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 Timken'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. Frone-Apple, you may begin your conference.

Thanks, Anna, and welcome everyone to our second quarter 2021 earnings conference call. This is Neil Frone-Apple, 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 comments 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 a chance 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 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 in the 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. Thank you for joining Timken's second quarter earnings call. Timken delivered a very strong second quarter with record revenue of $1.6 billion, record second quarter earnings per share of $1.37, solid EBITDA margins of 18.8%, and free cash flow of $116 million. We went into the second quarter optimistic about demand, but expecting a challenging operating environment, and both played out through the quarter. Demand continued to be greater than the ability to supply across many of our markets, with our backlog growing significantly in the quarter, despite the record revenue levels. The two areas that came in weaker than expected were India and on-highway vehicles, India due to the pandemic and government shutdowns in that country, and vehicles due to chip shortages. India recovered by the end of the quarter. Customer demand has returned to strong levels, and all of our facilities are operating fully. We expect sequential improvement from India in the second half. The global chip shortage had a significant impact on Q2 for automotive and truck revenue and will continue to impact our revenue through at least the third quarter. On a positive note, this is setting us up for a very strong 22 in auto and truck as vehicle sales remain strong and inventories will need to be replenished. Beyond those two areas, demand was very strong across most markets, including renewable energy, where we were up again double digits on a tough comp. We continued to ramp up supply, and despite the global supply issues, we grew revenue 4% from the first quarter. Orders were generally stronger than shipments, and demand for the current quarter remains very strong. In regards to the operating environment, the second quarter continued to be very challenging as we served increasing customer demand in a rising cost environment with widespread supply chain challenges. In addition to the headwinds from India and the chip shortage, logistics, labor, and inflation impacted the results for the quarter. We continued to face significant logistics delays in getting material to our operations and product to our customers. The situation in the second quarter was similar to that of the first, and we expect the logistics delays, higher cost, and higher inventory to continue at a similar level through at least the third quarter. In regards to labor, the third quarter is the first time in over a year that we are not facing any abnormally high absentee levels in any of our global operations. We expect that to hold for the rest of the year, which will provide a nice lift in the second half. However, we are in an extremely tight and competitive labor market, and we are not immune to that. In the vast majority of the locations where we operate, Timken is a preferred employer, Our retention is excellent, and we are normally able to attract new employees in a timely and efficient manner. Our retention remains excellent, but attraction of new employees in many parts of the world, including here in the United States, has become a significant challenge. We continue to make progress monthly, and we enter the third quarter at higher staffing and production levels than we were to start the second quarter. We expect labor markets to remain tight through the rest of the year and into 22, but we also expect to make steady progress in ramping up our operations. In total, the supply chain and ramp issues remain abnormally high, but they did improve through the quarter and are better today than they were three months ago. We expect them to be a headwind the rest of the year, but less of one in the second half than the first half. Inflation was also an impact in the quarter as steel and other input costs continued to We do not expect inflation to improve in the second half, but inflation in total remains manageable and less of an issue in magnitude than the supply chain and ramp costs. Overall, inflation has been increasing sequentially, and we expect that to continue through the end of the year. Price improved very modestly from the first quarter to the second, mostly due to pricing mechanisms that we have in OEM contracts to pass through raw material cost increases. In the second half, we expect price to be a more significant offset to cost than the first half. This is due to both the continued catch-up of the pass-through mechanisms as well as price increases currently being implemented. Our previous guide was for flattish pricing, and we now expect price to be 50 to 100 basis points favorable in the second half. Despite the supply and cost challenges, we took care of our customers, grew revenue 32% over last year, 4% from the first quarter, and delivered just shy of 19% EBITDA margins. Excellent results in a very dynamic environment, and one that continues to demonstrate the resiliency and strength of our business. We also continue to invest in and advance our strategic initiatives. The Aurora acquisition is off to a great start, and the combination of Groeneveld-BECA is progressing well. We will consolidate two more ERP systems to our global digital platform this year. We continue to optimize our global manufacturing footprint. Our new bearing plant in Mexico will be ramping up in the second half of the year. We just announced the closure of a small bearing plant in Italy. We completed the relocation and consolidation of our solar operations in the second quarter, and our wind investments are advancing. We're also pursuing new business opportunities and winning with our differentiated portfolio. Let me shift to the outlook. Our normal seasonality is a modest step down in revenue and earnings from first half to second half, with a significant percentage of our cash generated in the second half. We are expecting our seasonality to be more moderate this year, and we are planning for a strong second half. We expect demand to remain strong and second half sales to be in line with the first half. We expect supply chain issues and the associated costs to persist in the second half, but to be less than the first half. inflation to be modestly higher in the second half than the first half, and pricing to be higher in the second half. We expect cash flow to be good, but less than prior forecast due to persistence of the supply chain challenges, as well as working capital to support higher revenue levels. And while it's a little early to talk about 22, we are planning for the industrial expansion to continue at strong levels in the next year. Many of the macros are favorable, including supply shortages, low channel inventories, tight labor markets, commodity prices, and the possibility of infrastructure spend. It's not clear how much of the current inflationary environment is temporary versus permanent, but we are confident that Timken will perform well if inflation persists into 22. And finally, from a capital allocation standpoint, we're expecting good cash flow for the rest of the year, and we will be approaching the low end of our targeted leverage range. We do not plan to dip below the low end of our range, and capital allocation will be accretive in 2022. We continue to have a bias for M&A over buyback. In summary, Timken is in position to deliver record performance again this year, and we expect to move into 2022 with significant momentum. I'll now turn it over to Phil.