The Timken Company (TKR) Q1 2020 Earnings Report, Transcript and Summary

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 Timken's First Quarter Earnings Release Conference Call. [Operator Instructions]. Thank you. Mr. Frohnapple, you may begin your conference.

Thanks, Anita, and welcome, everyone, to our first quarter 2020 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 Fracassa, 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. [Operator Instructions]. 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 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.

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-19 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 2 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 2019. The acquisitions of BEKA 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-19 issues we are facing, but after 6 months of ownership, we remain very optimistic about the potential of this acquisition and the synergies with Groeneveld. Again, it 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 3 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 beginning of March, we were experiencing a modest revenue and production impact in Italy. And by the last week of 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 2 weeks of March, we had 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, Timken 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 3 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. U.S. has been about 3 to 4 weeks behind Europe in regards to impact, and we've been hovering around what appears to be a bottom for the last 3 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. And India was close to 0 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 a 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. I'll 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 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 the 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 taken 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 Timken 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 assure 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. As I said, we are prepared for 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 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 levels 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 million. 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. But we will slow further if the recovery is slower. We came into 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 employee 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 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, the Timken 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 have 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.

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-19, and you can see a summary of our results for the quarter on this slide. Revenue for the first quarter was $923 million, 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-19 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-19 across the globe. Acquisitions added nearly 5% to 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 outlined 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-19 shutdown in early February, and we saw solid growth in renewable energy in the quarter. In North America and Europe, we were down 13% and 12% respectively, as most sectors were down across those 2 regions in the quarter. Our operations in North America and Europe were both impacted by COVID-19 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 million or 19.2% of sales in the first quarter, compared to $202 million 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-19. 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&A expenses. In addition, recent acquisitions contributed $8 million to EBITDA in the quarter or around 16% of revenue, a nice step-up from the fourth quarter. BEKA performance improved significantly as our team continues to integrate this acquisition and drive cost synergies. Let me comment a little further on manufacturing and SG&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-19. Unabsorbed fixed costs drove most of the negative variance in the quarter. And SG&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 million or $1.06 per diluted share for the quarter on a GAAP basis. This includes $0.05 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-19 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 $0.84, 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 look at our business segment results, starting with Process Industries on Slide 15. For the first quarter, Process Industries sales were $457 million, 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 Timken, 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 million or 24.4% of sales compared to $131 million 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&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 million, 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 million or 16.3% of sales compared to $84 million 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 and a challenging environment. Turning to Slide 17. You'll see we generated operating cash flow of $56 million 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 million, 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 391st consecutive quarterly dividend and repurchased 1 million 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 million to $18 million 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 2019. 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 strong investment-grade balance sheet and $388 million of cash on hand. Our net debt to adjusted EBITDA was around 2.2x 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 2023. Note that we drew $350 million 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 million as of that date. We currently expect net interest expense in the range of $65 million to $70 million 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-19 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 want to remind you that we previously withdrew our sales and earnings guidance due to a significant uncertainty caused by COVID-19. 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?

[Operator Instructions]. We'll take our first question from Rob Wertheimer from Melius Research.

So thanks for all the detail in April. I think anything that helps to clarify this uncertainty. And in your case, anyway, it was...

Rob, are you there?

I think that probably has a lot to do with what you've done in mix, obviously, a lot of hard work over the years. So just a question on [indiscernible]

Rob, not to interrupt you. You broke out for about 15 seconds. Could you potentially -- could you start over, please?

So anyway, I guess what I was saying is that the color on April is very, very helpful. It just reduces uncertainty, and 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 in the years. I wondered if you can just look at either '09 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? Just 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?

Yes. I think there's certainly -- 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 over the course of the next 2 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 -- I've been said, there still are some things that are going to go down probably even in that scenario, but they would tend to be smaller parts of our business than the ones that I rattled off. So I think that would be a net positive. But I would also say we've been in an environment for the last 60 days that we're on a conference call at 8:00 at night and looking at India results and saying, look, India looks good, and we can count on that. And we get up at 8:00 the next morning and have an e-mail that the Indian government shut down our customers for 3 weeks. So I think we're still living with that level of bandwidth. Still with 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.

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 minority of it versus rotorcraft or whatever? I mean, is that a major pool or just one that you noted could come [indiscernible]

No. We're disproportionately weighted towards defense. So last year, of our 8% aerospace, over 50% of that would have been defense. So say, 3-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.

And now we take our next question from Michael Feniger from Bank of America.

Great color so far on what you're seeing on the ground. When you say customers are not stocking right now, that they're waiting to see what the recovery could look like, I'm just curious, is the inventory levels that the customers are holding, is that you feel like contingent on demand getting back to a pre COVID-type level?

Yes. I think we were -- many of us -- net, our markets were -- many of our markets were 3 to 4 quarters into a cyclical contraction already. And we guided to start the year down year-on-year, in the first half year-on-year. So I think inventory levels are in line with a single-digit decline in year-on-year revenue. And if we were to return to those types of levels, a 5% to 9% down sort of thing, then I think inventory destocking is factored into that for us. If we don't recover those kind of levels, and we're more 15% to 20%, then we would have some more pain to come in regards to inventory destocking. Does that get your question?

Yes. That is helpful. I mean do you have an idea -- I mean I know it's difficult because you guys have so many markets. Do you have an idea though that where -- is that more just a comment on like the distributors, Rich? Are you guys seeing that? I mean for example, like your auto customers or distributors in auto, have they already adjusted their inventories, assuming a lower level of demand?

Well, auto would be the -- auto and truck OEM at 13% to 15% of our business would probably be the exception where there's very little inventory between us and those customers. Now they had inventory, so they still had -- that would affect them. But we have very fast delivery and responsive delivery. So that -- but beyond those 2 markets, I would say my comments apply to more than distribution. So we took a lot of destocking activity in the second half of last year in our 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 -- generally, almost all of our markets with a few exceptions of where the inventory is quite tight between us and the customer.

Fair enough. And you said how Europe meaningfully bounced April off the lows of March, which is good to hear. You might have said this before, but how much of that is -- how much of what you see -- saw on April is down year-over-year in Europe versus where it was last year? And then can you also address -- you 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 maybe some secular shifts then gaining share and those end markets just holding up much better?

Yes. There's probably quite a few different answers on that. That was maybe 7 or 8 questions. I'll hit a few of them. I certainly think in some of those markets that share, certainly, we think over multiyears, wind, solar, marine, we have taken share. Also, those are markets that have not been negatively impacted with the exception of some like -- some of our production issues that we had in China, obviously, negatively impacted it. But order backlog remains strong, is well out into the future. And so that would be a combination of market dynamics as well as multiyear Timken 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 3 weeks were almost double what we were during that 1 period. So and for 3 weeks, quite a few of our customers took 1 to 3 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, 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 U.S. But again, some of the markets that are extremely depressed levels, almost half the uptick sometime here in the next few weeks off those low levels.

Yes. I think it's safe to say, Mike, that the Europe, while as Rich said, we bounced back up, we're still down year-over-year.

Yes. And just lastly, guys, you mentioned oil and gas. Can you just remind us your exposure to the oil and gas market? Just quantify it and where it is [indiscernible]. It's clearly small.

Our exposure is quite small. It used to be higher maybe 10 years ago. Never -- obviously we've grown other parts of the portfolio. In a good market, less than 2% direct. And there's some indirect ramifications of that in other markets like metals and transportation, et cetera. But direct, it's a pretty small bearing in the power transmission market.

And now we take our next question from Chris Dankert from Longbow Research.

Sorry if I missed it, Rich. Did you comment at all, and then I'd understand if you'd 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.

Yes. Just, I think -- Chris, this is Phil. I think as Rich mentioned on -- he did mention in his opening remarks, we do expect April sales to be down north of 30%. And while we have started to see some recovery in regions like Europe and are expecting North America to bottom here in the near term and India, India probably have already just bottomed. We do expect it will be down over 30%.

Got it. Okay. That's what I thought I heard. 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 a decremental margin near 30%? Or just kind of how should we think about the cost structure of the business in this down cycle versus last?

Well, in the second quarter, we've taken a lot of temporary cost actions to align with what we expect to be, together, 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 wouldn't have had time to make structural changes, et cetera. s you look out the third quarter, if we were to conclude that we expected 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, our decrementals probably would have been worse, the speed and the depth. But again, we've taken some pretty significant actions here in the second quarter.

Yes. I would just add, Chris. Tough for us to guide the decrementals, obviously. But we're working real hard to manage the decrementals. We're a 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 the bottom from a revenue standpoint. We also expect price cost to remain positive. We're going to 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, et cetera, it's tough for us to guide to a specific number.

Yes. Yes, absolutely. Appreciate the difficulty there. But 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 maybe excepting 2Q? Any thoughts there would be great.

Certainly, on receivables, as revenue declines, we expect to liquidate, if you will, a significant amount of cash from receivables, and we're managing that tightly. From an inventory standpoint, this significant of a decline in demand, it takes some time to turn the inbounds 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 60 days here in reaction to our customers' plans and intentions to the levels we're at in March and April we will not stay at. And as you look out in the second half, we would expect to rightsize our inventory with where we think the demand levels out at, which, again, we're not ready to call as we sit here today.

And now we take our next question from Joe O'Dea from Vertical Research.

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?

No, I think the challenge with ranges is right. You have to start with the revenue number and then get to an EBITDA number and then go from there. We're not particularly -- 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 2, 3 quarters. There's some natural hedge there that if EBITDA is under more pressure, we believe our cash conversion will be better. And if EBITDA is better, then obviously, we get the higher benefit of the starting point. So the focus will be on conversion, staying flexible. And we will react to -- with the working capital, CapEx and costs and spending proportionate with where we see the demand shaking out in the second half.

Okay. And then on distribution, I guess, primarily 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?

In North America, inventory was essentially flattish. And I would say, again, with the lags you go back North American distributors didn't feel a lot of the COVID-19 impact. And 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 end of 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 remarks, they will reduce inventory, and we will see some impact from that. But that has not happened through April.

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 sitting here today, based on what you're able to see, it does look like some stabilization of those declines?

No, I would not -- I would say that's one that we would probably have less visibility on that because it's been later. And -- but it's also less deep to your -- one of your opening comments, they -- obviously 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 in some cases that are going to 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 again, as you started the month, it would even be less than that. So it's too early, I think, to predict which way that goes.

And now we take our next question from Steve Barger from KeyBanc Capital Markets.

I know there's less inventory in other 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 dates so suppliers produce in front of that? Or does the OEM restart with inventory on hand and then the supply chain follows?

I would say, as you said, in 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 -- they've taken a week out here, a week out there and more, hey, we're going to push these orders out a week and everything in between. But generally not -- I would not say synced up. And again, when you look at the fragmentation of our markets and then our applications, the complexity of that is in thousands and thousands and thousands of part numbers. It would not be nearly that clean, and there would be an inventory buffer in between most of those supply chains.

Got it. So we'll see the OEMs turn on before they start pulling from you probably?

Yes. Although in most cases, I would say they have continued to pull, just at lower levels. So outside of auto and truck that we have not had -- well, in countries, India and Italy, we have not had OEMs and other industries shutting down for 2, 3, 4 weeks at a time. It's been more -- we're taking a week out. We're going to build less of this. We need less of that. It's been -- but generally, there have been pulls.

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?

I would say it is -- the long term, it's certainly, you 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 will be anything that we would point to.

Okay. And then last, just more of a philosophical question about we've had the combination of tariffs and now the virus. Do you think this changes supply chain? 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?

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 view would be more so on that one, 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, 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 the tariff situation and the virus has certainly -- certainly will accelerate. People not want to have all their eggs in 1 basket, for sure. And I think that was already happening to some degree. And -- but again, most of our customers have some diversity there. So I think the short answer to the question will be, yes, but I don't know that it will be -- it's going to accelerate, but I think it will continue to move over time.

And now we take our next question from Courtney Yakanovis from Morgan Stanley.

This is [indiscernible] 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 dropped out in the quarter and how strong the kind of exit rate was in March?

Yes. I would say, just to comment on Asia, generally speaking. So if you think that we're up by 6.25%, we were up in China year-on-year. So as we said, we did take the two weeks out, probably slightly 2 weeks more than what we would have taken out in a typical Chinese New Year holiday. But we rebounded nicely, came back online and have since recovered nicely in China. And in [indiscernible] 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 principally Asia and primarily China in Asia. India was down. Started to feel the effects of COVID-19 at the end of the quarter, but it was down last year just with the economic situation there and was down again in the quarter. And then obviously, India worked through April being shut down virtually completely. So China is still relatively strong. India is coming out of the COVID-19 shutdown. And in the rest of Asia, I would say flattish to slightly down in the quarter. But for us, Asia is primarily China and India. So overall, a good story, and it was really the China recovery as well as the strong growth in renewable energy.

Okay. Got it. That's helpful. And then maybe switching over to decrementals. I know you kind of highlighted some moving pieces there, and I understand that there's a lot of fluidity in the situation. But I guess, in the quarter on the Process, they were still a little bit higher than your historical performance in that business. So I guess looking through the trends in 2Q, how much of that decremental affected performance in the quarter is still related to BEKA and Diamond Chain? And I guess, to what extent can you sell-through some utilization next quarter?

Yes. So I think it's a great question. So on incrementals and decrementals, I 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 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 mix. Mix was a headwind this year. With the growth in renewable energy, well, it's a great market for Timken, great long-term opportunity there. When renewable energy is up and the 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, when you look at the mix we were running in the environment we were in, 24.4% was pretty strong considering everything we were dealing with in the quarter.

Okay. Got it. And then maybe just the last one if I can sneak it in. In terms of the aerospace exposure, I think can you highlighted this partially in Rob's question. But thinking more thematically, I think that market has been an area that you've been targeting via M&A over the past few years. Has the look on in that market changed your mindset around that going forward? Or do you still kind of view that as a more attractive [indiscernible] index towards over time?

So our aerospace business said that 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. That 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 the flip side is going to 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 under pressure for the foreseeable future.

And now take our next question from David Raso from Evercore ISI.

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 all set with the cost actions. Do you feel the company at a net income level will be profitable in the second quarter?

Well, I think, I'd just 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 that said, we could certainly be worse than that going forward as well. So I think we answer that as 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 6 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.

And that's all I was trying to sanity check. What we saw in April, the recent improvement, if that trend continues, 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.

Yes.

[Operator Instructions]. And now we'll take our next question from Justin Bergner from G.research.

Two questions on my end. Most others have been answered. You mentioned the change in the compensation, I think, expense second quarter versus first quarter that you're expecting given the temporary actions. Could you repeat that? And is that for all salary, all both salaried and hourly folks or just salaried individuals?

The comment was 25 -- we 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 salaried and SG&A side, we would expect to be down 25% year-on-year in the quarter, regardless of how the demand plays out from here on out.

Okay. 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 million benefit from price/mix. Could 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?

Yes. No, it's a great question. We don't normally break out the price and the mix individually. But what I would tell you is they were both positive. So pricing was positive. Mix was positive. And we talked about pricing on the last call. And I think at that time, we had guided directionally to a 50 bps ish, maybe a little bit better. We probably -- we still expect positive pricing for the year. I mean that's one number I can tell you. And we ran probably slightly above our full year outlook in the first quarter, 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 good story for Timken. As we move through the year, we expect material cost 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.

Got it. And so if I look at the combination of price and material costs, not that that's exactly quantifiable, given how you break it out, I mean, would that price versus cost benefit in the first quarter, do you expect it to sort of propagate through future quarters this year at a similar level?

Well, I'd probably hesitate to comment on that, but I mean, we would expect price cost to be -- I would say we -- 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 positive.

Yes. I think there's -- the mix is -- I just caution on that, the mix has changed so much and is a part of that, right? When you -- again, you have India close to 0 revenue, automotive close to 0 revenue and some learnings up. That wasn't really factored into the price outlook. So how Groeneveld's going to be positive for the year, but the magnitude is also going to be dependent on how the mix shakes out.

And now we take our next question from Michael Feniger from Bank of America.

Just a quick one. I think you mentioned that there's a -- if we do see that step down in demand, you would examine more structural cost saving measures 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 costs you guys have really removed in '18, '19? 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 the bone at that point?

Yes. I would say we've been targeting 1% net a year and largely have 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 some 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'll look to accelerate. Our digital platform has been a big driver of efficiency. We took a couple systems off line 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 get some structural part. And then I will say there's the integration acquisition synergies. As an example, with Groeneveld and BEKA, we've already made significant progress on consolidating the regional structures within those 2 businesses and have some cost savings from that as an example. So the 1 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 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.

Thanks, everyone, for joining us today. If you have further questions after today's call, please contact me. Again, my name is Neil Frohnapple, and my number is 234-262-2310. Thank you, and this concludes our call.

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