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. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question- and- answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star, then the number two. 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. During the Q&A, I would ask that you please limit your questions to one question and one follow-up at a time to allow everyone an opportunity to participate.
During today's call, you may hear forward-looking statements related to our future financial results, plans, and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today's press release and in our reports filed with the SEC, which are available on the timken.com website. We have included reconciliations between non-GAAP financial information and its GAAP equivalent in the press release and presentation materials. Today's call is copyrighted by The Timken Company, and without express written consent, we prohibit any use, recording, or transmission of any portion of the call. With that, I would like to thank you for your interest in The Timken Company, and I will now turn the call over to Rich.
Thanks, Neil. Good morning, everyone. Thanks for joining us today. I'll start with some very brief comments about the first quarter. 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. Then the bigger impact it had across the globe in March. Our end markets were largely in line with our projections for the first two months of the year. 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 Chain 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 six 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 three 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 two weeks of March, we had temporarily idled over 30% of our production, primarily due to weak customer demand. All of those issues are included in our $1.11 of earnings per share and our 19.2% EBITDA margins. 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 three weeks starting in late March.
It bounced up meaningfully off that bottom in mid-April. 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 three to four weeks behind Europe in regards to impact. We've been hovering around what appears to be a bottom for the last three weeks or so in the U.S. Our automotive business in the U.S. has been down over 80% in April. 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, largely driven by renewable energy. India was close to zero revenue for the entire month of April. We expect India customers to restart demand beginning next week, 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 that 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.
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. 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.
While we have several markets and customers that appear to have bottomed, we also have several that are likely to weaken or taking 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. 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 in the third quarter.
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. 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. Again, Phil will elaborate on this in a moment.
We will be more conservative on capital allocation until the virus and 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. We will slow it 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. 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. These are temporary measures. During May and June, we will prepare to make structural cost reductions in the second half of the year if they are deemed necessary as visibility to 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, 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 enter the downturn with a good balance sheet. 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%. 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. 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 Industries 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 outline organic growth by region, 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 two 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.
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. 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. 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-$18 million for 2020, essentially unchanged from our prior outlook. 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 de-risk 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 a 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 31st. 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 3rd 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- $70 million for the full year. 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. Finally, I want to remind you that we previously withdrew our sales and earnings guidance due to a significant uncertainty caused by COVID-19. 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. With that, we'll end the formal remarks and open the line for questions. Operator?
Thank you. As a reminder, please press star one to ask a question. Now we take our first question from Rob Wertheimer from Melius Research. Please go ahead. Your line is open.
Hey, good morning, everybody.
Morning.
Morning, Rob.
Thanks for all the detail on April. I think anything that helps to clarify reduces the 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. Just a question. I don't know whether you can.
Rob.
Yeah.
Not to interrupt you. You broke out for about 15 seconds. Could you start over, please?
I beg your pardon. Can you hear me now?
Yep. Yeah, perfect.
Okay. Sorry for that. Anyway, I guess what I was saying is that the color on April is very helpful. Just reduces uncertainty, and that's great for everybody. Down 30 is also way better than we had feared at least, is inventory swing up and down, and you sell into people we thought it could've been worse. That's great. I think it reflects some of the very positive mix improvements you've done over the years. I wonder, though, if you can just look at either 2009 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? Thanks.
Yeah, I think there certainly is, 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 zero to 10% to 15%, those are not going to be numbers that sustain. 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. 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.
I think if over the course of the next two 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. Now, that being 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. I think that would be a net positive.
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 P.M. and looking at India results and saying, "India looks good, and we can count on that." We get up at 8:00 A.M. the next morning and have an email that the Indian government shut down our customers for three weeks. I think we're still living with that level of bandwidth, still some possibilities, but definitely the trend line, I think if things continue to go the way they have, Europe is off of a bottom, and the U.S. appears to be coming off of one right now.
That's very helpful. 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? Is that a major pool or just one that you know that could come down?
No, we're disproportionately weighted towards defense. Last year of our 8% aerospace, over 50% of that would have been defense. Say 3% would be commercial. 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.
Perfect. Thanks, Kyle.
Thanks, Rob.
Thank you. Now we take our next question from Michael Feniger from Bank of America. Your line is open. Please go ahead.
Thanks, guys. Good morning. Thanks for taking the questions, and 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?
Yeah. I think many of our markets were three to four quarters into a cyclical contraction already, and we guided to start the year down year-on-year in the first half year-on-year. I think inventory levels are in line with a single-digit decline in year-on-year revenue. If we were to return to those types of levels, say, 5%- 9% down sort of thing, then I think inventory destocking is factored into that for us. If we don't recover to those kind of levels, and we're more 15%- 20%, then we would have some more pain to come in regards to inventory destocking. Does that get your question?
Yeah. That is helpful. I know it's difficult because you guys serve so many markets. Do you have an idea, though, is that more just a comment on the distributors, Rich, or are you guys seeing that, for example, your auto customers or distributors of auto, have they already adjusted their inventories assuming a lower level of demand?
Well, auto and truck OEM, that 13%- 15% of our business, would probably be the exception, where there's very little inventory between us and those customers. Now, they have inventory, so that would affect them. We have very fast delivery and responsive delivery. Beyond those two markets, I would say my comments apply to more of the distribution. We took a lot of destocking activity in the second half of last year in off-highway markets, as an example. Our off-highway sales in the first quarter were more in line with our customer sales than below that, as an example. We took a lot of that pain last year. Again, rail would be another example of that. I think that would apply to generally almost all of our markets, with a few exceptions of where the inventory's quite tight between us and the customer.
Fair enough. you said how Europe meaningfully bounced in April off the lows of March, which is good to hear. You might have said this before, Rich. How much of what you saw in April is down year-over-year in Europe versus where it was last year? Can you also address, we 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 and renewable energy? is that more of maybe some secular shift, you guys gaining share and those markets just holding up much better?
Yeah. There's probably quite a few different answers in that. That was maybe seven or eight questions. I'll hit a few of them. I certainly think in some of those markets, it's share. Certainly, we think over multi-years, wind, solar, marine, we have taken share. Also, those are markets that have not been negatively impacted, with the exception of some of our production issues that we had in China, obviously negatively impacted it. Order backlog remains strong, is well out into the future. That would be a combination of market dynamics as well as multi-year Timken share. In regards to bottoming again in Europe, about three weeks again, late to mid-March to early to mid-April, we're hovering down around a number. The last three weeks we're almost double what we were during that one period.
For three weeks, quite a few of our customers took one to three weeks of production out. Automotive and truck in Europe largely shut down. Some of that's come back online. We've seen a significant uptick in demand in Europe off that. Now, again, as you look out over the next month of what we know, we've got some pluses and minuses from that, but certainly up significantly. We haven't really seen the uptick yet in the U.S. Again, some of the markets that are extremely depressed levels almost have to uptick sometime here in the next few weeks off those low levels.
Yeah. I think it's safe to say, like that the Europe, while as Rich said, we bounced back up, we're still down year-on-year.
Yeah. 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. It's clearly small. Yeah.
Direct exposure is quite small. It used to be higher maybe 10 years ago. 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 into other markets like metals and transportation, et cetera. direct, it's pretty small, bearing and power transmission market.
Perfect. Thank you.
Thank you. Now we take our next question from Chris Dankert from Longbow Research. Your line is open. Please go ahead.
Hey, morning everyone.
Morning, Chris.
Sorry if I missed it, Rich, did you comment at all, and then I understand if you would prefer not to, but any comments on April and what the initial orders have been, what sales have been through that month, just any short-term data there?
Hey, Chris, this is Phil. I think as Rich mentioned, he did mention in his opening remarks, we do expect April sales to be down north of 30%. 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 probably have already hit bottom. We do expect April to be down over 30%.
Yeah. Okay. That's what I thought I heard, but thank you for the clarification, Phil. I guess it's extremely difficult to get hands around cost because sales can move so wildly here. If we assume full year sales are down in mid-teens-ish, should we expect decremental margin near 30%? Just 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, again, a very challenging quarter. I expect that 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. As you look out at 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%-35% range, depending on mix and so on. I do think the speed at which this came at us without temporary actions or 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.
Yeah. I would just add, Chris, tough for us to guide the decrementals, obviously. 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. 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 protect margins and help decrementals as we move through the year.
Until we get better clarity on, as Rich said, steepness, length, et cetera, it's tough for us to guide to a specific number.
Yep. Absolutely appreciate the difficulty there, but thanks so much for the color. Just one last one from me, if I could sneak it 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, maybe accepting 2Qs? Any thoughts there would be great.
Certainly on receivables. As revenue declines, we'd expect to liquidate, if you will, a significant amount of cash from receivables, and we're managing that tightly. From an inventory standpoint, again, with this significant of a decline in demand, it takes some time to turn the inbound 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. As you look out in the second half, we would expect to right-size our inventory with where we think the demand levels out at, which again, we're not ready to call as we sit here today.
Yep, fair enough. Thanks so much, guys, and best of luck as we move through this bizarre time.
Thank you.
Thanks, Chris.
Thank you. Now we take our next question from Joe O'Dea from Vertical Research. Your line is open. Please go ahead.
Hi. Good morning, everyone.
Morning.
Good morning, Joe.
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 in significant free cash flow?
No, I think the challenge with ranges is, right, you have to start with a revenue number and then get to an EBITDA number and then go from there. We're not ready to make that call, but we are confident in conversion. Generally, our conversion percentage we believe would go higher under a lower revenue and a lower EBITDA number. In the short term, there's some natural hedge in the two, three quarters. There's some natural hedge there that if EBITDA is under more pressure, we believe our cash conversion would be better. If EBIT is better, then obviously we get the higher benefit of the starting point. The focus will be on conversion, staying flexible, and we will react with working capital CapEx and cost and spending proportionate with where we see the demand shaking out in the second half.
Okay. 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 de-stock in distribution? Is it really about your production aligned to that distributor sell-through at this point?
In North America, inventory was essentially flattish. I would say, again, with the lag, as you go back, North American distributors didn't feel a lot of the COVID-19 impact 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. 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. 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 or March, they will reduce inventory, and we will see some impact from that. That has not happened through April.
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 say that's one that we would probably have less visibility at because it's been later and, but it's also less deep. To 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. The revenue decline there, for us, would be significantly less than the 30% that we're experiencing for the company as a whole. Again, as you start the month, it would even been less than that. It's too early, I think, to predict which way that goes.
That's very helpful. Thank you.
Thanks, Joe.
Thank you. Now we take our next question from Steve Barger from KeyBanc Capital Markets. Your line is open. Please go ahead.
Good morning, guys. Good to hear your voice.
Good morning, Steve.
Hey, Steve.
I know there's less inventory in auto 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 date, 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 five four, five eleven, five eighteen, and want you to start up with us. I would say other industries would generally be taking 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. Generally not, I would not say synced up. Again, when you look at the fragmentation of our markets and then our applications, the complexity of that is in 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. We'll see the OEMs turn on before they'd start pulling from you probably.
Yeah. Although in most cases, I would say they have continued to pull, just at lower levels.
Okay.
outside of auto and truck, well, in countries, India and Italy, we have not had OEMs in other industries shutting down for two, three, four 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." 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? Is this more about managing service levels for current programs?
I would say it is the long term. 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. The 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. 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'll be anything that we would point to.
Okay. 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 chains? Do you expect more reshoring or localization of supply? 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?
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. I certainly think the volatility we've seen from the tariff situation, and the virus has certainly will accelerate people not wanting to have all their eggs in one basket for sure. I think that was already happening to some degree.
Again, most of our customers have some diversity there. I think the short answer to the question would be yes, but I don't know that it's going to accelerate, but I think it'll continue to move over time.
Okay. Thanks for your time.
Thanks, Steve.
Thank you. Now we take our next question from Cmourtney Yakavonis from Morgan Stanley. Your line is open. Please go ahead.
Yeah. Hey, good morning, guys. This is Dillon coming on for Courtney.
Morning.
Morning. I was wondering if you kind of could first talk about the cadence of sales trends in Asia Pacific through the quarter. I think the plus 6% outcome was a bit surprising. Maybe you can just talk through where revenues troughed out in the quarter and how strong the kind of exit rate was in March?
Yeah, I would say just to comment on Asia, generally speaking, if you think of we're up 6% in the quarter, we were up in China year-over-year. As we said, we did take the two weeks out, probably slightly two weeks more than what we would have taken out in a typical Chinese New Year holiday. We rebounded nicely, came back online, and have since recovered nicely in China. In China, remember, that's a big chunk of our renewable energy business, which was up significantly, well into the double digits year-over-year from renewables, which is principally Asia and primarily China within Asia. India was down.
Started to feel the effects of COVID-19 at the end of the quarter, but 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. China's still relatively strong. India's coming out of the COVID-19 shutdown. The rest of Asia, I would say flattish to slightly down in the quarter. For us, Asia's primarily China and India. Overall, a good story, and it was really the China recovery as well as the strong growth in renewable energy.
Okay, got it. Thanks. That's helpful. Maybe switching over to decrementals. I know you kind of highlighted the moving pieces there, and you understand there's been a lot of fluidity in the situation, but I guess in the quarter, in Process, they were still a bit higher than your historical performance in that business. I guess just thinking through the trends into Q2, how much of that decremental margin performance in the quarter was still related to BEKA and Diamond Chain, and I guess to what extent can you see a piece of normalization next quarter?
Yeah. I think it's a great question. On incrementals and decrementals, the first thing to keep in mind is the acquisitions and currency can skew it a bit. 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. 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, while 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.
those are probably the main items. I would tell you, when you look at the mix we were running and the environment we were in, 24.4% was pretty strong considering everything we were dealing with in the quarter.
Okay, got it. then maybe that's the last one I have for you, Dan. In terms of the aerospace exposure, I think you highlighted this partially in Rob's question, but I think more mathematically, I think that market's been an area you've been targeting via M&A over the past few years. Has what's going on in that market changed your mindset around that going forward, or do you still view that as a more attractive vehicle for looking to index towards over time?
Our aerospace business said last year, about 8% of sales, over 50% of that weighted towards defense. It has not been a significant part of our acquisition strategy. It 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. 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.
Hi. Thank you for taking my call and my question.
Hey, David.
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 said with the cost actions, do you feel the company at a net income level will be profitable in the second quarter?
Well, I think you could 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. You said we could certainly be worse than that going forward as well. I think we use that as we could be profitable under quite a wide range of scenarios, but certainly not all scenarios. We have customers that have had no revenue for six weeks at a time. Certainly if something like that were to evolve for Timken, that would be a challenge. If the trend lines stay positive, yes.
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. Okay. That's really my only question. Thank you so much.
Thanks, David.
Thanks, David.
Thank you. Once again, if you would like to ask a question, please press star one. Now we take our next question from Justin Bergner from G.r esearch. Your line is open. Please go ahead.
Good morning, Rich. Good morning, Phil.
Morning.
Hi, Justin.
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? Is that for all both salaried and hourly folks or just salaried individuals?
The comment was we expect compensation to be down 25% across the company in the second quarter. That would include salary and operations. 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. The salary and SG&A side, we would expect to be down 25% year-over-year in the quarter, regardless of how the demand plays out from here on out.
Okay. Thanks for clarifying. The other question was regarding 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? Where does material deflation, to the extent it played a role, fit into that adjusted EBITDA bridge slide?
Yeah, no, it's a great question. We don't normally break out the pricing and mix individually, but what I would tell you is they were both positive. Pricing was positive, mix was positive. We talked about pricing on the last call, and I think at that time we had guided directionally to 50 basis points, maybe a little bit better. We still expect positive pricing for the year. That's one number I can tell you. We ran probably slightly above our full year outlook in the first quarter. Had positive pricing in both mobile and process. 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. 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. It continues to be a good story for Timken. As we move through the year, we expect material costs to remain depressed, and while that may require some pass-through, we're not expecting a material number, and it'd be more than offset by benefits we get on the material line.
Got it. If I look at the combination of price and material cost, not that that's exactly quantifiable given how you break it out. Would that price versus cost benefit in the first quarter be expected to propagate through future quarters this year at a similar level?
Well, I probably hesitate to comment on that, but we would expect price cost to be, I would say, 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.
Yeah, I just caution on that. The mix has changed so much and is a part of that, right? When you again have India at close to zero revenue, automotive close to zero revenue, and some other things up, that wasn't really factored into the price outlook. I agree with Phil. It's going to be positive for the year, but the magnitude is also going to be dependent on how the mix shakes out.
Okay. Thank you for taking my questions, and best of luck in the coming months. Thank you.
Thank you, Justin.
Thank you. Now we take our next question from Michael Feniger from Bank of America. Your line is open. Please go ahead.
Hey, guys. Yeah, just a quick one. I think you mentioned 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 lot on the cost savings front over the years. Can you just remind us the structural costs you guys have really removed in 2018, 2019? 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? Thank you.
Yeah, I would say we've been targeting 1% net a year and largely been getting that, and the biggest contributor to that has been our manufacturing footprint. 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. That's a significant contributor, and we look to do that up or down markets. Certainly we look to accelerate. Our digital platform has been a big driver of efficiency. We took a couple systems offline 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. I will say there's the integration acquisition synergies.
As an example of Groeneveld and BEKA, we've already made significant progress on consolidating the regional structures within those two businesses and have some cost savings from that, as an example. The 1% number is 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 look not to cut bone. We look to make moves that make us better when we're down and make us stronger when we're coming back up. Okay, thanks. Thanks, Mike.
Yeah. 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.
This concludes today's call. Thank you for your participation. You may now disconnect.