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. [Operator Instructions]. 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 Fracassa, 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. [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. 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 have 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 up our last call on May 1 as our business bottomed in April and improved sequentially through the quarter. On that call, we projected that April will be down about 30% from prior year. We did it slightly better than that projection. 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 are 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 idled much of April and May. The two bright spots for revenue were China in renewable energy. Renewables were up globally and also the driver of our strong China results. Our position in 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…

Okay. Thanks, Rich, and good morning, everyone. For the financial review, I'm going to start on Slide 13 of the materials. Timken delivered strong results for the second quarter despite the broad economic slowdown caused by COVID-19. And you can see a summary of our results for the quarter on this slide. Revenue for the second quarter was $804 million, down just under 20% from last year. We delivered an adjusted EBITDA margin of 20.4%, up 70 basis points from last year, with strong decremental margin performance. Margins were also up sequentially, and adjusted earnings per share came in at $1.02, down about 20% from last year's record second quarter. Turning to Slide 14. Let's take a closer look at our second quarter sales performance. Organically, sales were down about 20% in the quarter. Both segments saw lower sales volume versus the year ago period, while price realization was positive. As Rich highlighted, revenue improved in the months of May and June compared to the April low point. As COVID-19 interruption subsided, we began to see underlying demand improve in some sectors like automotive. Acquisitions added approximately 3% of the top line in the quarter as we benefited from the BEKA acquisition completed last year, while currency was a sizable headwind, negatively impacting revenue by almost 3%. 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're up 8%. Our sales in China increased significantly in the quarter from last year due mainly to strong growth in renewable energy, which more than offset the negative impact from India being virtually shut down for most of April and May. In both North America and Europe, we were down in the mid-20s…

[Operator Instructions]. And we take our first question from Stephen Volkmann from Jefferies.

Let's see, why don't we start -- I guess the decremental margins seem to be sort of the most eye-catching to me, and they're -- I think they're about half of what you thought they might be. So I guess I'm curious how that turned out so much better. Was there just more short-term, cost-effective actions than you had thought? Or was there something else you think that drove that? And then obviously, the question is sort of how that impacts the second half? I'll follow up and then a second.

Well, so the -- for the quarter, we didn't guide the decrementals, but I think your question is pertinent still. If you look at the first half and for the year, I would say, we believe we can deliver good decrementals. Certainly, when we were on the last call and looking at 30% down and not sure at that point that we had bottomed, our good decrementals would -- we have a little less confidence in that with that sort of magnitude. So first, I would say, the revenue sequentially improving off the bottom was the first factor. And then I would say, the second factor was, yes, more temporary cost actions. And I think we look for the full year. Obviously, the revenue and the volume will play a significant part in it, but we look for the full year to be pretty close to what we would have said, we have been in an objective for decremental margins.

Okay. So I guess as we think about the second half, will all these temporary things theoretically be done by the end of this year? And is it sort of 2/3, 3Q; 1/3, 4Q; I don't know, just any kind of way to think about that trajectory?

I think that's probably more specific than what we would intend to be. We -- as I said in my notes, we continued with temporary actions in July of pretty significant size. Definitely easing, though, in the quarter and the ones that will stretch out to the end of the year will be pretty targeted in places where the volume remains severely depressed. But we are looking at the other cost actions starting to offset that. So again, I think as you look at second half decrementals in total, we would expect to be good and full year decrementals to be good but not as good as the second quarter.

We take our next question from David Raso from Evercore.

The question relates to Process. Obviously, very strong margins in 2Q. But in your comment about 3Q that total company sales sequentially flat to up mid-single digit, how would you perceive Process to be in that? I assume Mobile is up more sequentially, but do you think Process can stay flat sequential or even up or should we think that's down? And the margin obviously was very strong in 2Q. Can you give us some guide? I would think the margin sequentially maybe comes down off that a high level. Just some idea of the sequential bump process.

Yes, David, this is Phil. I'll take a crack, and then Rich can jump in. So I think sequentially, as Rich said, best estimate right now would be flat to up single digit sequentially in the third quarter from the second. More of that in Mobile as those markets improve, so we'd expect greater contribution from Mobile. I mean Process is probably more susceptible to that normal seasonality that we might expect to see, given the fact that Process was certainly less impacted in the second quarter. So probably the best color I can give you would be more in Process -- more up in Process -- I'm sorry, more up in Mobile and then Process would be more subjected to the normal-type seasonally.

And how to digest the margin was another related question. Just given the EBITDA margin, obviously, is huge and I'm not sure how much the renewable business helped it versus savings that maybe don't repeat. I'm just trying to get a sense for that, it's almost 28% EBITDA margin in 2Q for Process.

Well, I think the Process margins would have been very good without the temporary actions. The renewables business would have contributed to a well manufacturing performance, was strong and at a high single digit type of revenue decline, we would have delivered good decrementals. But it was aided further by temporary cost actions that we would not look to continue. So I think given Phil's comment on the revenue sequentially being impacted by seasonality, take out the temporary cost actions, we would look at that second quarter Process EBITDA margin as a peak.

Okay. And the ability to keep margins up year-over-year, should we be more consistent with if organics down for 3Q process? It would be difficult to match the EBITDA from a year ago? Because obviously, this quarter was down in comparison with the down inventory with the margins up.

Yes. I think really, all we're really saying at this point, David, is EBITDA margins in the second half will be below first half. That's really all we're seeing at this point.

The next question comes from Stanley Elliott from Stifel.

Can you talk a little bit about -- I mean, inventory is obviously down for you all. I'm assuming it's down in distribution as well. How would you expect your portfolio to perform on the way out? I'm assuming you're looking at getting some shelf space with the expanded portfolio, but just curious how you're thinking about that.

Well, I think I would have said coming into the year that inventory was about the right levels for where the revenue was. As you look at The Timken Company, our second quarter revenue declined quite a bit more than the inventory. And given the flattish to up slightly outlook, we'd still say our inventory needs to come down. And therefore, our comments that we expect to underproduce, and I would say that's generally true of most of our customers as well. If they do not see demand coming back stronger, I would say, inventory levels are a little bit high. So in our short-term outlook for revenue, we are expecting inventory to generally come out of our customers' channels.

And interesting commentary on kind of going back on the offensive on the M&A environment, what are you seeing out there? I mean how quickly can my guess is that a lot of the conversations got shelved? But would love to hear what you're thinking about in terms of kind of opportunity set to expand kind of what you guys have going on.

Yes. I think the market, certainly -- the inbound market certainly slowed down and, I would say, has not returned to prior year and early year levels. That being said, our communications with our targets remains very active. And certainly, as we work to improve the performance of the business significantly through cycles, one of the objectives we have is to have a significantly shorter period between when we hunker down, if you will, in a down cycle and get back on the offenses than in the past we had uncontrolled for a long period, our troughs were deep, the cash flow was not as robust with steel pensions, higher fixed costs. And again, we're not out of the woods as we sit here today, but with net debt to EBITDA at a little over 2% with good cash flow coming, we hunker down in the second quarter. We expect to do that again in the third quarter, possibly the fourth. And I think that's the prudent thing to do right now, but we want to get back out there and do more with our cash flow long term and pay down debt at 3%. And we sit in a good position to do so and think that, that will be a differentiator of how we perform through the cycle than how we have in past cycles.

The next question comes from Joe Ritchie from Goldman Sachs.

I'd like to maybe go back to the cost out to see if I can make sure I'm triangulating all this correctly. So you guys talked about $50 million to $60 million in the second half of the year. And also the second half cost benefits stepping down. So is it fair to assume that in the second quarter you had, I don't know, $30 million, $35 million of cost benefits at least? And then how do I think about this as we kind of think through 2021 on what comes back in '21?

Well, I think it's fair to say that the second quarter would have been more than the second half number divided by two. So yes, I think your number is directionally there that the -- in regards to the temporary because we would expect it to have been more. So I think the answer to that is yes, directionally. And on '21 -- I think as you look out at '21, it's really too early to certainly get to say much about '21, as you -- we look out. Q1 will be still relatively tough revenue comp and EPS comp from where we sit. Q2 will be a low revenue comp, but a tough margin comp. And the second half is to be determined based on what happens in the second half year. But I think one of the comments I'd add on the margins through the first half as well as what we're looking at the second half as well as the comment I just made on the shorter period between getting back on the offensive with our cash flow and capital allocation, I think this is a moment that Timken has spent years preparing for. And I don't mean by that, that we've spent years preparing for pandemic because we haven't. But we have spent years preparing for our cyclicality and working to both dampen that as well as perform through it. So while we were not planning on a 20% pandemic-induced decline in revenue with significant government shutdowns in the quarter, we have spent years preparing for performing better through a double-digit decline in revenue. So while the cause is unique and the depth was maybe severe, we're ready to perform and we remain focused on performing. I think that starts for us with a better relative…

That's certainly helpful color. I guess my one follow-up since you did touch on growth, your clearly renewables has been a bright spot for you this year. I know it might be a little too early to talk about 2021, but it would be helpful to have some context for how to think about that end market for you over the next 12, call it, 18 months? And then conversely, aero was also a surprise this quarter as flat. How are you thinking about that end market over the next, again, kind of like 12 to 18 months?

So on wind, second half of the year, expected to continue to be up double digits. Long term, expect it to continue to become a bigger part of the portfolio and expect this to have a broader product offering and the secular growth trend of that, I think remains very strong. That being said, there will be some level of cyclicality and pauses and booms in that market. So not ready to call '21 on that. But '20, including the second half, is going to be an excellent year of top line growth. On the aerospace side, as I mentioned, commercial aerospace, which was a few percent of last year, it was a few percent of the company's revenue that softened for us sequentially through the quarter. And is a headwind for us still going forward, probably some further declines coming there. But again, it started at 3% of sales and is already below that. So pretty cautious outlook there. On the commercial side, we are slightly bigger on the defense side and remain bullish on that, not a high-growth market for us, but a stable one and expect to have a good year, mid-second half and a good outlook there as well.

Next question comes from Joe O'Dea from Vertical Research.

First, I just wanted to touch on the $50 million to $60 million of back half savings. It sounds like some of those actions were underway already in the quarter. And could you talk at all about if it's $12 million to $15 million quarterly run rate, how much contribution you got from that in the second quarter?

Let's say, we come into most years targeting roughly 1% of revenue. So we came into this year, call it, a $35 million cost out target. So we would have delivered that in the first half and have roughly that left in the second half. So the $50 million to $60 million, if I take off $15 million to $20 million, that was kind of probably in the hopper and things that were going to happen and then the rest, again, things that we have done either accelerated, expanded and/or initiated as a result to -- of the demand situation to increase the number significantly up to the $50 million to $60 million. But there certainly would have been an outlook -- some run rate, but the $50 million to $60 million is new as you look at the year-over-year numbers.

Got it. And then can you give any context on distribution experienced through the quarter and July? I'm just trying to understand how far you saw that come down and where that may be run rating right now.

First, I would say, to the earlier question on inventory, we did see a reduction in inventory in the quarter and another reduction in inventory in July within that channel. And I would say, that is a market that was a little later to be impacted as we talk about U.S. distribution, a little later to be impacted and probably weakened, is still at a level of greater than 10% down. That would not be the case in other parts of the world. In China, the distribution business is pretty strong. In Europe, it was down significantly back in the March, April time frame and has rebounded off that. But I would throw it in with the group of markets that remains in a greater than 10% down level.

Perfect. And then just wanted to ask the renewables and the strength that you're seeing this year, the degree to which you think about that being a tough comp next year or the degree to which maybe we saw this step function move in 2020 on the horizon, but if that's more of a sustainable base? Obviously, there's some cyclicality comments, but that it's not so much but a lot happened in the year that -- and that it's not a reflection of the underlying kind of revenue generation capability.

No, I think it is a recognition of the underlying revenue capability, and I certainly do not see 2020 being the peak. And again, that said, I'm not calling whether 2021 will be up or down off that number. And it certainly is a tough comp to sustain and grow off of back to back to back. But you believe it is a long-term sustainable number that we can continue to build off of.

The next question comes from Robert Wertheimer from Melius Research.

So I have two questions. One is a real small one, but are you seeing any differential trends in Europe versus North America, just given the different progression of the virus? Or are things relatively stable between the two?

U.S. automotive is definitely stronger than European automotive and was weaker in April and May. So I think that would be 1 outlier. And then I would say, after that, they have -- sit here today, they've caught each other and somewhat normalized, whereas there was a timing element as the virus and government issues worked their way through the world that Europe went down earlier and came back -- and went down more and came back. But I would say, they're at relatively close levels today.

That's helpful. And then Richard, I just really wanted to ask a question about Process and acquisition. You've obviously done good things with the mix and some steady deal flow, and things are pretty disruptive right now. I'm curious about whether the virus is a hindrance to getting aggressive next year, whether it's due diligence or otherwise, whether you're keeping active with sellers and people talking and so forth. Just questions on the pipeline, the Process and whether that continues to be robust or whether we have to wait for a real clear out of the virus before you can really execute?

No. I think if the virus situation stabilized with where we're at, we could get back active with that. I mean we aren't traveling anywhere near the degree that we used to, but certainly have the ability to travel and do due diligence. So I -- clearly, there's a risk of it that could pause. And if government restrictions came up more on those sorts of things, but I think we could do that. I think our comments today are one more of a cautious approach to making sure we have a stable market environment, stable EBITDA before we go back on the offensive. I think the other challenge when we do get back into that is both buyer and seller feeling comfortable with what the trailing revenue and EBITDA looks like versus the forward because of the magnitude of disruption that's happened in many of our markets over the last 5 or 6 months.

The next question comes from Ross Gilardi from Bank of America.

Just another question on renewables. Where do we finish the year given what's going on with the different end markets? I mean can renewables be 10% of total sales, 20% of Process for all of 2020, when all is said and done, given what you're seeing now?

I think over 10% -- slightly over 10% is within range, which would put it at close to 20% for Process.

Yes. Ross, through the first half, obviously, selling markets in Mobile being down. But to the first half, renewables would have grown around 12% of sales for the company. And as you know, you've covered us for a long time, and that's up from 0, 10, 15 years ago, so quite a remarkable growth trajectory for us.

Okay, we will talk more about wind because it's been a part of our portfolio longer and is bigger. But the solar side of the business that really came with Cone Drive acquisition has really performed very strong as well.

So when you talk about product diversification opportunities, I think you mentioned that in your comments. Can you elaborate a little bit further? And are those organic opportunities or just things that you see that could be acquired?

But certainly with -- obviously mentioned the Cone Drive acquisition really put us into solar, I mentioned at the time, the BEKA acquisition put us into automatic lubrication systems in renewable energy, which we were not in. So that's a nice addition. And then we do have a couple of organic initiatives beyond bearings that we are working on. Obviously, those take a little bit longer. And then we continue to build out, I'll say, the range of products that we have and the capabilities that we have within the bearing space. So a combination of all of the above.

So just when you add in your other less cyclical end markets, I mean you guys have got some, I think, some food and beverage exposure. And maybe you could just elaborate on that, too. I'm just trying to get a sense of the end market mix has obviously changed very dramatically over time in terms of like less cyclical and, I mean, certainly, renewables would have cyclicality to them. And so with all of your end markets. But what else would you put in that less cyclical category? And what portion of Process will that account for by the end of the year, given what you're seeing now?

Yes. Phil mentioned the renewables being already double digits for the first half. Marine definitely has a -- for us is essentially defense for us and has a very different cycle and is one that we have been growing and at a slower, steadier cadence than renewables, but a good cadence and one that we feel good about for the -- for several years forward. I would say, the defense side of bearings, which again, a small few percent, but that definitely has a different cycle. And then after those, I think we have built several sub-3% parts of the portfolio that cycle very differently that probably collectively get you close to double digits, but they're not at scale yet that those other three would really be something that you could point to, had a meaningful impact on offsetting construction equipment or mining equipment market softening. But it definitely is having an impact. And again, when you look at how rough the numbers were in the second quarter for automotive, truck and India to be down 20% is, I think, a pretty good indication of the improved strength of the portfolio.

The next question comes from Steve Barger from KeyBanc.

The company is obviously operating really well right now. So as you look across product lines or geographies, are there any unusual opportunities for growth or share gains, whether it's competitors struggling with the service levels or customers accelerating design changes to take share?

I'd say, we're focused -- on the OEM side, I would say, the answer to that is largely no that these are things that are happening over a long period of time and are usually not event-driven. I would say, the positive side of that, though, is we and our customers have all continued on with that slowdown, but not a lot of slowdown and has gone from doing it virtually, and our application platform side there is as active as it's been. So I think the good news is it's not been slowed really by the pandemic, but I wouldn't say OEMs, if anything. I think there's probably less impetus to change suppliers in today's environment without being able to travel and interact in person with folks. So I think that's, I would say, probably the answer on that side is no. In the aftermarket, there's always some with product availability, and there's certainly been some minor product disruptions of being able to get things around the world and in the regions. But I think it's probably too small for us to point to in our results or looking forward. So I would say much more business as usual focused on winning platforms and winning our disproportionate share in the aftermarket and the fragmented parts of the market.

Understood. Can you talk about global rail and, specifically, North America? Are you seeing activity pick up at all given some sequential increases in rail traffic?

No. I would say, that's one of the markets we have a fairly rough -- North American rail specifically have a fairly rough outlook on to the second half. That being said, there's some other parts of the world like India rail, which was a good market for us and one that was way down in the second quarter that we would expect to be better in the second half. So there's some offsets. But no, North American rail would be for us in that greater than 10% down category.

The next question comes from Courtney Yakavonis from Morgan Stanley.

Just on the comment for second half EBITDA margins to be down, could you give us any color just on third quarter versus fourth quarter, because I think historically, third quarter tends to be in line with the second quarter margins, given those sales typically sequentially do fall in that third quarter? And then conversely, should we expect fourth quarter to maybe be a little bit more stronger than seasonality would imply because more of those permanent cost cuts will be rolling through, but any guidance you can give us there would be helpful.

Yes, Courtney, this is Phil. I mean all I would say is I think we're going to have to limit it, too, again, expect second half EBITDA to be lower than the first half. But as you think about third and fourth, I think what I would tell you is you've got the phenomenon of the seasonality from third to fourth, as Rich talked about. Then you've also got the offsetting impact, if you will, of the cost reduction actions, which as they ramp in, it may be a little bit more back half weighted than fourth quarter weighted than third quarter. So you have a little bit of a put and a take there. But -- and that's probably about as far as we'll be able to go on that.

Okay. Understood. And then just on APAC, I think that was kind of obviously improved from the first quarter, but up pretty constant high single digits, even though it's being dragged down by India. So could you just comment on that region? Is that an area where we could see growth up double digits in the second half? Or are we seeing any plateauing in China after, obviously, renewable growth there?

Yes. I think the way to frame up Asia would be, if you take, obviously, for us, China and India are the biggest geographies, but we also have Australia, Asia and other parts of the region. But China was up significantly and that was led by renewable energy. So a lot of the commentary around renewable energy. Keep in mind our business is principally -- it's global, but it's principally in Asia more than anywhere -- I mean in China more than anywhere else in the world. So China would benefited from that. I'd say, the rest of the markets in China were by and large, collectively, kind of flattish as that economy, as Rich was talking about, the timing of recovering from COVID, China is clearly ahead of everybody else. So the rest of the markets were plus or minus kind of in that sort of flattish range which helped. And then India was absolutely very severely impacted, obviously, the country being shut down for most of April and May, really impacted us significantly. So as we look at moving ahead to the second half, Rich talked about renewables, I think we will see some market improvement in India as we move from second quarter into the rest of the year. That's part of the commentary around second to third sequential revenue improvement. India will be part of that certainly. And so I do think Asia can continue to be a bright spot among the regions for Timken.

And our last question comes from Chris Dankert from Longbow Research.

I guess, first off, more of a clarification, and sorry if I missed it. But are the permanent savings targeted more at Mobile, I'd assume? And then I assume it's also more Americas and EU. Just any details you're able to discuss at this point?

More Mobile and Process and I wouldn't probably want to comment on the geographic part of it.

Fair. Fair. And sorry to ask another one on wind. But I guess, since it's such a big piece of the growth here, how often are these things serviced? I mean what I'm thinking about the big main rotor bearing, is it a kind of a 5- to 6-year time frame, 10, 15? I know it varies a lot, but just to give us a sense for what the repetition is on some of these earnings. And then is it still more bearings content versus lubrication? Any kind of details there would be great.

Yes, very heavy bearings, still small than the other product categories, but opportunity for us there. Definitely, hopefully not 5 years because the warranty periods are typically 3 to 5 years. I would say, more like double digits, so get out 10. So I mean, for us, it's very, very heavy OEM mix because we haven't been in the market that long, but expect that over the next decade to 2 decades to become a better mix of aftermarket and OEM, but it's probably still 5 years from now before we're talking about the aftermarket in a sizable way.

Got it. Got it. That's extremely helpful. If I could just sneak one last one in. When we're thinking about India, obviously, April, May, really, really tough, but just exiting the quarter maybe or early July, I guess, what kind of a run rate were we seeing in growth for India, specifically?

I would say, still down double digits year-on-year in the June, July time frame. So some upside for that to continue to improve sequentially, but per the earlier comments, would not expect India to be an outlier in the comments of being down year-on-year for the rest of the year.

Thank you. I would like to turn the call back for any additional or closing remarks.

Okay. Thanks, Anna, and thank you, everyone, for joining us today. If you have any 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.

Ladies and gentlemen, thank you for your participation. You may now disconnect.