The Timken Company - Earnings Call - Q1 2020
May 1, 2020
Transcript
Speaker 0
Good morning. My name is Anita, and I will be your conference operator today. As a reminder, this call is being recorded. At this time, I would like to welcome everyone to Think Tank's First Quarter 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. Thank you. Mr. Frohnapal, you may begin your conference.
Speaker 1
Thanks, Anita, and welcome everyone to our first quarter twenty twenty earnings conference call. This is Neil Frohnapple, Director of Investor Relations for The Timken Company. We appreciate you joining today. Before we begin our remarks this morning, I want to point out that we have posted presentation materials on the company's website that we will reference as part of 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 The Timken Company's President and CEO, Rich Kyle and Phil Percasa, our Chief Financial Officer. We will have opening comments this morning from both Rich and Phil before we open up the call for your questions. During the Q and A, I would ask that you please limit your questions to one question and one follow-up at a time to allow everyone an opportunity to participate. During today's call, you may hear forward looking statements related to our future financial results, plans and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today's press release and in our reports filed with the SEC, which are available on the timken.com website.
We have included reconciliations between non GAAP financial information and its GAAP equivalent in the press release and presentation materials. Today's call is copyrighted by the Company. And without expressed written consent, we prohibit any use, recording or transmission of any portion of the call. With that, I would like to thank you for your interest in the Timken Company. And I will now turn the call over to Rich.
Speaker 2
Thanks, Neil. Good morning, everyone, and thanks for joining us today. I'll start with some very brief comments about the first quarter and then spend most of my time discussing the impact that the COVID-nineteen pandemic is having on our business and the actions that we are taking in response. We had a good first quarter, particularly in light of the impact from the coronavirus in China in February and then the bigger impact it had across the globe in March. Our end markets were largely in line with our projections for the first two months of the year.
Then in early March, we began to experience various adverse impacts from the virus. Our execution was good both in regards to our results as well as our quick response to the impact from the virus. For the quarter, organic revenue was up 3% from the fourth quarter and down 9% from the first quarter of twenty nineteen. The acquisitions of Beck and Diamond added 5% to our revenue, and currency was just under negative 2% for a net of negative 6% from last year. We delivered 1.11 of earnings per share and 19.2% EBITDA margins despite the weak finish to the quarter.
EBITDA margins were up almost 300 basis points from the fourth quarter. Also worth highlighting, the BEKA acquisition performed much better in the first quarter with EBITDA margins in the mid teens. The business will not be immune to the short term COVID-nineteen issues we are facing. But after six months of ownership, we remain very optimistic about the potential of this acquisition and the synergies with Chronovelt. Again, was a good quarter.
But as you all know, our markets have changed significantly since February, and I will expand on the impact that we have seen from the coronavirus. Our first experience with the coronavirus was in China in late January and early February. We were shut down in China for one full week due to government mandate, and then we lost about the equivalent of another week due to ramp issues that impacted us and our customers. By the end of the first quarter, our China customers and our China operations were back to normal levels. We grew year on year in March and again in April.
After China, our next business impact was in Italy. We have three manufacturing facilities in Italy that serve local as well as export markets. From there, the virus and government mandates spread through Europe to The U. S. And other parts of the world.
In the March, we were experiencing a modest revenue and production impact in Italy. And by the last March, our revenue in Europe was down by over 50%. The global automotive and truck industries were essentially shut down. India had mandated a shutdown of all industrial manufacturing, and the impact was starting to hit industrial markets in The U. S.
And the rest of the world. In the last two weeks of March, we have temporarily idled over 30% of our production, primarily due to weak customer demand. And all of those issues are included in our 1.11 of earnings per share and our 19.2% EBITDA margins. So again, we performed very well given the environment in the first quarter. Let me now jump to April.
From a supply perspective, Temkin operations have largely been deemed essential around the world, and we have been able to meet customer demand. We've had some supply challenges and inefficiencies, primarily in Italy and India, but supply has not been a major contributor to our revenue decline, and we are filling the needs of our customers. Our expectation is that this coming Monday, restrictions in India and Italy will be lifted, at which point we will be able to operate all Timken Global facilities to the degree that we need to. We expect April revenue to be down slightly more than 30% from prior year. Some more color on that number.
Europe has been the hardest hit geography for Timken. Our revenue in Europe bottomed for about three weeks starting in late March. It bounced up meaningfully off that bottom in mid April, and we believe we have more customer demand coming back in the next couple of weeks as customers restart or step up operations. The U. S.
Has been about three to four weeks behind Europe in regards to impact, and we've been hovering around what appears to be a bottom for the last three weeks or so in The U. S. Our automotive business in The U. S. Has been down over 80% in April.
And while we do not have definitive restart dates, we do expect more automotive revenue in May and June than April. China, as I said earlier, was up year on year in April, partly driven by renewable energy. In India, it was close to zero revenue for the entire month of April. We expect India customers to restart demand beginning next week, but starting at modest levels. Our other smaller geographies are all experiencing various and in most cases significant declines in demand and have not yet shown signs of a rebound.
In regards to the outlook for the rest of the second quarter of the year, the situation remains dynamic and our visibility is limited. We are in close contact with customers. We're managing our supply chains tightly, and we plan to remain flexible through the second quarter. There are lot of variables and possibilities for the second quarter, and we will continue to be responsive to changes in demand. As we look out, there are positive signs as well as negative signs.
Start with some of the positives. I'll say the spread of the virus appears to be much better than the worst case scenarios that we were that we were contemplating in late March and early April. The world in general appears to be headed to reopen and work through the pandemic in the coming weeks. And Timken and other manufacturers are quickly implementing new work practices to aid in safely working through the pandemic. Our customers have not made structural reductions in capacity.
They have furloughed employees and temporarily shut down plants, but they have not closed plants, permanently reduced staffing levels or reduced inventory. They are planning and prepared for a rebound. A significant amount of customers are telling us that they intend to ramp up production through May and June and that they expect the third quarter to be better than the second. Timken should see improvement off of April revenue levels for automotive, commercial truck in India, which have all been at extremely low levels as well as several other markets where revenue has also been low in March and April. And also positive, the diversity of our revenue by end market, customer and geography has put us in good position to weather the storm.
As an example of that, our demand in China, wind, solar, aerospace, defense, marine, logistics and several niche markets has remained strong through the pandemic. On the negative and uncertain side, we do not know how the pandemic will play out, including if there is a resurgence in the virus as the world lifts restrictions and returns to work. And while as I said, our customers generally remain optimistic on ramping production back up in May and June in third quarter, they also do not know how this plays out. They don't know how the virus plays out and they don't know how their own customer demand will develop in the coming months. And while we have several markets and customers that appear to have bottomed, we also have several that are likely to weaken or taking more time to recover.
Commercial aerospace, oil and longer cycle markets like our industrial services are all likely to be lower in the coming months. There's also the risk of channel destocking. As I said, our customers have largely responded to this with temporary actions. But if demand remains down, we could experience inventory destocking impacts. And while China and several of our other markets remain strong, there's no guarantee that they will be immune to the economic spillover from the other markets.
Based on all these factors, we are planning for a very challenging second quarter, but also for the second quarter to be the bottom and to see sequential revenue improvement off the second quarter and the third quarter. But again, there are a lot of variables in play. The situation remains dynamic, and we are preparing for a wide range of revenue possibilities. The Temp and management team has responded quickly and decisively to the pandemic. We've taken significant actions to retain our employees while keeping them healthy, to serve customer demand, reduce costs and ensure liquidity and financial strength through the crisis.
Let me expand on each of those. Safety has always been at the top of Timken's priorities and remains at the top through the pandemic. We've been very proactive across our global operations in assuring safe workplaces and safe practices for our associates. We were early adopters of preventative measures that included work from home and restricted travel, PPE, social distancing within our facilities and more. And we will continue to lead in our safe operating practices.
Speaker 3
As I said, we are prepared for
Speaker 2
a wide range of demand possibilities. While we hope the worst doesn't happen, we will be prepared if it does, and we believe we can stay profitable and positive quarterly cash flow through a significant and sustained decline in demand. We've taken short term steps to increase our liquidity, which Phil will go into in a moment. We hope this will prove to have been unnecessary. But again, we are prepared for a wide range of demand scenarios.
We've increased our focus focus on cash generation and are confident that we will generate strong cash flow in a contracting or expanding market in 2020. And again, Phil will elaborate on this in a moment. We will be more conservative on capital allocation until the virus in our demand stabilizes, including the suspension of share buyback and the deployment of free cash flow after dividends to the reduction of debt. We have quickly reduced production in line with reduced demand. We do not expect to reduce inventory significantly until we get better clarity on the outlook, but we will manage working capital in line with demand levels as the year progresses.
In a down market scenario, working capital will be a significant generator of cash for us. We slowed capital spending in the second quarter and expect the full year to be more than 20% below our prior guide of $160,000,000 We could go further, but that will depend on better visibility in the second half as we continue to believe in the long term attractiveness of investing in our markets and the value creation of our capital projects.
Speaker 3
But we will slow
Speaker 2
it further if the recovery is slower. We came to the year with a good pipeline of cost reduction activities, the partial results of which were evident in our first quarter margins. We will continue to execute these initiatives through the year to drive structural cost improvements. Through April, we have retained our global workforce and their benefits. However, we have all taken various forms of temporary reductions in our compensation.
I appreciate our employees' sacrifices and support of these measures. We've taken an aggressive approach to temporary cost reductions in the second quarter that include reductions in spending, furloughs and compensation reductions. We expect compensation costs to be down more than 25% in the second quarter. However, these are temporary measures. During May and June, we will be we will prepare to make structural cost reductions in the second half of the year if they are deemed necessary as visibility to demand improves.
We remain closely connected with our customers, their production plans, their new product plans, and we remain focused on our long term objectives to outgrow our markets. In summary, pension company is well positioned to perform through this crisis. Our strategy is to diversify the revenue of the company by product, by end market and by geography, and that diversity will serve us well. Our products are critical elements of our customers' equipment and supply chains. We have been solid generators of cash and will continue to be in shrinking or growing market conditions.
We've been disciplined allocators of capital and entered the downturn with a good balance sheet. And we have a management team that has significant experience in managing through challenging cycles and a dedicated and talented workforce that is committed to our success. I'll now turn it over to Phil.
Speaker 3
Okay. Thanks, Rich, and good morning, everyone. For the financial review, I'm going to start on Slide 11. Timken delivered solid results for the first quarter despite the growing impact of COVID-nineteen, and you can see a summary of our results for the quarter on this slide. Revenue for the first quarter was $923,000,000 down just under 6% from last year.
We delivered an adjusted EBITDA margin of 19.2%, and adjusted earnings came in at $1.11 per share. Keep in mind that last year was a difficult comp as both adjusted EBITDA and earnings per share were records for the company, and the current year was impacted by market conditions, COVID-nineteen and currency headwinds. I want to point out that our performance did improve meaningfully from the fourth quarter as we guided, with revenue up 3% and adjusted EBITDA margins expanding by almost 300 basis points sequentially. Turning to Slide 12. Let's take a closer look at our first quarter sales performance.
Organically, sales were down about 9% in the quarter with both mobile and process industries down versus the year ago period. As Rich mentioned, revenue was largely in line with our initial expectations in the months of January and February. Sales were adversely impacted beginning in March due to the broadening impact of COVID-nineteen across the globe. Acquisitions added nearly 5% of the top line in the quarter as we benefited from the BEKA and Diamond Chain acquisitions completed last year, while currency was a sizable headwind, negatively impacting revenue by around 1.5%. On the right hand side of the slide, we outline organic growth by region, so excluding both currency and acquisitions.
Let me briefly comment on a few regions. In Asia, we were up 6%. Our operations in China have recovered nicely from the COVID-nineteen shutdown in early February, and we saw solid growth in renewable energy in the quarter. In North America and Europe, we were down 1312%, respectively, as most sectors were down across those two regions in the quarter. Our operations in North America and Europe were both impacted by COVID-nineteen in March, and this had a meaningful impact on end market demand in automotive, heavy truck and other industrial sectors.
Turning to Slide 13, adjusted EBITDA was $177,000,000 or 19.2% of sales in the first quarter compared to $2.00 $2,000,000 or 20.7% of sales last year. The decline in adjusted EBITDA reflects the impact of lower volume and related manufacturing utilization, driven in part by COVID-nineteen. Currency also had a negative impact on EBITDA in the quarter. On the positive side, we had favorable price mix, lower material and logistics costs and lower SG and A expenses. In addition, recent acquisitions contributed $8,000,000 to EBITDA in the quarter or around 16% of revenue, a nice step up from the fourth quarter.
Becket performance improved significantly as our team continued to integrate this acquisition and drive cost synergies. Let me comment a little further on manufacturing and SG and A. On the manufacturing line, we delivered good operating performance in the quarter, considering the lower production volume. Our teams around the world acted quickly to flex down labor and variable costs in response to COVID-nineteen. Unabsorbed fixed costs drove most of the negative variance in the quarter.
And SG and A was favorable compared to last year, driven mainly by lower incentive compensation expense. On Slide 14, you'll see that we posted net income of $81,000,000 or $1.6 per diluted share for the quarter on a GAAP basis. This includes $05 of net special charges related to restructuring and other items. On an adjusted basis, we earned $1.11 per diluted share in the quarter, down 18% from the record earnings per share we posted last year. While it's hard to quantify exactly, we would estimate that COVID-nineteen was easily a $0.10 headwind in the quarter.
Note that the $1.11 we earned in the first quarter was a significant step up from our fourth quarter adjusted earnings per share of zero eight four dollars as we saw a normalization of the higher expenses we called out last quarter. We also had the benefit of higher volume and better mix as well as a nice improvement in BEKA profitability. Our adjusted tax rate was 27% in the quarter, reflecting our geographic mix of earnings and in line with our prior expectations. Right now, we expect the tax rate to remain in this range as we move through the year. Now let's take a let's take a look at our business segment results, starting with Process Industries on Slide 15.
For the first quarter, Process Industries sales were 457,000,000, down 4.8% from last year. Organically, sales were down 7.5% driven by declines in global industrial distribution and the general and heavy industrial sectors, partially offset by strong growth in renewable energy and positive pricing. Marine demand, which is mainly defense related for Kempen, also remained strong. Currency translation was unfavorable by 1.7%, while acquisitions added 4.4% to the top line in the quarter. For the quarter, Process Industries adjusted EBITDA was 112,000,000 or 24.4% of sales compared to $131,000,000 or 27.4% of sales last year.
The decrease in adjusted EBITDA was driven by the impact of lower volume and related manufacturing utilization and unfavorable currency, offset partially by lower SG and A expenses and the benefit of acquisitions. Now let's turn to Mobile Industries on Slide 16. In the first quarter, Mobile Industries sales were $467,000,000 down 6.7% from last year. Organically, sales were down 10.4, reflecting lower shipments in Off Highway, Automotive and Heavy Truck, partially offset by growth in Aerospace, which was mostly defense related and positive pricing. Acquisitions added 5.3% to the top line in the quarter, while currency translation was unfavorable by 1.6%.
Mobile Industries adjusted EBITDA was $76,000,000 or 16.3% of sales compared to $84,000,000 or 16.8% of sales last year. The decrease in adjusted EBITDA reflects the impact of lower volume and related manufacturing utilization and unfavorable currency, partially offset by favorable price mix, lower material and logistics costs and the benefit of acquisitions. This represents a decremental margin of around 18% on an organic basis. So very good operating performance for Mobile Industries in the quarter despite a double digit organic sales decline in a challenging environment. Turning to Slide 17.
You'll see we generated operating cash flow of $56,000,000 in the quarter, up slightly compared to last year as improved working capital performance more than offset the impact of lower earnings. We generated free cash flow of $24,000,000 which was down from last year as we had higher CapEx spending in the quarter to support long term growth and operational excellence initiatives. In the first quarter, we also paid our three hundred and ninety first consecutive quarterly dividend and repurchased 1,000,000 shares of company stock. Keep in mind that cash flow was seasonally low in the first quarter of the year as our incentive compensation payouts occur in March, and we normally see some working capital increase from December. Over the rest of 2020, we expect to generate significant free cash flow, which will reflect favorable working capital performance and the impact of costs and other spending reduction initiatives.
And we plan to deploy our free cash flow after dividends to reduce debt. You'll note that we have suspended our share repurchase program while we navigate through this period of uncertainty. I want to reiterate that we're confident in our ability to generate strong cash flow in 2020 under almost any scenario. When revenue drops, we typically reduce working capital, and we also have the ability to reduce CapEx. This serves to mitigate the impact of lower earnings on our cash flow when markets contract and vice versa.
I'd also like to comment briefly on our pension situation. From a cash standpoint, we expect pension and OPEB contributions in the range of 14,000,000 to $18,000,000 for 2020, essentially unchanged from our prior outlook. And despite all the stock market and interest rate volatility, our estimated funded status has moved only modestly since the end of two thousand nineteen. We took steps several years ago to derisk our pension exposure by investing in liability matching assets. This is helping protect our funded status in this environment.
Let's take a closer look at our capital structure with a summary on slide 18. We ended the quarter with a strong investment grade balance sheet and 388,000,000 of cash on hand. Our net debt to adjusted EBITDA was around 2.2 times as of March 31. We included a long term debt maturity schedule on the top right where you can see that we don't have any significant long term debt maturities before 02/2023. Note that we drew 350,000,000 on our revolving credit facility on April 3 as a precautionary measure to enhance our financial flexibility during this period of uncertainty.
This increased our cash on hand to well over 700,000,000 as of that date. We currently expect net interest expense in the range of 65,000,000 to $70,000,000 for the full year. So to summarize, our balance sheet, liquidity and expected strong cash flow put us in a great position to successfully navigate this period of uncertainty. We're taking aggressive actions in response to COVID-nineteen to conserve cash, and we're shifting our short term capital allocation priorities to direct our free cash flow after dividends toward debt reduction. And finally, I wanna remind you that we previously withdrew our sales and earnings guidance due to a significant uncertainty caused by COVID nineteen.
And while we are not providing sales and earnings guidance today, we do intend to reinstate guidance at some point in the future. In closing, we'd like to commend our more than 18,000 Timken employees for delivering solid first quarter results. It is their hard work and dedication that drives our confidence that Timken will emerge from this environment well positioned to continue to advance as a global industrial leader. And with that, we'll end the formal remarks and open the line for questions. Operator?
Speaker 0
Thank you. And now we take our first question from Rob Wertheimer from Melius Research. Please go ahead. Your line is open.
Speaker 3
Hey. Good morning, everybody. Good morning. Good morning, Rob. So thanks for all the detail in April.
I think anything that helps to, you know, clarify, I think this is the uncertainty. And in in your case, anyway, it was Rob, are you there?
Speaker 1
I I think that
Speaker 3
probably has a lot to do
Speaker 4
with what you've done in mix. Obviously, a lot of
Speaker 3
hard work over the years. So just a question.
Speaker 4
I don't know if you've been looking at
Speaker 3
Not to interrupt you. You you out for about fifteen seconds. Could you potentially could you start over, please? I beg your pardon. Can you hear me now?
Yep. Yes. Perfect. Okay. So sorry for that.
So so anyway, I I guess what I was saying is that the color on April is very, very helpful. It just reduces uncertainty, that's great for everybody. Down 30% is also way better than we had feared, at least, as inventories swing up and down, and you sell into people who thought it could have been worse. So that's great. And I think it reflects some of the very positive mix improvements you've done over the years.
I wonder, though, if you could just look at either 2009 or just what pockets of business you have that have been strong. Does that really feel like the bottom in April? Or could we have a major destock that's big enough to drag us down a little bit more? There's really a sense of whether that really does feel like a bottom and whether the remaining pockets that could trend down are big enough to pull us off that or not.
Speaker 2
Yeah. I think there there certainly as as I try to say in my comments, there's quite a few markets that, have to be close to a bottom. I think automotive, heavy truck, India, Italy, when you're down at 0% to 10% to 15%, those are not going to be numbers that sustain. So I think certainly, we can count on higher revenue at some point in the near future, I believe, with some of those markets over what we had in March and or April and what were in the numbers that I rattled off with you there. I think the and the other part of that I would say is as I tried to allude to in my comments, the trend line that we are on is certainly for, markets to improve.
And I think if if, over the course of the next two months, you're hearing things like automotive companies are going back to work, the virus is dissipating, things are getting better, then that bottom is likely there. But there's also now that being said, there still are some things that are gonna go down probably even in that scenario, but they would tend to be smaller parts of our business than than the ones that I rattle off. So I think that would be a net positive. But, you know, I would also say we've been in an environment for the last sixty days that that we're on a conference call at 08:00 at night and looking at India results and saying, look, India looks good and we can count on that. And we get up at 08:00 the next morning and have an email that, the Indian government shut down our customers for three weeks.
So it I think we're still, living with that level of bandwidth. Still some possibilities, but definitely the trend line, I think if things continue to go the way they have, Europe is up off of a bottom, and The U. S. Appears to be coming off of one right now.
Speaker 3
That's very helpful. And then just a clarification. You mentioned, obviously, commercial aero is one that is highly uncertain and can trend down. In your aerospace business, is commercial the the minority of it versus, you know, rotorcraft or whatever? I mean, is that is that a major pool or just one that you noted could come down?
Speaker 2
No. We're we're we're just we're we're disproportionately weighted towards, towards defense. So last year of our 8% aerospace, over 50% of that would have been defense. So say three ish percent would be commercial. But that 3% has done pretty well through April.
But I would also say that's living off backlog, and we'll likely see some pressure in the coming quarters as an example.
Speaker 3
Perfect. Thanks, Rob. Thanks Rob.
Speaker 0
Thank you. And now we take our next question from Michael Feniger from Bank of America. Your
Speaker 3
line
Speaker 0
is open. Please go ahead.
Speaker 4
Thanks, guys. And thanks for Good
Speaker 3
morning, man. Taking my good morning, guys.
Speaker 4
And thanks for taking taking the questions and and great color so far on on what you're seeing on the ground. When you say customers are not destocking right now, that they're waiting to see what the recovery could look like, I'm just curious, the inventory levels that the customers are holding, is that you feel like contingent on demand getting back to a a pre COVID type level?
Speaker 2
Yeah. I do I I think, you know, we were many of our in net, our markets were many of our markets were three to four quarters into a cyclical contraction already. And we guided to start the year down year on year and the first half year on year. So I think inventory levels are in line with single digit decline in year on year revenue. And if we were to return to those types of levels, say 5% to 9% down sort of thing, then I think inventory destocking is factored into that for us.
If, we don't recover to those kind of levels and we're more 15 to 20, then, we would be we would we would have some, more pain to come in regards to inventory destocking. Does that get your question?
Speaker 4
Yeah. That's no. That that is helpful.
Speaker 3
I mean, do you have an idea I mean, I
Speaker 4
I know it's difficult because you guys search so many markets. Do you have an idea, though, that where you know, is that more just a comment on, like, the distributors? Rich, are you guys seeing that I mean, you know, for example, like, your auto customers or distributors with auto, have they already adjusted their inventories assuming a a lower level of demand?
Speaker 2
Well, auto would be the auto and truck OEM at 13% to 15% of our business would probably be the exception where there there's very little inventory between us and those customers. Now they have inventory, so they still have they that would affect them, but we have very fast delivery and responsive delivery. That but beyond those two markets, I would say my comments apply to more than distribution. So I mean we took a lot of destocking activity in the second half of last year in off highway markets, as an example. So our off highway sales in the first quarter were more in line with our customer sales than below that as an example.
So we took a lot of that pain last year. Again, rail would be another example of that. So I think that would apply to most generally almost all of our markets with few exceptions of where the inventory is quite tight between us and the customer.
Speaker 4
Fair enough. And you said how Europe meaningfully bounced in April off the lows of March, which is good to hear. You might have said this before. How much of that is is how much of what you see saw in April is down year over year in Europe versus where it was was was last year? And then can you also address we talked about some of these businesses like Commercial Aero living off the backlog.
Do you think that's why some of your portfolio has done well in certain areas like marine or in renewable energy? Or is that more of maybe some secular shift you're gaining share and those markets just holding up much better?
Speaker 2
Yeah. There's a there's a probably quite a few different answers in that. That was maybe seven or eight questions. I'll hit few of them. I certainly think in some of those markets that share.
Certainly, we think over multi years, wind, solar, marine, we have taken share. Also, those are markets that have not been negatively impacted with the exception of some of our production issues that we had in China, obviously, negatively impacted it. But order backlog remains strong as well out into the future. And so that would be a combination of market dynamics as well as multiyear Tim can share. In regards to, bottoming again in Europe, about three weeks again, mid, late to mid March to early to mid April, we're hovering down around a number.
In the last three weeks, we're almost double what we were during that one period. So in for three weeks, quite a few of our customers took one to three weeks of production out. Automotive and truck in Europe largely shut down. Some of that's come back online. So we've seen a significant uptick in demand in Europe off that.
Now again, we've got as you look out over the next month of what we know, we've got some pluses and minuses from that, but certainly up significantly. And we haven't really seen the uptick yet in The US. But again, some of the markets that are extremely depressed levels, almost have to uptick sometime here in the next, next few weeks off those low levels.
Speaker 3
Yeah. I think it's safe to say like that the Europe well well, as Richard said, we bounced back up. We're still we're still down, you know, year
Speaker 2
over year.
Speaker 4
Yeah. Yeah. And just and just lastly, guys, you you mentioned oil and gas. Can you just remind us how you know, your exposure to the the the oil and gas market? Just quantify it and, you know, where it is.
Direct
Speaker 2
exposure is quite small. It used to be higher maybe ten years ago. I've never obviously grown other parts of the portfolio. In a good market, than 2% direct, And there's some indirect ramifications of that in other markets like metals and transportation, etcetera. But direct, it's a pretty small bearing power transmission market.
Speaker 3
Perfect. Thank you.
Speaker 0
Thank you. And now we take our next question from Chris Stankert from Longbow Research. Your line is open. Please go ahead.
Speaker 4
Hey, good morning, everyone.
Speaker 3
Good morning, Chris.
Speaker 4
Sorry if I missed it, Rich.
Speaker 5
Did you comment at all? And then I understand if you would prefer not to, but any comments on kind of April and kind of what the initial orders have been, what sales have been kind of through that month? Just any short term data there?
Speaker 3
Yeah. Just I think hey, Chris. This is Phil. I think as as Rich mentioned on he did mention in his opening remarks, we do expect April sales to be down in north of 30%. And, you know, while we have started to see, you know, some recovery in regions like Europe and and, you know, are expecting North America to bottom here in the near term and and India to India probably have already hit bottom.
We do expect the EBITDA will be down over 30%.
Speaker 5
Got it. Okay. That's what I thought I heard, but thank you for the clarification. So I guess it's extremely difficult to kind of get hands around cost because sales can move so wildly here. But if we assume full year sales are down in mid teens ish, should we expect decremental margin near 30%?
Or just how should we think about the cost structure of the business in this down cycle versus last?
Speaker 2
Well, in the second quarter, we've taken a lot of temporary cost actions to align with what we expect to be, again, a very challenging quarter. So the traditional decrementals, I'm not sure, will hold in a market where we could be down 30% in quick order where we would have had time to make structural changes, etcetera. As you look out the third quarter, if we were to conclude that we expect it to be down significantly in the second half, we would start taking more structural actions to try to get back to whatever historical type of decrementals would be, which would typically be in the 25% to 35 range depending on mix and so on. I do think the speed at which this came at us without temporary actions or decrementals probably would have been worse, the speed and the depth. But, again, we've taken some pretty significant actions here
Speaker 3
in the second quarter. Yeah. I would just I would just add, Chris. Tough for us to to guide the decrementals, obviously, but we're working real hard to manage the decrementals. You know, we're we and we're at better business today than we were in prior cycles.
I expect to perform, relatively speaking, better. And as Rich said, we're moving quickly to reduce costs in the second quarter, which we think will be will be the bottom from a revenue standpoint. We also expect price cost to remain positive. We're gonna benefit from lower incentive compensation as we would in this kind of an environment as well as the ongoing cost reduction initiatives, not just the second quarter actions, but we had actions coming into the year, all of which, I would say, will help us help protect margins and help decrementals as we move through the year. But until we get better clarity on, as Rich said, steepness, length, etcetera, it's tough for us to guide to a specific number.
Speaker 5
Yes, yes. Absolutely appreciate the difficulty there, but thanks so much for the color. And just one last one for me, if I could sneak in here, I guess. Just any commentary on what your internal working capital targets are? How should we be thinking about cash flow into the back half of the year kind of be accepting 2Q?
Any thoughts there would be great.
Speaker 2
Certainly, on receivables, as revenue declines, we'd expect to liquidate, if you will, a significant amount of cash from receivables, and we're managing that tightly. From an inventory standpoint, with this significant of a decline in demand and takes some time to turn the inbound spigot off, we have turned the spigot of production off proportionate with demand. We haven't taken it significantly below demand to get inventory out. And that, again, is strategically what we're choosing to do at least through the first sixty days here in reaction to our customers' plans and intentions to that the levels we're at in March and April, will not stay at. And as you look out in the second half, we would expect to right size our inventory with where we think the demand levels out at, which, again, we're not ready to call as we sit here today.
Speaker 5
Yes. Fair enough. Thanks so much, guys, and best of luck as we kind of move to this bizarre time.
Speaker 3
Thank you. Thanks, Chris.
Speaker 0
Thank you. And now we take our next question from Joe O'Dea from Vertical Research. Your line is open. Please go ahead.
Speaker 4
Hi, good morning, everyone.
Speaker 2
Good morning.
Speaker 4
Good morning, Joe. You commented on significant free cash flow this year and obviously a whole host of scenarios, but just your confidence in that. Can you talk about those ranges at all and give us some perspective around confidence and significant free cash flow?
Speaker 2
No. I think the challenge with ranges is, right, you have to start with a revenue number and then get to an EBITDA number and then go from there. We're not we're not ready to make that call, but we are confident in conversion. And generally, our conversion percentage, we believe, would go higher under a lower revenue and a lower EBITDA number. So there is some in the short term, there's some natural hedge in the two, three quarters, there's some natural hedge there that if EBITDA is under more pressure, we believe our cash conversion would be better.
And if EBITDA is better, then obviously, we get the higher benefit of the starting point. So focus will be on conversion, staying flexible, and we will react to with working capital, CapEx and costs and spending proportionate with where we see the demand shaking out in the second half.
Speaker 4
Okay. And then on distribution, I guess, in North America, where I think you have really good visibility among large distributors on sell in and sell through. And curious as you're taking some of the temporary actions, but pockets of the economy continue to work and demand for aftermarket could still be there. Whether or not you're actually seeing the sell in lag the sell through in certain pockets of that? Is there a period of time where there's actually, just given the circumstances, some destock in distribution?
Or is it really about your production aligned to that distributor sell through at this point?
Speaker 2
In North America, inventory was was essentially flattish. And I would say, again, with the with the lags, you go back. North American distributors didn't feel a lot of the COVID nineteen impact. Certainly in early March. It was more they were feeling a little bit of it in early April and then feeling it significantly by the April.
So I think they've, at this point, taken the same approach that they are looking to hold inventory to support their customers and be there for these industries. But certainly, if by the time we work our way through this quarter, if they have a lower outlook on the second half than what they had maybe back in February or March, they will they will reduce inventory, and we will see some impact from that. But that has not happened through April.
Speaker 4
And talking about the timing there and some of the mid April crunch that they would have felt, as you're able to monitor those trends, North America distributors specifically, is that something that, you know, sitting here today, you know, based on what you're able to see, it it does look some like some stabilization of those declines?
Speaker 3
No. I would not I would say
Speaker 2
that's one that we would would probably have would probably have less, visibility because it's been later and but it's also less deep. To your one of your opening comments, they answer a lot of MRO, a lot of critical industries like food and beverage that are logistics, material handling that are, going to be, impacted in the opposite direction, some cases that are gonna be up. So the revenue decline there, for us would be significantly less than the 30%, that we're experiencing for the company as a whole. So and and, again, as you started the month, it would have been less than that. So it's too early, I think, to predict which way that goes.
Speaker 4
That's very helpful. Thank you.
Speaker 3
Thanks, Jim.
Speaker 0
Thank you. And now we take our next question from Steve Barger from KeyBanc Capital Markets. Your line is open. Please go ahead.
Speaker 2
Good morning, guys. Good to hear your voice.
Speaker 3
Good morning, Steve. Hey, Steve.
Speaker 4
I know there's less inventory in auto truck and truck. But for other industries, how will it structurally work in terms of turning things back on? Does the OEM warn the supply chain that it's going to restart on some date so suppliers produce in front of that, or does the OEM restart with inventory on hand and then the supply chain follows?
Speaker 2
I would say, as you said, an automotive and truck tends to be in sync. We're going to start back up 5.4, 5.11, 5.18 and want you to start up with us. I would say other industries would generally be, you know, they've taken a week out here, a week out there and, more, hey, we're gonna push these orders out a week, and everything in between. But generally not I would not say synced up. And, when you look at the fragmentation of our markets and then our applications, the complexity of that is and and thousands and thousands and thousands of part numbers, it would not be nearly that clean, and and there will be an inventory buffer in between most of those, supply chains.
Speaker 4
Got it. So we'll see the OEMs turn on before before you they'd start pulling from you probably.
Speaker 2
Yeah. Although in most cases, I would say they have continued to pull just at lower levels. Okay. So out outside of auto and truck that and we have not had well, in countries, India and Italy, we have not had OEMs in other industries shutting down for two, three, four weeks at a time. It's been more, we're taking a week out.
We're, we're gonna build less of this. We need less of that. It's been, but, generally, there have been pulls.
Speaker 4
Okay. How much time are you spending with the team talking about share gain opportunities or getting incremental content from customers, or is this more about managing service levels for current programs?
Speaker 2
I would say it is, the long term. You know, certainly, you know know as well, Steve, in terms of our long term application, working with engineering, functions, on winning next design platforms. I would say that is just as robust and active. We're all doing it from home and on video with customers now versus in person. But customers haven't slowed that activity, and that is happening.
I would say there is some share gain opportunity for product availability and distribution always. And I think we are well positioned that should that be an opportunity, we would be there. Although I don't think there have been major supply demand imbalances in that regard and with demand being as weak as what it's been for this period. But I think we would be well positioned. Certainly would not expect to be a loser in that.
We would expect to be a winner. I don't know if it'll be big enough that it'll be anything that we would point to. Okay. And then last, just more
Speaker 4
of a philosophical question about we've had a combination of tariffs and now the virus. Do you think this changes supply chains? Do you expect more reshoring or localization of supply? And second, do you think you or your customers will shift more towards automation or robotics? And would that be meaningful to your power and motion control product lines?
Speaker 2
So on the second one, I think well, I guess on both of them, the trends were there. I think on the second one, my my view would be more so on that one that that that that this will be more of an accelerant on that one. I think the other one, for probably more so some of our customers but, again, you know, our customers, in most cases, operate global footprints, are very comfortable sourcing things globally. Economics will always play a role in that. It was certainly happening more so.
And as you know, our strategy is to have a lot of regionally local, content. But I certainly think the volatility we've seen from from the tariff situation, and the virus has certainly certainly, will will accelerate people not wanna have all their eggs in one basket, for sure. And, I think that was already happening to some degree. And, but, again, most of our customers have have some diversity there. So I think the short answer
Speaker 1
to the
Speaker 2
question would be yes, but I don't know that it'll be it it's gonna accelerate, but I think it'll continue to to move over time.
Speaker 3
Okay. Thanks for your time. Thanks, Steve.
Speaker 0
Thank you. And now we take our next question from Courtney Yakanovitz from Morgan Stanley. Your line is open. Please go ahead.
Speaker 3
This is Dylan coming on for Courtney. I was wondering if you kind of could first talk about the cadence of sales trends in Asia Pacific for the quarter. I think the plus 6% outcome was a bit surprising. Maybe you can just talk through where revenues troughed out in the quarter and how strong the kind of exit rate was in March. Yes.
Would say just to count on Asia, generally speaking. So if you think that we're up by six and a quarter, we were up in China year on year. So as we said, we did take the two weeks out. Probably, you know, slightly two weeks more than what we would have taken out in a typical Chinese New Year holiday, but, you know, we rebounded nicely, came back online, and and have since recovered nicely in China. And, you know, and in China, remember, that's a big chunk of our renewables renewable energy business, which was up significantly, well into the double digits year on year from renewables, which is, you know, principally Asia and primarily China within Asia.
India was India was down. We started to feel the effects of COVID nineteen at the end of the quarter, but, you know, was down last year just with the the economic situation there and was was down again in the quarter. And then, obviously, India worked through April being shut down virtually completely. So, you know, China is still relatively strong. India is coming out of the COVID nineteen shutdown.
And the rest of Asia, I would say flattish to, slightly down in the quarter. But, for us, Asia is primarily, China and India. So, you know, overall, good story, and it was really the China recovery as well as the strong growth in renewable energy. Okay. Got it.
Thanks. That's helpful. And then maybe switching over to decrementals. I know you kind of highlighted some moving pieces there, and you understand that there's a lot of fluidity in the situation. But I guess in the quarter process, you know, they were still a bit higher still a bit higher than your historical performance in that business.
So I guess the same through the trends in 2Q, you know, how much of that decremental margin performance in the quarter is still related to back end and Diamond Chain? And, I guess, to what extent can you still piece in the organization next quarter? Yes. I think it's a great question. So on so on incrementals and decrementals, mean, the first thing to keep in mind is the acquisitions and currency can skew it a bit.
So in the quarter, the organic decremental for the company was 29%. Mobile was very good at 18%. Process was around 55%. So it was it was a little higher than what we normally would run. And then a few things to keep in mind there.
The gross margins are generally higher, so process will run higher. Volume declines can have a bigger impact. We had a difficult comp last year with the with the mix. Mix was a headwind this year. With the growth in renewable energy, while it's a great market for Timken, great long term opportunity there, when renewable energy is up and industrial distribution is down like we saw this past quarter, that can really negatively impact the mix.
So those are probably the main items. But I would tell you, you know, when when you look at the mix we were running and the environment we were in, 24.4% was pretty strong considering considering everything we were dealing with in the quarter. Okay. Got it. And then maybe just the last one, then can sneak it in.
In terms of the aerospace exposure, think, you highlighted this partially in in Rob's question. But I think more dramatically, I think that market's been an area you've been targeting via M and A over the past few years. You know, has been what's going on in that market, you know, changed your mindset around that going forward? Or do still kind of do that as a more attractive vertical or looking to index towards over time?
Speaker 2
So our aerospace business said, last year, about 8% of sales, over 50 of that weighted towards, defense. And it has not been a significant part of our, acquisition strategy. It has been a significant part of our organic growth and outgrowth strategy. The commercial side of that is no doubt going to be challenged for probably quite some time. The defense side, though, on
Speaker 6
the flip side, is going
Speaker 2
be very strong and remains an opportunity for us. So I think net, it's still certainly long term an attractive marketplace for us, but definitely the commercial side of it is going to be on the line.
Speaker 5
Hi. Thank you for taking my call and my I was curious, now that we're a month into the quarter, you are starting to see a little bit better trend sequentially. I know they're tenuous, but still offset with the cost actions. Do you feel the company at a net income level will be profitable in the second quarter?
Speaker 2
Well, I think you could say that. You'd have to pick a revenue number, which we're not ready to do. If we stayed on the trend lines that, we talked about and April was the bottom, the answer would be yes. But you said, we could certainly be, worse than that going forward as well. So I think we the answer that is we could be profitable under quite a wide range of scenarios, but not certainly not all scenarios.
And we have customers that, have had no revenue for six weeks at a time. And, certainly, if something like that were to, evolve for Timken, that would be a challenge. But if the trend lines stay positive, yes.
Speaker 5
And that's all I was trying to sanity check. What we saw in April, the recent improvement, if that trend continues, not not step up, but not a double dip, that would be a profitable scenario for the company in 2Q. I just wanted to make sure about that. That's really my only question. Thank you so much.
Speaker 3
Thanks, David. Thanks, David.
Speaker 0
And now we take our next question from Justin Bergner from G Research. Your line is open. Please go ahead.
Speaker 6
Good morning, Rich. Good morning, Phil.
Speaker 3
Good morning. Hi, Justin.
Speaker 6
Two questions on my end. Most others have been answered. You mentioned the change in the compensation, I think, second quarter versus first quarter that you're expecting given the temporary actions. Could you repeat that? And is that for all salaried all both salaried and hourly folks or just salaried individuals?
Speaker 2
The comment was 25 expect compensation to be down 25% across the company in the second quarter, and that would include salary and operative. If the and that again assumes that we have a fair amount of our production idled in May and June. Actually, if that got better, that would come back up. But the salary and SG and A side, would expect to be down 25% year on year in the quarter regardless of how the demand plays out from here on out.
Speaker 6
Okay. Thanks for clarifying. The other question was regards to price cost. Looking at the adjusted EBITDA bridge in the first quarter, it looks like there was a $12,000,000 benefit from price mix. You break out the price versus mix?
And then where does material deflation to the extent that played a role fit into that adjusted EBITDA bridge slide?
Speaker 3
Yes. No, it's a great question. We don't normally break out the pricing and mix individually. But what what I would tell you is they were both positive. So pricing was positive.
Mix was positive. And, you know, we talked about pricing on the last call, and and I think at that time, we had guided directionally directionally to, you know, 50 bps ish, maybe a little bit better. We probably we're still we still expect positive pricing for the year. I mean, that's one number I can I can tell you? And we and we ran probably slightly above our full year outlook in the first quarter.
I had positive pricing in both mobile and process. So that continues to be a good story for the company. Now in that number would be material pass through where we have to give it. It tends to be on a lag, so it would be netted in those numbers. And we did see material cost favorability in the quarter.
There's a material logistics bucket also on that slide. Again, both material and logistics were positive. We don't break them out separately, but material was probably a bigger contributor in the quarter than was logistics. So I mean, it continues to be a big story for Kim Kim. As we move through the year, we expect material costs to remain depressed.
And while that may require some pass through, we're not expecting a material number, and it would more it'd be more than offset by benefits we get on the material line.
Speaker 6
Got it. And so if I look at the combination of price and material cost, not that that's exactly quantifiable given how you break it out, I mean, that price versus cost benefit in the first quarter be expected to sort of propagate through future quarters this year at a similar level?
Speaker 3
Well, I'm not know, I probably hesitate to to comment on that, but, I mean, we would expect price cost to be I would say we I I just told you price will be positive for the year, and I think we'd expect cost to be positive as well. Now to that magnitude or not, probably TBD, but, but positive.
Speaker 2
Yeah. I think, you know, there's the the mix is I just caution on that. The mix has changed so much and is is a part When you, again, you have India close to zero revenue, automotive close to zero revenue and some other things up, that wasn't really factored into the price outlook. So I agree with Phil, it's going be positive for the year, but the magnitude is is also gonna be dependent on how the mix shakes out.
Speaker 6
Okay. Thank you for taking my questions, and best of luck in the coming months.
Speaker 3
You.
Speaker 0
Thank you. And now we take our next question from Michael Sanitary from Bank of America. Your line is open. Please go ahead.
Speaker 4
Hey, guys. Yes. Just a quick one. I think you mentioned if there's a if we do see that step down in demand, you would examine more structural cost saving measures in in the second half. You guys have done a whole lot of on the cost savings front over the years.
Can you just remind us the structural cost you guys have really removed in twenty eighteen, nineteen? And if you do have to take out more, is there still low hanging fruit out there for you guys to address? Or are you cutting into
Speaker 3
the bone at that point?
Speaker 2
Yes. I would say we've been targeting 1% net a year and largely been getting that. And that has been the biggest contributor to that has been our manufacturing footprint. And we came into this year with a couple of large projects there, the acquisition of Diamond Chain. We've announced some manufacturing restructuring there.
We've announced manufacturing restructuring within our bearing operations. So that's a significant contributor. And we look to do that up or down markets. But certainly, we look to accelerate. Our digital platform has been a big driver of efficiency.
We took a couple systems offline last year and consolidated them onto our primary digital platform. We have our material savings, some of which is structural, some of which is cyclical. The cyclical part of that looks pretty good right now, but we also did some structural part. And then I would also say there's the integration acquisition synergies as an example with Grondel and Beko. We've already made significant progress on consolidating the regional structures within those two businesses and have some cost savings from that as an example.
So the one percentage number is kind of what we'd be targeting this year. To your question on cutting bone, we're certainly still more focused long term on growing the business, and and we'd look not to cut bone. We'd look to make moves that make us better when we're down and make us stronger when we're coming back up.
Speaker 3
Okay. Thanks. Thanks, Mike.
Speaker 1
Yes. Thanks, everyone, for joining us today. If you have further questions after today's call, please contact me. Again, my name is Neil Pronappel, and my number is (234) 262-2310. Thank you, and this concludes our call.
Speaker 0
This concludes today's call. Thank you for your participation. You may now disconnect.