Timken Company (The)

Good morning. My name is Anna, 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 Tin Can's second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, Simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press star then the number two on your telephone keypad. Thank you. Mr. Frohnapple, you may begin your conference.

Thanks, Anna, and welcome everyone to our second quarter 2020 earnings conference call. This is Neil Frohnapple, Director of Investor Relations for the Timken Company. We appreciate you joining us 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 Fricasa, our Chief Financial Officer. We will have opening remarks this morning from both Rich and Phil before we open up the call for your questions. During the Q&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 Timken Company and without express 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.

Thanks Neil, good morning everyone and thanks for joining us today. Given the environment, I'm very pleased with how Timken has responded to the global pandemic this year and how we delivered in the second quarter. We've kept our facilities safe places to work, we've responded quickly to the restrictions and guidelines set by government and health authorities, served our global customers with a reliable supply of products, and we've kept the company financially strong through the pandemic. Our revenue in the quarter was 20% down from 2019's record quarter of $1 billion. This is better than we anticipated when we held our last call on May 1st, as our business bottomed in April and improved sequentially through the quarter. On that call, we projected that April would be down about 30% from prior year, and we did it slightly better than that projection. From there, our business improved in May and then again further in June. By the end of the quarter, we and our customers faced minimal government restrictions. Within the decline of 20%, there were a lot of moving pieces, so let me provide some perspective on our markets. The three lowest performing parts of our business were OEMs in the automotive and heavy truck sectors and the entire country of India. All three were down over 40% in the quarter and idle much of April and May. Two bright spots for revenue were China and renewable energy. Renewables were up globally and also the driver of our strong China results. Our position in the renewable space has been built organically over the last decade and recently complemented through acquisitions. This market expansion made a material difference in our revenue results for the quarter as well as year to date, demonstrating a more diverse mix than prior cycles. Defense also performed solidly for us in the quarter. but from there essentially all of our other markets and geographies were down more than 10% from prior year. June sequential strengthening was led by the markets that were hardest hit in April and May like automotive in India. There were some exceptions like commercial aerospace which weakened for us as the quarter progressed but the sequential strengthening through the quarter held for most markets. Moving from revenue to profits, we made $1.02 per share in the quarter on over 20% EBITDA margins. Through the course of the quarter, we took a variety of significant cost reduction measures to react to the decline in customer demand. The majority of the cost reductions in the quarter were temporary, including cuts in discretionary spending, furloughs, and reductions in compensation. We also accelerated efforts to reduce structural costs going forward, which I will talk more about in a moment. We focused heavily on cash generation and took significant actions in the quarter to produce less than demand, which resulted in an inventory reduction of more than $40 million in the quarter. Receivables came down with revenue, and when combined with inventory reduction in EBITDA, we generated over $220 million in free cash flow for the quarter. It was a very strong quarter on cash flow, with the expectation that we will continue to generate strong cash through the second half. We also took steps to bolster our liquidity and balance sheet, which I will let Phil elaborate on later. The results from the BEC acquisition also contributed to the quarter, helping the top line by about 3% at EBITDA margins, below the company average, but above the pre-acquisition levels, despite the impact from COVID-19. The BEC integration has continued through COVID, and we expect further margin expansion again next year, as we target to be at 20% by the end of 2021. While stability in our markets has improved significantly since our call on May 1st, uncertainty remains elevated, and we are not providing revenue or earnings guidance for the second half of the year. I will provide some color on July and what we are seeing short term. First, just a reminder of our normal seasonality. The last five years, we have averaged a 4% organic sequential decline in revenue from the second quarter to the third, and then another 2% from the third quarter to the fourth. So even though the second quarter of 20 was particularly weak, many of our normal seasonality headwinds still exist as we look at the second half. At this point, we do not see a snapback scenario in the third quarter or the second half. We are planning for revenue to be below 2019 levels for the rest of the year. July revenue is holding at roughly June levels, which is better than normal seasonality, but is also not another step change in sequential growth like we saw in June. As we look at demand in August and September, our best estimate for third quarter revenue is to be between flat and up mid-single digits for the second quarter, which when seasonality is factored in, would be a solid sequential revenue result and imply that our markets are continuing to recover but would remain well below 2019. And I would add there remains more variability in that projection than normal as customers continue to adjust their operating plans and inventories. From a specific market standpoint, I would say we are not seeing any major changes in in-markets in July or the third quarter from June, except for U.S. Automotive, which is expected to be stronger as the channel restocks after an extended shutdown. From a profitability standpoint, we expect second half EBITDA margins to be solid, but to be down from first half margins. There are several factors in this projection. The first give me the normal seasonality including this year's first quarter only being modestly impacted by COVID-19. This will be an impact company even in margins in the second quarter were helped by process revenue being down much less than mobile revenue and that gap narrows in the second half as mobile markets recover. Temporary cost reductions in the form of furloughs and pay cuts will decline significantly in the second half from the second quarter. We are still managing discretionary spending tightly and we took further temporary actions in July, but the actions are smaller and more targeted than they were in the second quarter. Moderating temporary cost actions will be partially offset by the ramp-up of structural cost actions. Late in the second quarter, we began moving from furloughs to workforce reductions to reflect the new realities of demand. Our company-wide employment has been reduced by over 1,000 since the first of the year, with a reduction of about 300 more expected this quarter. We are also accelerating footprint initiatives, right-sizing plant staffing levels, and accelerating other cost and productivity measures. These measures are expected to generate $50 to $60 million in year-over-year benefit in the second half of this year. A few examples of our many cost actions include Two large plant rationalizations already underway along with the consolidation of several smaller operations across our footprint. Acquisition synergies including sales force and geographic consolidation between Becca and Groeneveld Lubrication and business consolidation between Drives and Diamond Chain. And we continue to leverage our digital platforms for improved productivity This quarter, we are adding our ABC bearing acquisition to our ERP system, which will further simplify our business systems across the enterprise. Within the $50 to $60 million in cost reduction actions, some of these initiatives are already in process, some are being pulled ahead, and some have been launched directly in response to new realities of demand. Finally, impacting second half margins, we plan to continue to reduce inventory through the remainder of the year. The magnitude depends on how revenue develops, but we plan to underproduce the actual demand through the balance of the year. Again, we will deliver solid margins in the second half, but below the first half. From a cash flow standpoint, we expect cash flow from operations for the rest of the year to be strong under a wide range of demand scenarios. Our capital allocation priority for the remainder of the year after CapEx and the dividend will be to reduce debt. One final comment for the outlook. While the virus and government reactions could go many different directions in the coming quarters and could continue to be a drag on global industrial demand, we think the risk of repeating widespread shutdowns across our markets is relatively low. The current focus of governments on travel, hospitality, entertainment, and large gatherings has minimal short-term impact on us and our customer base. In regards to the longer-term outlook for Timken products, we continue to believe that the long-term changes that arise from the post-pandemic world will have a relatively small impact on our value proposition and the demand for what we do will endure and grow. Summary, the second quarter was extremely dynamic and challenging, but Timken employees responded, we kept our operations safe, we took care of customers, and we kept the company financially strong with solid earnings and strong cash flow. Relative to the environment, we executed extremely well. And while uncertainty reigns elevated, Timken will continue to deliver results through the pandemic while advancing the company to the better times that will inevitably come. And with that, I will turn it over to Phil.