The Timken Company (TKR) on Q2 2021 Results - Earnings Call Transcript
Operator: 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 speakers remarks, there will be a question-and-answer session. Thank you. Mr. Frohnapple, you may begin your conference. Neil Frohnapple: Thanks, Anna and welcome everyone to our second quarter 2021 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 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. Richard Kyle: Thanks, Neil. Good morning, everyone, and thank you for joining Timken's second quarter earnings call. Timken delivered a very strong second quarter with record revenue of $1.06 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 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 continue 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. Philip Fracassa: Okay. Thanks, Rich, and good morning, everyone. For the financial review, I'm going to start on Slide 10 of the materials with a summary of our strong second quarter results. Revenue was a record 1.06 billion in the second quarter, up 32% from last year and up 6% from the second quarter of 2019. We delivered an adjusted EBITDA margin of 18.8% and adjusted earnings per share of $1.37, which was up 34% from the prior year, strong performance anyway you look at it. Turning to Slide 11, let's take a closer look at our sales performance. Organically, sales were up 26.5%. Both segments posted strong double-digit sales increases with mobile industries leading the way. Currency added almost 5% to the topline in the quarter, while Aurora Bearing contributed close to 1%. Total sales increased nearly 4% sequentially from the first quarter even though on-highway, auto and truck demand was negatively impacted by semiconductor and chip shortages. On the right hand side of the slide, we show year-on-year organic growth by region. So excluding both currency and acquisitions, all regions were up strongly and broadly in the quarter. Let me comment further on each region. In Asia, sales were up 25% as we saw broad growth across most sectors in the region with renewable energy, off-highway, distribution rail and heavy truck posting the strongest gains. In Latin America, we more than doubled sales versus last year and the significant growth was led by the distribution in on-highway auto and truck sectors. In Europe, we were up 27%, driven by growth across most sectors there as well, led by off-highway, on-highway auto and truck and distribution. And finally, in North America, our largest region, we were up 20% in the quarter, driven mainly by strong gains in the off-highway, on-highway auto and truck, distribution and general industrial sectors, partially offset by lower Aerospace revenue. Turning to Slide 12. Adjusted EBITDA was $200 million or 18.8% of sales in the second quarter compared to $164 million or 20.4% of sales last year. Keep in mind, that our incremental margin and year-on-year margin comparison were impacted by the significant amount of temporary cost actions we took last year in response to the pandemic. If we exclude those temporary actions from the analysis, incremental margins would have been nearly 30% in the quarter with adjusted EBITDA margin expansion of over 300 basis points. Looking at the change in adjusted EBITDA dollars, the increase compared to the prior year reflects the benefits of higher volume and related manufacturing performance, which more than offset higher SG&A expense and material and logistics costs as well as unfavorable mix. The unfavorable mix was driven mainly by the significant growth in OEM sales mainly within mobile industries during the quarter. Currency had a positive impact on EBITDA this past quarter and Aurora Bearing added nearly $2 million, with adjusted EBITDA margins of roughly 20%, but that acquisition is performing extremely well for us right now and there's more to come. Operator: Yes, sir. Thank you. And we'll now take a question from Stephen Volkmann with Jefferies. Stephen Volkmann: Great. Good morning, guys. Thanks for taking my questions. Richard Kyle: Good morning, Steve. Stephen Volkmann: I was a little surprised I guess just on the commentary relative to mix. I think one or both of you said that OE was just quite a bit stronger than aftermarket. Is that just because aftermarket doesn't -- isn't as volatile or is there something holding back? Do you think the aftermarket maybe or even prioritizing OE versus aftermarket in this environment? I don't know. Just any commentary on kind of the thinking around that? Philip Fracassa: Yes, Steve, this is Phil. I'll take. 0 think in the quarter, I think the right way to look at it, as you know, last year we were down so much on the mobile side, in particularly OEM customers like automotive and truck customers which recovered and off-highway as well which recovered relatively more in the second quarter of this year just on a percentage basis. So that drove most of the -- most of the negative mix in the quarter year-on-year. I would say sequentially it was roughly flat with the first quarter. So I think from that standpoint it was relatively flat. But I think when you look at the-- it's really OEM that drives that mix force versus distribution and then with more of that in mobile and Process, I think this quarter was what we saw in the on-highway and off-highway sectors, in particular, were the biggest drivers of the mix. Stephen Volkmann: Okay, all right. That makes sense. And then, maybe can you just talk about pricing in the aftermarket? I would think you'd be able to adjust that sort of more quickly and it doesn't seem like that's happening as much as I might have thought just any outlook there? And I'll pass it on. Thanks. Richard Kyle: Yes. Specifically, as you know, Steve, we have a lot of pricing mechanisms. We have thousands and thousands of part numbers and customers and the fragmentation is good from a stickiness standpoint, the stickiness price, but also, I mean a lot of complexity within that. So specifically, your question on distribution, we did raise prices late in the second quarter for global distribution, I'll say, and that's a big part of why we expect pricing to be more favorable in the second half than the first half. In addition to that, we have most of our, certainly all of our contracts that stand out extended periods have surcharge mechanisms that lag sometimes a quarter or sometimes a couple of quarters. Those are passing through and increasing a small uptick in the second quarter, we'll see more of that in the second half. And then where we have contractual pricing as it opens, although more of that would be on a calendar basis, but some of that is open as well. We started taking action there. So, but you will, I think the evidence of the distribution pricing will be significantly more evident in the second half than what you saw in the second quarter. Stephen Volkmann: All right. Thank you, guys. Richard Kyle: Thanks, Steve. Operator: We'll now take a question from David Raso with Evercore ISI. David Raso: Hi, thank you for the time. Speaking about '22, these price increases you're putting in through the end of the quarter on distribution, thinking through contracts that roll off and assuming a bump up in prices on those contracts. When you think about your pricing carrying into '22, actions already taken and just being logical about some bump up on the contracts that are rolling off, how should we think about how '22 starts on pricing gains? Just with actions already in place and some of those contract issues. And the second part of that on the cost side, given some of the long lead times and some things that at your own disposal as they have, we feel comfortable on our pricing, maybe we lock in cost a little earlier. I'm just trying to get a feel the price cost dynamic starting '22 on things that you can lock in and actions already taken? Thank you. Richard Kyle: We certainly would expect that the price cost dynamic for us to really embark in '22 and I think the magnitude of that remains to be seen, but I would certainly expect it to be positive by the time we get to January of '22. We'll have the carry-over of the actions that we're taking now and then we'll have contractual actions then. And material shot up in the fourth quarter of last year and has been creeping up since. So specifically on the material side, would certainly expect that to go into next year positive. I think the magnitude of the price, particularly on the contractual side will somewhat depend on what happens with material cost and it will be more if the material cost continues to go up or a little less if the material cost flat lines or recedes from here. But expect it to be pretty good pricing environment, and obviously, with demand is strong as it is, we choose to be a little pickier with how we partake in that if we so choose as well. But we think we're -- feel good that we can both move prices up, get price cost positive and gain share next year as well. David Raso: And so, if I heard you correctly, I think you said 51 bps of better pricing. Was that sequential first half, second half? And if that's the case, how should we think about that year-over-year in January? Richard Kyle: More than 50 bps year-over-year second half was my comments. So, second half would expect more than 50 basis points and would expect that the roll over to next year, plus more. David Raso: But again, the 50 bps was a sequential comment, correct? Or is that year-over-year, the 50 bps? Richard Kyle: Year-over-year -- it was year-over-year earlier. David Raso: All right, thank you very much. Philip Fracassa: Sequential. It started with sequential comment of pricing will be better sequentially, but it was 50 basis points favorable year-on-year. David Raso: Year-over-year, but then you think greater in January year-over-year. Richard Kyle: Yes, right. David Raso: Sure. Okay, thank you very much. Richard Kyle: Thanks, Dave. Philip Fracassa: Thanks, Dave. Operator: Richard Kyle: Okay. And we'll -- will take our next question, please. Operator: Okay, great. We'll now take a question from Steve Barger with KeyBanc Capital Market. Steve Barger: Hey, good morning guys. Thanks. Richard Kyle: Good morning, Steve. Steve Barger: Rich, just staying on that line of thought about the possible outcomes around pricing as it relates to your contracts. What's your view on how input cost play out in the second half and into '22? What are you hearing from suppliers? Richard Kyle: I believe, under the scenario I described with a robust industrial market next year, they will continue to go up and our pricing will have to go up more to cover it. And I think we're in a good position to do that. I think the step change on steel cost is over. I don't think we'll see another step change like we saw in the fourth quarter, but I think you'll continue to see pressure there. And then as I described in my comments as well, there is certainly some pressure on the labor side as well, so we're preparing for a gradually increasing cost environment through the second half and into next year. Steve Barger: And I know it's too early to get specific on next year, but you did kind of bring it up with incrementals under pressure this year because of all the things we've talked about. If we get into mid to high single-digit growth next year organically, is it possible to think that you're going to run above that typical incremental and put up double-digit earnings growth? Richard Kyle: Yes. And yes, I would say definitely better incrementals next year than this year and would expect our operations to run better next year and a little less churn there, and then the big one to talk about it, I mean, we came in and probably undershot pricing to start the year, we're starting to make amends for that, but would not expect that to happen next year. So certainly would expect significantly better incrementals next year. And yes, I think we should get good leverage on a mid-single digit, low double-digit revenue situation. And I think we have the capacity and ramp ability to get up to those kind of levels should the demand situation run through that way next year. Philip Fracassa: Yes. The only thing I might add to that is that -- you look back in history, Steve, you look back in '17, as an example, we would have -- we ran below 20% incrementals that year and then they stepped up in '18, in that particular they stepped up to north of 30 and I think this year our guidance kind of implies just shy of 20% high-teens 20 percentage kind of incrementals year-on-year and I think that's with the perfect storm of all the things we're dealing with this year. So I think the performance is actually quite good excluding temporary cost actions from last year, taking into account some of the unique, I would say rather unique headwinds this year. So I think fast forward to next year with pricing if the topline cooperates. I agree with Rich. I think it will be a step up in incrementals and a step up from there. Steve Barger: Got it. And as I look at Slide 11and the strong growth rates across the geographies, can we just talk about available capacity in the footprint? You've done a lot of acquisitions over the past few years. Do you have room to build out production without a lot of CapEx dollars to support or to meet this demand? Richard Kyle: Yes, I would expect our CapEx to stay pretty consistent with where it's been. We did have a heavy mix still going on expanding our renewable capacity, and there'll be nothing there that would preclude us from hitting the double-digit type growth next year. I mean, we really just in most of these areas just kind of go back to where we were in '19, some are above, some are still below. So no, we think we'd be in really good position for next year. Steve Barger: And I'll just ask one more. You talked about the back half being a parity maybe with on the topline. Do you think that 2Q will be the highest EPS quarter, which is typically the case, right? But or will the back half ramp and pricing come through to make 3Q at or above what you put up for 2Q? Richard Kyle: Well, I think our fourth we would expect to be a step down, typically. So, I mean, you're be looking at second quarter or third quarter, second quarter pretty close I think to get to the high end of the guide and on the lower end of the guide it would be a little further down from that. Philip Fracassa: Yes, Steve, I would probably say if you look at sort of the midpoint of the guide, it would sort of imply, at least imply sort of third quarter kind of flattish with the second quarter on the topline, which would normally be a step down, but kind of flattish on the topline and then with a little bit of a decline from third to fourth with a little bit at seasonality, albeit, less than what we would normally expect in the second half. And so I think when you look at that, we would think, as margins progress for the rest of the year off the second quarter, probably flattish into Q3 and then volume-related slight step down in Q4 would be the right way to look at it and take into account volume in the seasonality that we would see in the fourth quarter. So second quarter probably with the tax adjustment is probably at least a penny or two above the third quarter and then adjusting from there. And again, talking from the midpoint. And then as things progress if we do better than that, obviously, we'd be north and so forth. Steve Barger: Understood. No, that's great detail. I appreciate it. Richard Kyle: Thanks, Steve. Operator: And we will now take our next question from Stanley Elliott with Stifel. Stanley Elliott: Hey, good morning guys. Thank you all for taking the question. You mentioned M&A, your hitting close to the low end of your targeted range. You mentioned M&A. Can you talk about what you're seeing out there in terms of your deal pipeline? I mean, large deal kind of happened here recently; would love to see what you're seeing both in terms of volume and then also in terms of price points. Richard Kyle: I would say volume is back to pre-pandemic levels. Price points, I think expectations are high, depends on. Also if you're look at it forward versus trailing, because obviously, mostly to be looking at right now -- still have fairly significant pandemic impact in them, but I think the pipeline is healthy and certainly would expect to be active in the coming 12 months or so. Stanley Elliott: Perfect. Thank you very much. Richard Kyle: Thanks, Stanley. Philip Fracassa: Thanks, Stanley. Operator: And it appears there are no further telephone questions. I'd like to turn the conference back over to our presenters for any additional or closing remarks. Neil Frohnapple: Okay. Thanks, Anna, and thank you everyone for joining us today. If you have any further questions after today's call, please contact me. Thank you. And this concludes our call. Operator: And once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.TKR Ratings Summary
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