The Timken Company (TKR) Earnings Call Transcript & Summary

All right. I think we are live. Good morning, everybody. This is the very first session for the Jefferies Industrial Conference this year, and we're very pleased to welcome you all to the event and anyone who might be listening online. We are even more happy to welcome Timken to the podium. So we have Mike Discenza, CFO of Timken. He's been the CFO for 1.5 years or so now, right?

Yes.

But he's been a Timken guy since 2000. So a little bit of a rare unicorn where he actually has been at the company for a very long time and sort of knows where all the bodies are buried. And we also have Neil Frohnapple, I think people probably know he's in charge of IR for Timken. And before that, he spent his -- misspent youth as a sell-side analyst. So he figured out early on, it's easier to cover one company than many. And so he's at your disposal as well. So we're going to run this as a fireside chat, and we're just going to kind of dive in. I'll try to leave a few minutes at the end for questions from the field here. So Mike, welcome. Thank you.

Thank you. Thanks, Steve.

So why don't we kick off? You've entered sort of a new strategic phase you're calling Elevate to Outperform, which you talked about in your Investor Day, and you're sort of transitioning from a broad portfolio transition to a more disciplined execution framework with 80/20 as really, I think, the guidestone. So maybe for those that aren't as familiar with how this has evolved, maybe just give us a quick overview of what you're doing there. Great. Yes, happy to do so. Thank you, and good morning, everyone.

Great. Yes, happy to do so. Thank you, and good morning, everyone. Yes. So our Elevate to Outperform strategy, as Steve mentioned, is really deploying our 80/20 mindset to accelerate profitable growth. And we're really focused on structurally increasing margins and driving value for shareholders. The strategy itself is based on 3 pillars, again, which we rolled out. First pillar, optimizing our portfolio. Secondly, focusing resources to our strategic verticals like robotics and automation to increase growth and then better leveraging our multinational footprint as we operate as One Timken, and I'll hopefully get into that a little bit more. The execution of the strategy is well underway, and we're operating with urgency to achieve the 2028 financial targets we laid out, which include mid-single-digit organic sales growth, a 500 basis point increase in adjusted EBITDA margins and adjusted earnings per share of around $8.50. So yes, we're really excited about the new strategy. We just had our leadership team together kind of the top 100 last week, and I can tell you the excitement is there across the board. So really happy to get going on this new strategy and looking forward to delivering our 2028 targets.

Okay. Great. So I get a bunch of questions around this, as you might imagine. So let's just dive in a little bit. In terms of 80/20, there's obviously been a number of companies who have done that fairly successfully. So how would you counsel us to think about where you are in that -- the adoption of the 80/20 plan and kind of where you go from here?

Yes, sure. So where we are. So to this point, one way to measure that is how much we've kind of rolled 80/20 out to the company. So at this point, we've covered about 60% of the enterprise with training, and we have -- excuse me, work streams launched -- 80s and 20s work streams launched across all of those businesses that have been trained by the end of the quarter, so by the end of this month, we should be much closer to 75% of the revenue covered. So we continue rolling this out. And by the end of the year, we will have our entire company covered with training. Just speaking a little more about 80/20 personally, I'm really excited about 80/20. I think it's a significant opportunity for Timken. And we believe that this will lead to faster growth and maybe not something you hear as much on 80/20, but for us, 80/20 is absolutely a growth initiative as we're able to free up resources and dedicate them to the pillars I just talked about, focusing on strategic verticals. We think this is really a catalyst to our growth initiatives. So -- but of course, we also expect to generate higher margins and we will free up some working capital as well. An interesting stat, and we said this at our Investor Day back in May, but within Engineered Bearings, so our largest business, about 2/3 of our revenue, our data showed that 50% of our customer count and 50% of our SKUs generate about 1% of revenue. So from a complexity standpoint, highly complex, long tail, perfect for 80/20. So our goal is now serve these customers differently. So focus on those top customers, make sure we're serving them differently and start working on addressing the complexity. So we've implemented so far or in the midst of implementing minimum order value, one of the first things we're implementing, which when we went and looked at the data, we realized that we didn't have minimum order values, even though we thought we did and customers were ordering below what really was the processing cost, even the order intake cost for an order. So just some simple things like that will help with simplicity -- with simplification, excuse me. And then price increase is, again, another lever you pull early on in 80/20, which is making sure that our Quad 4, Quad 3 customers are being treated differently, and we've implemented price increases across those. So 80/20 is in full swing. We expect to see benefits accrue to the margin line, if you will, beginning, call it, first half of 2027. And of course, growth takes a little bit longer to kick in, but certainly believe that '27 is when we'll start to see the benefits of the refocused efforts on growth from 80/20 as well.

So you had, I think, a slight net negative with 80/20 in the first half. I think you're thinking flattish in the second half and then tailwind in '27. That's still on track.

Yes, still on track, and that's exactly right. We brought in, I'll say, one of the leading 80/20 consultants, a lot of companies in our space use. And when we brought them in, obviously, a lot of cost early on, not a lot of benefit. coming into the second half as we put in these changes I talked about. We're seeing benefits, but offsetting that additional cost. And then, yes, still on track to deliver improvement in 2027.

Great. Okay. And I think you brought on a new COO about 5 or 7 days ago, if my math is correct.

That is correct.

Talk about how that sort of makes the plan move faster?

Yes. Yes, I think you're exactly right, 7 days, he started -- it was great. I'm not sure there's a better way to start with the company. Again, we had our leadership team together. His first day was with the top 100. So got to really get steeped in the culture, in the strategy and excited to have him on board. I think it's going to be a great add. So Steve Ribaudo, who came to us from Carrier Global, comes with quite a good reputation. It's still early days in this new organizational structure, but we think these changes, so a combination of Chief Operating Officer, and we've announced the Chief Commercial Officer, who was with us, but we moved him into a Chief Commercial Officer role. So we think these changes will help with enhanced execution, speed and accountability. And for example, even early on, I'm hearing some really positive anecdotes on how we're better serving our customers through this One Timken sales approach. So with the commercial excellence initiatives we have and our commercial -- Chief Commercial Officer and 80/20 really focused on differentiating how we serve our A customers, and we're already seeing positive results from that. And then on the operational side, so a little -- I'm not sure I can attribute this to our new Chief Operating Officer, but we've already started to see some reduced complexity across the organization from 80/20. So I expect Steve to come in who has experience with 80/20, expect him to come in and accelerate those efforts. So really happy to have Steve on board. I think with this new org structure, again, we're going to focus on enhanced execution and speed, which has been a challenge for us with the complexity, and we think that will unlock growth.

Great. And have there been any other changes in the firm yet relative to sort of executive compensation or even how sales folks get paid? Anything else that's changed in the incentive structure yet or planned?

So no changes in the structure yet. And I'll remind you that our executive compensation is our variable -- executive compensation is based on earnings growth. It's based on return on invested capital, and that remains the same. So highly incented to generate return on invested capital. From an incentive at the, call it, the sales incentive level, and I get this question quite a bit, we've not changed the sales incentive plan for this year, but we are actively working on implementing new sales incentive plans aligned to 80/20 beginning in 2027. So with, again, the recent appointment of our Chief Commercial Officer, underneath him, we've announced a new Vice President of Commercial Excellence, who has responsibility for designing these sales incentive programs across the enterprise. So to come. The changes will begin next year, but the behaviors are already starting to be rewarded differently. And then we just felt better to change compensation at the beginning of our compensation year. So -- but no concerns. We know that, that's an important part of driving the change we want to drive.

Okay. Great. Maybe let's switch gears now then from kind of the longer term or medium term to something a little shorter. We're just back from sort of an extended holiday period and all of us are trying to get our brains ready for work again. Let's just talk a little bit about what you're seeing in your various end markets. You guys are fairly diversified. So you're, I think, a pretty good leading indicator. What's really exciting for you right now? Is there anything sort of not coming along the way you'd like it to? Just any end market update would be great.

Yes. I'll start, and please, Neil, chime in if anything you want to add. So maybe just to pick a couple of our key end markets. I'll start with maybe aerospace and defense. Aero and defense is about 12% of our total company sales and one of the strategic verticals we're doubling down on that I've talked about. This market has been strong, was strong in the second quarter. We talked about making an investment in that business in the second half of the year, and that investment is partly related to capacity, which we'd already announced, but really focused on investing in our people to improve retention and address some output issues we've had in that business. So the backlog is there. It's a solid business, and we're working on getting after that as fast as possible. So that market remains really strong for us. Another one, automation and robotics was strong for us in the second quarter as well. We grew high single digits year-over-year in that market. And this is a market that we believe can continue to grow at a double-digit organic sales CAGR through 2028. So one of our, again, focused markets. So a strong market for us as well there. Any others you'd comment on?

Yes. I would just say more broadly, as you look at Timken strategic verticals that you can see on this slide comprise about 50% of the company's total sales. And so as Mike talked about, these are the strategic verticals where we're doubling down is in the spirit of 80/20. In the second quarter, these strategic verticals grew high single digits year-on-year. And through 2028, we would expect them to grow high single digits. But to Mike's point, if you look at verticals within that aerospace and defense, automation, robotics, we certainly think that can grow above that high single-digit average. So seeing some good early benefits from the strategy as we focus on these strategic verticals.

Okay. Maybe can we dive into Power and Electrification? That's a fan favorite these days. I think it was one that was a little bit weaker in the most recent quarter. Just talk about what's happening there.

Yes. Great question. And that -- you're right. Well, we reported it being weaker, but really, that weakness was just in our Industrial Motion segment. And for us, Industrial Motion, Power and Electrification is largely or not largely, partly made up of our solar business and the solar business for us has been a little bit weaker. But in Engineered Bearings, we actually were up year-on-year in Power and Electrification. So between bearings and what we saw in Industrial Motion was relatively flat year-over-year at the company level. So still really bullish on this, the renewable energy piece, the wind and solar, but it also includes power gen. And so for us, that is one of our strategic verticals, looking to expand our business in power generation, and we expect that to grow significantly over the coming years. So yes, another market that we think by doubling down on, we can outgrow, and we believe that we have a really good offering with our industrial gearing business, of course, our bearing business to continue to grow in this market.

Yes. And the only thing I'd add is that the solar business at this point, it has been down for several quarters. So the comparisons get a lot easier in the back half of the year. And so again, we would expect the growth to resume within Industrial Motion and Power and Electrification in the coming quarters.

Okay. So since you mentioned the back half, Neil, I think your first half, we started to grow again organically for the first time in, I don't know, 10 quarters or something, if my math is right. But it felt like your guide for the second half was actually slightly weaker than the first. How should we think about that?

Yes, you're right. We did guide -- we grew at about 4% organically in the first half, and our implied second half guide would say we're growing at about 2.5%. Just a couple of notes on that. First of all, pricing in the first half year-over-year was around 2%. And then we've said in the second half, because we started implementing pricing in the second half of last year, that starts to anniversary out, if you will. And so the growth rate on pricing year-over-year is part of that decline, if you will, or the second half being at a slower rate. Even though we have a lower second half, we did raise our guidance at our last earnings call, we took our growth up 0.5% for the year. So still feel really good about the year. Another small thing, I mentioned again on the call, but we've announced the divestiture of our belts business, and that's expected to close by the end of the third quarter. And as part of that, we've seen customer behavior change a little bit, obviously, with Gates who we're divesting the business to remaining in the business. Some of those orders that we thought -- that we were previously seeing are starting to flow to them. So a little bit of a drag on that second half growth rate as well. So -- but look, we remain cautiously optimistic. We think we're in the early innings of an industrial up cycle, a little bit different up cycle for us, and we've talked about this before, Steve. Timken historically, coming out of an industrial cycle, we'd see big -- almost a V-shaped recovery where we'd see big growth year-on-year in the first part of an up cycle, we're not seeing that. So a little bit different recovery, but still very cautiously optimistic on this. And hopefully, if we can clear some of the uncertainty in the geopolitics and the macro economy with tariffs, we think there's room to run on this industrial recovery.

And I think we talked about this a little last night, but every cycle I've ever seen sort of you lead with distribution, and that doesn't seem to really be happening here. Remind us how much distribution is for you? And then what's the outlook there?

Yes, industrial distribution is in the 25% to 30% of total company sales. And if you take a step back, over 40% of Timken's annual revenue is driven by aftermarket and services. Certainly, independent distribution is a big driver to that. But yes, so 25% to 30%, Steve.

Can you think of a reason why that wouldn't sort of respond eventually the way we'd expect?

We saw growth in the second quarter in industrial distribution. But again, we think the geopolitical uncertainty, the tariff volatility maybe has dampened sentiment from some of our customers in that space. But again, we would say inventory levels are very well positioned for current demand, not just within industrial distribution, but more broadly across several of our markets. So we're confident that it will resume to faster growth at some point. But this year has been a bit unique and so the growth has been a bit slower.

That's the quote of the conference so far. A bit unique this year. So is the margin differential between that industrial distribution and everything else still the way it's always been. So if it does come back, we'll see some mix benefit?

Yes, we like the margins on our industrial distribution portfolio. So they remain above company average. And yes, if that were to grow faster, we would definitely benefit from a mixup effect there.

Right. Good. Okay. So you mentioned the belts business. So maybe let's take a minute and talk about sort of the stuff you're deemphasizing here. So remind us sort of what happened or what's happening with the belts business. And then I think auto is another area where we're maybe exiting some.

Yes. Yes, you're right. So yes, first, let's maybe talk about the belts business. So again, in our Investor Day targets, the 2028 targets that we laid out, we assumed that the belts divestiture would add around 200 basis points to segment margins. So this is a business that has been underperforming for us, and we talk about being a natural owner. And this is a business that when we looked across the portfolio, we didn't feel we were the best natural owner of this business. It was underperforming, and we think that Gates will operate it much better than we could, and it allows us to focus our energy on the growth areas that we want to double down on those strategic verticals we talked about. So we're addressing that part of the portfolio. As you mentioned, the automotive OE exit. So we've announced that we are -- and we use the word automotive OE exit, but really, what we've said is we're shrinking our automotive OE business. Today, 2025 comprised roughly 8% of sales, automotive OE, and we're targeting to reduce that by roughly half to about 4% of company sales through a phased transition out. So we're working with our customers on an orderly transition, making sure that we're not leaving them high and dry. And so between now and call it, 2028, we'll shed another $150 million of automotive business. Again, it will be accretive to the portfolio and are in those 2028 margin targets we talked about. So the 500 basis points of company margin expansion includes both the belts divestiture and the automotive OE exit. Thinking about the rest of the portfolio, there's nothing else. We've talked about addressing, call it, high single digits percentage of our total portfolio, which if you take this plus belts, you're pretty much there. So it doesn't mean that we're done. What I would say is that we are implementing this 80/20 portfolio discipline. So we'll continue to look at the portfolio, continue to look for things that either don't fit or better in someone else's portfolio as a natural owner from a divestiture standpoint. But as we sit right now, I don't have plans to address a significant portion of the portfolio that's left.