The Timken Company (TKR) Earnings Call Transcript & Summary

[Audio Gap] second session. With me today Lucian Boldea, President and CEO; and Mike Discenza, who's the CFO. Neil is in the crowd hiding. I mean we have an extra chair up here and he said it's to hang on the crowd. But -- so it's going to be a joint hybrid, give some formal remarks, but then also have a lot of time for Q&A. So if you have any questions, please raise your hand, I'll call on you, send me an e-mail through the -- it should be somewhere when it comes up and it will come to my iPad. But either which way, if you got any questions, we'll make sure to incorporate that. So please, floor is yours. Thank you for your time.

Thank you, and thanks, Mike, and thanks to all of you for your interest in The Timken Company. I wanted to start by giving you just a brief overview of the company to kind of set the stage. Hopefully, it won't take more than 5 minutes, and then we can get into your questions. We have a very strong franchise. You see the slide here behind me, hopefully. So we have a very strong franchise we've built over 125 years that's recognized in the global industrial market. We're recognized for our technical leadership, our robust product portfolio and just our deep customer commitment. We have a highly Engineered Bearings portfolio that's about 2/3 of the company and an Industrial Motion portfolio that's 1/3. Both segments are high performing. You see the margins there close to 20% for 2024. We serve leading OEMs, but we also have an extensive network of distributors that support the aftermarket. And that's an important component for our business because more than 40% of the revenue stream is generated in the aftermarket. That is recurring revenue. That's really why we do what we do is create that installed base because that creates a lasting revenue stream that lasts really for decades in that aftermarket space. We also have a global manufacturing footprint, and that's been extremely handy to have at this time when we really need to have nimble supply chains to navigate tariff issues. The majority of our manufacturing is region for region. So that really allows us not only to navigate the tariff environment, but also to be flexible as different growth rates are experienced in different regions of the world to flex that manufacturing footprint. We've added a lot of complementary products to our bearings offering in the last few years. And we're now in a position where we can successfully add value to customers in those engineered-to-order mission-critical applications for quality, performance and reliability make a big difference. We can create a lot of value add through this, and we really do our best work in that selling process where an engineer-to-engineer specification happens. That's really what we prefer. That's really the markets that we seek. That's the engagement that we seek, it's the relationships that we seek with customers. We find applications where the cost of failure is very high and a premium offering is really the only option. Examples you can think about wind turbines, mining trucks or an aircraft landing bearing, for example. This is true on our complementary product portfolio that's serving customers. It's also true in applications that have very similar requirements and very similar sales channels. If you think of end markets where we participate, we have strong positions in essential industries. Examples of that would be rail, aerospace and defense, heavy industries and wind energy. We're targeting further growth in markets that are newer to Timken. Examples of those would be food and beverage and then also industrial automation. If you step back and look at our recent history, interesting fact about the company is we've posted double-digit sales growth over the last 10 years across new markets and those new markets where we've had double-digit sales growth now represent 1/3 of the company. So that's really a good indication of what is possible when focusing in good -- in new markets in our portfolio. We generate significant cash flow, and we have, as a result, a very solid balance sheet. We've generated $3 billion of cash flow over the last 10 years, and we're on track to generate another $375 million in 2025. We've also returned a significant portion of that capital to shareholders, including the fact that we've repurchased basically 25% of the company's stock in the time horizon that you see in front of you. 2025 also marks our 12th year of our consecutive dividend increases. If you look at what our near-term priorities are, the strong foundation, we certainly have a lot of opportunities to improve top line and bottom line performance. To start, we've communicated in our most recent conference call that we intend to approach the portfolio with an 80/20 mindset to structure to improve margins to grow faster in the most profitable verticals and also create significant value for our shareholders by focusing on the actions that will have the most impact. Margin expansion remains a key focus. We've committed to a 20% margin. So we certainly are taking a lot of actions to make sure that we leave no stone unturned as we review the business for margin potential. There's also opportunity to expand organic growth in a couple of dimensions. So one, expanding our market focus in fast-growing regions and verticals and also launching new products and services. As we look at the strength of our brand, we look to capitalize on that by using our global footprint and we have several of the acquired businesses that don't have the same global footprint that the rest of the company has. So really taking those businesses globally affords another growth vector. We also see additional continued synergies that can be delivered from further acquisition integration across the portfolio, leveraging our strong market positions and also aftermarket presence will allow that to continue. And really, when you look at it, these are just a few of the opportunities that we see for growth. Again, I look forward to getting into the Q&A and discussing more of this. But in the meantime, I want to assure you our team, Mike is here beside me, but also the team not present here is laser-focused on delivering. We had a good Q3. So that's one data point in the right direction on the organic growth. It doesn't make a trend by itself. So we certainly are looking to continue and turn that into a trend. So with that, I look forward to the conversation and to the questions.

Great. Thanks, Lucian. Again, as a reminder, if you have any questions, just let me know, we'll weave it in. A little bit of a unique situation. We've got both of you that are somewhat new to the organization. So maybe, Lucian, we'll start with you, and then we'll dovetail over to you, Mike. Why Timken? Early observations? And what do you think you can do organizationally to really make an impact and get this to where I think you believe it can go.

Yes. Yes. Look, I'm more excited today than I was the day I joined. And I joined with pretty high expectations. I knew this company as a supplier to Honeywell being at Honeywell, and I knew its reputation that it had for technology, for delivering for its customers and the trust that Honeywell had in The Timken Company. But joining here, I'm even more bullish on the upside that exists. And the reason is that the foundation is just extremely strong. I think there was a lot of heavy lifting that had to be done by the previous management team and the team before that to shift the market footprint of this company. It was very heavily leveraged more towards automotive and then really diversifying that away to other industries that have higher growth potentials. There's been a number of acquisitions that have been done that have some very unique product offerings that are complementary to the historical bearings portfolio. So integrating that further, taking some of those acquisitions globally really can make a big difference in the growth trajectory of the company.

Maybe same thought process or conversation for you...

Yes, sure. So a little bit different than Lucian. I've actually been with Timken for 25 years. So only new to the role, and I beat him by about 2 weeks into my job. So new to the role, not new to the company. And while Lucian is more excited than the day he joined, I'm also more excited than the day he joined. We have a lot of opportunities.

I thought you're going to say the day you joined, I was -- I hope so. I don't know...

Remember that day. But I certainly -- I've seen quite a bit of change in Timken over those 25 years, quite a transformation, but we're poised today in a really good place and with a really a new team who's excited to get going and make an impact, create value like Lucian said, we're laser-focused on it. So I'm excited like Lucian is more today than I was even 60 days ago.

So one of the things you've talked recently about is putting a simplification 80/20 framework to bear on Timken. A handful of questions here. Let's just start with a real simple one. What do you think that methodology and discipline can bring to the organization?

Yes. Look, I came in and I looked at the portfolio, and I'm very excited and very impressed about the number of options that we have. So if you look underlying, there's a strong balance sheet. I get a lot of questions about, well, what about capital allocation? And that's a first world order problem that you have a balance sheet that you have options and that people want to understand how you're going to allocate the capital versus not having it. So that's a position of strength, cash flow continues to generate. In looking at the portfolio, when we say 80/20, I had to find myself having to make sure that we ground everybody in what it means because we had some misunderstanding, it means you get rid of 20%, and that's absolutely not the case. This is applying the Pareto principle to the portfolio. And the primary driver is not what are we going to get rid of. The primary driver is where can we invest to get the highest return the quickest. That's the primary driver. That's -- for us, it's how do we put some points on the board quickly, how do we start turning the organic growth into more of a trend than the one data point that we had in Q3 and using our portfolio to do that. So really, we're going to look very critically with an open mind to the portfolio and say, what are the pieces where we say, okay, there's immediate opportunity. These are the markets we want to win in. These are the markets we're entitled to win in. These are the regions where we can do it, double down there. And then as a result, also, we have to do the opposite because the books have to balance, where do we deemphasize. And then are there any pieces of the portfolio where it's time to admit, this is not us. This is not -- doesn't belong to us. It's not part of our future, and we have the discipline to walk away even if we think that if we spent enough time and enough energy, we'd have the wherewithal to make it better. Is that really consistent with our strategy or not? That's the discipline we're trying to bring to the portfolio.

And do you have the data currently to be able to make those decisions? Or do you need to do more internally to get to the point where you've got enough of the segmentation work done to be able to make those decisions?

Yes. So we're about a month into that work internally. So that is the work that's going on right now, which is why we're not trying to be cagey about the answers, but we're also being very disciplined to let the data lead us to the answer rather than our intuition or our collective opinions. So that exact analysis, where are we winning, why? And then we have it already at a macro level. So we know kind of the tagline, but getting down to, okay, now by market, now by region. Now how far down can you go because you're going to find those disconnects where we may be very successful in winning in one region and not in the other in the market, understanding why that is. Is that an investment issue? Is that a market issue? And really, those are the low-hanging fruit. Those are the quick wins. And then once we have the data where we're winning, doubling down where we have market momentum is always going to get the results quicker than trying to reverse market momentum somewhere and then start growing from there.

So a lot of the 80/20 that you're referencing here seems to be tied to essentially portfolio constitution and then how to leverage your capital to the highest efficiency. Is there a margin component beyond just mixing to the right areas and things like that internally? Or do you think Timken from a foundational perspective is already in a good spot, more continuous improvement perspective?

Yes. Look, we'll never ever say we're in a good spot with margin. I think you always try to optimize that. You always try to stay humble. At the same time, I think we have to recognize that in an industry where you have fixed cost, leverage like we do, growing the top line is the best way to address the margin issue, especially where we have capacity that we can leverage -- that existing capacity that we can leverage. So that's kind of job one. How do we turn the organic engine -- organic growth engine on. So that's focus number one. And then after that, of course, you look at mixing up, but that somewhat takes care of itself because we have acquired a lot of these businesses with the intention of mixing up. So -- and they already have higher margins that are accretive to the portfolio. So that will happen. And then trimming on the other side of the ledger where you have businesses that really are dilutive to the margin is also going to mix you up. So I think there is a short-term opportunity to improve the margin just by doing that. And then longer term, as you step away, you look at our margins in Engineered Bearings, you look at Industrial Motion, there is more opportunity on the cost to serve side. So there's more opportunity on further integration on making sure that we achieve not only that revenue synergy, but the economy of scope between the 2 businesses as we go in front of customers. But that's a Phase 2. I think for Phase 1, there is gas in the tank on improving margin just from fixed cost leverage and from mixing up.

Maybe if I can just add to that. You talked about the data and the work and Lucian said we're 30 days into the work. We're really approaching everything with an open mind, which is one of the benefits of bringing Lucian in. We're looking at things with a fresh perspective. And we're really targeting -- we've announced in second quarter next year, we'll have an Investor Day. And so between now and then, a lot of work going on to lay out that growth algorithm, just as you said, and maybe put some more structure around what that margin profile looks like.

How do you balance all of that work with the capital allocation aspirations. You mentioned kind of at the outset, high-quality problem to have a lot of options, right? Are you able to move forward on the M&A side as you're doing this work? And if so, what types of things are you targeting that make you comfortable enough to say this will fit our prioritization over time?

Yes. And look, I appreciate the question because I think we do have to be realistic and say how many things can we do at the same time. The good news is I'm very, very excited about what more we can do with what we already have. And there's a lot of value that can be created from what we already have. So it's not that the cover is empty and we need to run out and buy something and then figure out what to do with it. We already have done that past 10. So now what can we do with that? How can we create value from that is job one. Now we've done a lot of strategic looking, a lot of effort has been put to understand what M&A targets we would like. And I would describe between now and Investor Day, our posture is opportunistic. So if one of those targets that we've been dreaming of, but it wasn't available, it wasn't actionable, becomes actionable, then definitely, we will not let that opportunity passes by. But realistically, what we would be looking at is between now and Investor Day, have that more reactive posture. And then as we get into Investor Day, we communicate our strategy and then we execute from there on our M&A.

So maybe let's talk end markets for a little bit here. How are you -- just as a high-level generic thought process, how are you seeing the trajectory of the end markets play out as we exit into '26? Did you see a lot of sequential change in the quarter or more kind of business as usual and sequential normality? What are the puts and takes and anything accelerating, decelerating as a starting point, and then we can dive off that.

Yes. So I'll start and then turn it over to Mike to add. But I think when we look at the year, one of the things you always try to call is we've been down longer than in other downturns. So previous downturns have been 6 quarters, 7 quarters were longer ones, and now it's 9. And so it is time for things to come back if history is a guide. And we're seeing signs of that. We're seeing signs of book-to-bills being more than 1 in several of our key markets. We're seeing signs in different regions. And then when you watch the inventories, when you see spikes in orders, you don't see spikes in inventory. So that tells you people are now buying to demand. And so Mike, maybe you want to add specific markets.

Yes, sure. So some of the encouraging things we saw in the third quarter, our order book was actually up year-over-year. And the area of that order book where we saw some growth was around off-highway, so our off-highway markets, general industrial, rail, aerospace, aerospace is probably not surprising, but those other markets where we saw growth year-over-year. So a little bit early to be calling any upturn, but certainly positive signs in our order book.

So the trajectory from here, what do you think kind of -- well, maybe start with this before I ask a follow-up question. What do you consider normal? So what's the growth algorithm for the portfolio in a normal landscape?

Yes. So...

If we ever see normal again?

Yes. From where we are in the cycle, it's going to be on the higher end of normal. We have our growth targets out there.

And those growth targets are?

From our last Investor Day, 4% to 5% top line growth, targeting 20% to roughly 20% EBITDA margin. So still committed to those targets. But again, from where we are in the cycle, we'd be on the higher end over the next few years, you'd expect to get to that average 4% to 5%. So we're sitting in a good place from an opportunity standpoint, but still look at our long-term growth is 4% to 5%. And again, we're doing the work inside the portfolio now. I'd expect to come back with a new growth algorithm, whether that's comes back to 4% to 5% or whatever, but that's the work we're doing now to kind of redefine what that looks like and how we're going to get there.

So maybe ask it a little differently, right? One of the questions I've gotten for the last 3 years from investors is why this year, right? Because last year, we thought maybe and then the year before, you thought maybe. So I don't get too much pushback on the idea that a lot of your types of businesses could be mid-single-digit-ish type growth. I think the question always becomes what does it take to get there, right? What does it take from a market perspective to enable that growth be unlocked. And so anything you do to help with that question would be great as well.

Yes. And look, I think when you look in the aggregate, and we've all been around businesses for many, many years, when a business delivers 4% or doesn't, nothing in the business delivers exactly 4%. There's a bunch of components that deliver double digit, and there's something that wipes it all out or a few some things, whether it's a region, whether it's a country, whether it's a market and where I feel more encouraged and more bullish is we're sitting here in Q4, and I don't see that something at this point in 2026 that's going to be the big negative. And so what that means is the fruits of our labor that we've put in place, whether it's the extra pricing that's going to drive some revenue growth, whether it's the new wins that we've had with customers, we should be able to have those points be actually additive on the board versus being offset by something else. Now again, we live in a very uncertain time right now. So this is in a stable demand environment, but we're in a good place. I think we've taken a lot of what I said earlier, the difficult decisions, a lot of them have been made. We've still got a little bit of pruning left on the portfolio to do, but there's not a substantial amount of that left to do. It's really around the edges at this point.

So if we're building a '26 is a thought process. You have a little bit of price, you have some, call it, internal initiatives that are market outgrowers. And comps are probably relatively easy. Book-to-bill, if you go on the right trajectory, that can add a little bit. And then -- so the foundation here is planning for some level of growth and then the question becomes how much growth based on what the market gives you?

That's right. And again, if history is a guide, you would say that a rebound in demand should come. Now calling it, is that in Q1 or in Q3, but -- and it probably varies by market, but we are seeing enough positive signs of light in multiple markets that it gives you some reason to actually be more hopeful.

So do you have any businesses internally that you particularly track closely for as leading indicators in the general industrial space or maybe it's an inventory level at the off-highway or the on-highway, however you want to put it. I mean any particular things that you key on internally that would be a good indicator?

We track very closely. And obviously, our distribution business, our channel partners are a very important component of that because we have some visibility into what that inventory is in the channel. So that's where when you see buying patterns actually not result in changes in inventory, but result in demand that tells you that you're actually servicing that actual demand in the market. So that's encouraging. Good relationships with our OEMs where we get good visibility into what their production schedules are and they -- but I think in those conversations, you still hear the word uncertainty. They're still trying to be very cautious. And that's why we're a little more cautious on our Q4 guide because the word caution, the word uncertainty is there and Q4 is seasonally always one that's a little less easy to predict because customers might make year-end inventory decisions, and you never know how many weeks December actually has. And you know that in December.

Everyone likes a little break between Christmas and New Year, right? How do you think about the tariff side of things today? And let's take it from the lens of the conversation we just had where do you think this is a delaying point still for your customers? And then take it from the other side, which is just how is that price cost dynamic working out? And how are you managing through that piece?

Yes. And look, I'm glad you separated the 2 because the answers are quite different. So to me, the biggest thing we need on tariffs is certainty. Whatever that number is, 5, 10, 15, 25, 30, once we know what it is and it stays there, the market will adjust. We have demonstrated over a long period of time that inflationary pressures do get passed through. They get passed through successfully. If you look at what we've had to deal with since 2021, '22 until today, it's pretty dramatic as an industrial sector, but we've dealt with it. And we're going to deal with whatever other pressure. But that uncertainty is what pauses demand and what causes our customers to really delay their investments. That's the key issue. In terms of offsetting the tariffs, we've now dollar for dollar, we're going to be on a run rate basis, recovered in 2025 for the tariffs as we've committed. And so in 2026, we've also committed by the end of '26 to really on a run rate basis, cover the margin as well in the tariffs. And that's -- if tariffs stay flat or they keep moving up, if they go down, then obviously, prices are sticky and then we'll be very likely ahead a little quicker.

I was looking at your organic growth chart that you laid out in the third quarter. And I think a lot of the pieces make a lot of sense in the context of what I hear from all my companies I look at. I think the one that stands out is the renewable energy piece up as much as it is. Now some people definitionally talk about renewable energy and has a gas component. Some of those are the gas pieces that are doing so well. I'd be curious what you're seeing on the renewable energy side. And does that include your wind offering and just a generic thought process?

Yes, it is, and it is the main driver in there is wind and the main driver there is wind China. And so that also should explain a little bit why we didn't take that one data point and extrapolate it too far out into Q4 or beyond. But there is a very logical and sensible explanation to why we're performing in that market. And if you look at what we like about wind energy as an application inherently, yes, there's some cyclicality to it. But what is true about it is the application is getting increasingly more challenging, increasingly more demanding. So the wind turbines only get bigger, the loads get bigger, they go offshore, the cost of failure is only higher. So as a result, taking a chance with a product that's not as high performance as maybe you could on a 2-wheeler, you could on a bicycle, you could even on a car, you wouldn't do that on a wind turbine. And we've had to go through that growing pain as an industry, and there have been a few attempts to look at lesser solutions. But I think as the turbines get bigger, as the technology is getting more demanding, we see us winning again. And so we're forecasting to keep that double-digit outlook going into next year as well on wind. It's just the quarter-to-quarter timing is a little harder to call. But that's -- to answer your question, that's wind and a lot of it is China.

So a couple more here. First one, how are you specifically implementing AI in your organization? Anything interesting that you're doing, any learnings? And how do you think about that from a return perspective?

Yes. Look, it's a very exciting opportunity. And obviously, coming from Honeywell, that's a company that's a full embrace adopter of AI and also provider of AI solutions to customers. This is second nature to me at this point. And I think there's a lot of productivity that can be enabled with AI in a heavily engineered space like we do because you don't have to reinvent the wheel every time when you have a customer problem. When you have a customer complaint somewhere in the organization, there is a report, there is a documentation. It's just not always neatly filed. It might be in an e-mail, it might be somewhere. So being able to retrieve that knowledge quickly and then being able to respond to a customer quickly, being able to prepare a proposal quickly. All those aspects are useful for AI. We're in the earlier stages of adopting that. And then on the engineering, on the technology, on the new product development, there's also the ability. Then you take it to the e-commerce portal where how do you get our customers to do -- be easier to do business is another aspect. Next frontier, where we're looking at how do you use AI, for example, for contracts. If you have -- hypothetically speaking, we have tariffs that come in, and we need to figure out which contract has what clause in it. We can have the legal department read a lot of contracts for a long time where you can use AI tools and very quickly be able to understand what your addressable potential is. So those are all areas where AI is here ready now to be able to be used to really make life more productive and really allow people then to focus on higher-value activities than what they have so far.

And you referenced earlier that you've got some kind of growth product initiatives going into next year, kind of alluded to in the AI conversation as well. What are those types of products? What would you speak to as far as what those growth initiatives are that specifically can help growth for '26?

Yes. Really a couple of places that come to mind just to use as examples. I mean it's a broad answer. We have new products across the portfolio, but a couple that we're very excited about. Automation and humanoids, robotics, this is a new area. We've made a couple of acquisitions on Precision Motion. This is our CGI acquisition, our Spinea acquisition. Using that same technology on humanoids, we're doing work there with prototypes. We're doing work with key OEMs to really establish those new applications. That's certainly a very, very exciting area. Linear motion, applying that to humanoids, applying that to industrial robotics, industrial automation is also another growth area. Utility power gen is another one really enabling more reliability in the power generation area, whether it's gas turbines, whether it's nuclear, that's another area where not only the legacy bearings portfolio, but the newly acquired businesses all come together to serve that customer. And these are all needs that have increasing technical requirements, which is what we love.

Great. Well, please join me in thanking Lucian and Mike and...