Steve, this is Phil. We continue to be in the market repurchasing shares. We assess the level and timing, et cetera, with our management team, with the advising counsel of the board. Also, as you indicated, taking into account the capital structures we're anticipating for Timken and TimkenSteel.

But we are in the market in the second quarter and expect to continue to be throughout. So relative to capital allocation in general, we continue to look at potential M&A opportunities, they tend to be of a small bolt-on nature, I would say. But we have not shut that off on any side of the business, frankly.

We haven't had anything to announce in a few months, but we continue to look at opportunities there as well..

Okay, great. That's helpful. And then I guess I'm just thinking kind of big picture, obviously, the Process business looks like it's operating fairly well and as it pertains to Mobile, margin sort of stand out a little bit more on the downside.

I guess I'm just wondering, are we happy with where we are in Mobile with respect to kind of the big picture, the cost structure? Is there more that needs to be done there over time to sort of make it maybe a more double -- mid double-digit type business? Or is this kind of the right area that you're thinking about going forward?.

Yes, Steve, this is Rich. We've communicated that we're really targeting a low, say, 10% to 13% EBIT margins for the Mobile business. The real turning point for us on the Mobile business as we have gone through a multi-year period here of losing significant share in the automotive business, intentionally planned, et cetera.

But we've been able to sustain the low end of that margin rate at 10% with that. And now as we turn to what we expect to be growth, now -- sequentially, now that, that's behind us, we would like to move up in that range.

But we would see that, depending on where we're at in the cycle and where we're at being more in the 10% to 13% range than your mid double-digit suggestions..

And our next question comes from Steve Barger of KeyBanc Capital Markets..

I'll ask a question, price on the Bearings side.

How much is factored into your guidance walk for Bearings? And with volumes starting to pick up, is there room for additional price increases in the back half?.

Well, first of all, I guess I don't want to comment on how much is in our guidance or not in our guidance. But to provide some color on it, clearly, within global distribution, we have announced price increases for most regions of the world and that's pretty typical. Every year, we do that.

On the OE side, I think it's not -- I don't know the answer to that, I guess, is what I would tell you. Right now, there's still -- it's still pretty competitive. And I would say right now, pricing is not a huge detriment to us but not a huge positive. We'll have to see how the balance of the year plays out on that.

But I would say on the balance of the business, meaning the non-distribution business, I'd take sort of a neutral stance on the topic in total..

In past cycles, where you've seen a destocking occur and then a restocking, do people -- do the competitors start to raise price relatively quickly? Or is that something that takes a while historically?.

It varies. It depends on the cycle, depends on the market. It can be anything and everything, I think, is the truth of the matter..

Okay. I think in the past, you've talked about incremental margins running mid-30% or better for the consolidated business, as volume starts to ramp.

Is there a target for the Bearings business itself in terms of what you think the current cost structure can deliver as revenues starts to ramp?.

Steve, this is Phil. Yes, I would say you saw a really good pull-through in the first quarter and that really gets back to what Rich commented on around the manufacturing performance that we've seen. We have sort of been systematically lowering our manufacturing costs throughout the organization, and that's kind of spilling over in the material now.

So I would estimate, and maybe ask Rich to comment further, I would estimate that what you saw in the first quarter would be pretty typical in terms of what you'd expect to see going forward.

Rich?.

Yes, I would agree with that. To some of the earlier questions with distribution versus OEM and between segments, it is somewhat mix-dependent. But I think Phil's guidance is a good barometer assuming mix is relatively consistent..

If I could sneak 1 other in on wind.

Is that improvement largely in North America or is it more international?.

That is global. The whole global wind market is pretty hot right now. We made a significant amount of investment in that market space 3 to 4 years ago. It's actually been a drag on our performance in the 2010 through '13 timeframe. So we're now beginning to see some of that stuff pay off.

The market is very hot in China, but it's also pretty robust in other regions as well..

And it appears we have 1 more question in the queue. [Operator Instructions] We will now hear from Eli Lustgarten of Longbow Securities..

Just a quick follow-up on the wind issue.

Is that mostly new product? Or is that aftermarket replacement that you're selling at this point?.

Yes. Right now it's mostly original equipment, Eli. But we are only on new platforms, new platforms meaning the last 7 years, and that's by choice. We intentionally stayed out of the wind energy market because we didn't like some of the technical designs of the history. So we've really only been in the business for the last 7 years.

Now to your point, though, the aftermarket -- the first beginnings of the aftermarket cycle are beginning to show up right now. But it's probably another 10 years, quite honestly, until you'll see a robust aftermarket in the wind energy space where Timken is operating..

Can you give us a rough idea of what percentage of the Process business is related to wind, in round numbers, is it 10% or something like that or....

Yes. It's probably -- it's 10% and climbing..

And we'll hear from Steve Barger of KeyBanc Capital Markets..

Just one quick follow-up. For the Aerospace segment, what are some of the operational issues that are dragging on margin performance? And what are you doing to mitigate that? Because it seems like that's been underperforming expectations for a while now..

Yes, Steve, this is Rich. It has been, it's the positive -- we were 4, 5 quarters of sequentially declining margins. We did improve from fourth quarter and the first quarter and we expect further improvement through the course of the year.

The business has had a variety of execution issues, I'm including the fact that we really haven't had the traction in the market that we've been working to, which has hurt the growth rates. So the business had been fairly -- stagnant at the top line.

Then, we've had some mix issues and we're also in the midst of implementing some specific cost-reduction tactics that, short-term, are a drag but we expect to pay off in the longer term. So recognize the results are not satisfactory and you can expect them to improve.

And to your point that it's been going out too long, we're certainly holding ourselves accountable for that as well..

Okay.

Are the cost reduction initiatives that you're undertaking, do you think that will lead to sequential improvement? Or is that drag going to affect 2Q and keep that flattish and then you expect it in the back half?.

More, the back half..

And it appears that there are no further questions. So I'd like to turn the conference back over to you, Mr. Griffith..

Before Jim closes out, I'd like -- this is Tim Timken, I'd like to take the opportunity to point out that this will actually be Jim Griffith's last phone call -- quarterly call.

And I wanted to take an opportunity to thank Jim for all of his years of service to The Timken Company, the positive, lasting effect that he has had on this business as he approaches retirement at the end of June. And I'm sure you will all join me in recognizing the contributions that he's made.

So with that, I will hand it over to Jim for his final farewell..

Thanks, Tim. Obviously, we had a good quarter in the first quarter, and I really would like to congratulate our team. To the questions about are we still in the market looking at M&A, the team's done a phenomenal job of separating the process of strategically moving the company forward to become 2 companies, with running the company well.

And I will simply say we appreciate your support during this time period and hope you share the same confidence that we share in the future of The Timken Companies. Thank you..

And that concludes today's conference. We thank you for your participation..