All right, I think we are live. Good morning, everybody. This is the very first session for the Jefferies Global Industrials Conference this year, and we are 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. We have Mike Discenza, CFO of Timken. He has been CFO for a year and a half or so now, right?
Yeah.
He has 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. We also have Neil Frohnapple. I think people probably know is in charge of IR for Timken. Before that, he spent his misspent youth as a sell-side analyst. He figured out early on it is easier to cover one company than many, and so he is at your disposal as well. We are going to run this as a fireside chat, and we are just going to kind of dive in. I will try to leave a few minutes at the end for questions from the field here. Mike, welcome. Thank you.
Thank you. Thanks, Steve.
Why do not we kick off? You have entered sort of a new strategic phase you are calling Elevate to Outperform, which you talked about in your Investor Day, and you are sort of transitioning from a broad portfolio transition to a more disciplined execution framework with 80/20 as really, I think, the guidepost. Maybe for those that are not as familiar with how this has evolved, maybe just give us a quick overview of what you are doing there.
Great. Yeah, happy to do so. Thank you, and good morning, everyone. 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 three 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. 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.
Yeah, 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. Really happy to get going on this new strategy and looking forward to delivering our 2028 targets.
Okay, great. I get a bunch of questions around this, as you might imagine, let's just dive in a little bit. In terms of 80/20, there's obviously been a number of companies who've done that fairly successfully. How would you counsel us to think about where you are in the adoption of the 80/20 plan and kind of where you go from here?
Yeah, sure. Where we are, to this point, one way to measure that is how much we've kind of rolled 80/20 out to the company. At this point, we've covered about 60% of the enterprise with training, and we have long, excuse me, work streams launched, 80/20s work streams launched across all of those businesses that have been trained. By the end of the quarter, by the end of this month, we should be much closer to 75% of the revenue covered. 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.
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 are 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 initiative. 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. From a complexity standpoint, highly complex, long tail, perfect for 80/20. Our goal is now serve these customers differently.
Focus on those top customers, make sure we are serving them differently, and start working on addressing the complexity. We have implemented so far, or we are in the midst of implementing minimum order value, one of the first things we are implementing, which when we went and looked at the data, we realized that we did not 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. Just some simple things like that will help with simplicity, with simplification, excuse me. Price increases, 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 have implemented price increases across those. 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. Of course, growth takes a little bit longer to kick in, but certainly believe that 2027 is when we will start to see the benefits of the refocused efforts on growth from 80/20 as well.
You had, I think, a slight net negative with 80/20 in the first half. I think you are thinking flattish in the second half.
That is right.
Then tailwind in 2027. That is still on track?
Yeah, still on track, and that is exactly right. We have brought in, I will say, one of the leading 80/20 consultants a lot of companies in our space use. When we brought them in, obviously, a lot of cost early on, not a lot of benefit. Coming to the second half, as we put in these changes I talked about, we are seeing benefits, but offsetting that additional cost. Then, yeah, still on track to deliver improvement in 2027.
Great. Okay. I think you brought on a new COO about five or seven days ago, if my math is correct.
That is correct.
Talk about how that sort of makes the plan move faster.
Yeah. I think you're exactly right, seven 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 he's going to be a great add. 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 a Chief Commercial Officer who was with us, but we moved him into a Chief Commercial Officer role. We think these changes will help with enhanced execution, speed, and accountability.
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. With the commercial excellence initiatives we have and our 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. On the operational side, 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. I expect Steve to come in, who has experience with 80/20, expect him to come in and accelerate those efforts. 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'll unlock growth.
Great. Has there been any other changes in the firm yet relative to executive compensation or even how sales folks get paid? Anything else that's changed in the incentive structure yet or planned?
No changes in the structure yet. I'll remind you that our executive compensation is variable, and executive compensation is based on earnings growth. It's based on return on invested capital, and that remains the same. 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. 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. To come, the changes will begin next year, but the behaviors are already starting to be rewarded differently.
We just felt better to change compensation at the beginning of our compensation year. 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 a 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.
Yeah. 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, let's start with maybe aerospace and defense. Air and defense is about 12% of our total company sales and one of the strategic verticals we're doubling down on that I 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. 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, focus markets. So, a strong market for us as well there. Any others you'd comment on?
Yeah, 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. As Mike talked about, these are the strategic verticals where we're doubling down in the spirit of 80/20. In the second quarter, these strategic verticals grew high single digits year-on-year. 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 is 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 is happening there.
Yeah. Great question. You are right. We reported it being weaker, but really, that weakness was just in our Industrial Motion segment. 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. For us, that is one of our strategic verticals, looking to expand our business in power generation. We expect that to grow significantly over the coming years.
Yeah, 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.
Yeah, the only thing I would add is that the solar business at this point has been down for several quarters, so the comparisons get a lot easier in the back half of the year. Again, would expect the growth to resume within Industrial Motion and power and electrification in the coming quarters.
Okay. 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. 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%. 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. 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, and we took our growth up a half percent for the year. Still feel really good about the year.
Another small thing, 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. 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 were previously seeing are starting to flow to them. So, a little bit of a drag on that second half growth rate as well. But look, we remain cautiously optimistic. We think we're in the early innings of an industrial upcycle. Little bit different upcycle for us. We've talked about this before, Steve, that Timken historically, coming out of an industrial cycle, we'd see almost that V-shaped recovery where we'd see big growth year on year in the first part of an upcycle. We're not seeing that.
A little bit different recovery, but still very cautiously optimistic on this and hopefully, if we can clear some of the uncertainty and the geopolitics and the macroeconomy with tariffs, we think there's room to run on this industrial recovery.
I think we talked about this a little last night, but every cycle I've ever seen, sort of you lead with distribution, that doesn't seem to really be happening here. Remind us how much distribution is for you, then what's the outlook there?
Yeah. Industrial distribution's in the 25%-30% of total company sales. If you take a step back, over 40% of Timken's annual revenue is driven by aftermarket and services. Certainly, independent distribution's a big driver to that. But, yeah, so 25%-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. We are confident that it will resume to faster growth at some point. But this year has been a bit unique and-
Yeah
-the growth has been a bit slower.
That is the quote of the conference so far, a bit unique this year.
A bit unique, yeah.
Is the margin differential between that industrial distribution and everything else still the way it has always been? If it does come back, we will see some mix benefit?
Yeah, we like the margins on our industrial distribution portfolio. They remain above company average and, yes, if that were to grow faster, we would definitely benefit from a mix-up effect there.
Right. Good. Okay. You mentioned the belts business, so maybe let us take a minute and talk about the stuff you are de-emphasizing here. Remind us what happened or what is happening with the belts business, and then I think auto is another area where we are maybe exiting some.
Yes. Yeah, no, you are right. First let us maybe talk about the belts business. 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. This is a business that has been underperforming for us. We talk about being a natural owner, and this is a business that when we looked across the portfolio, we did not 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. We are addressing that part of the portfolio.
As you mentioned, the automotive OE exit, we have announced that we are. We use the word automotive OE exit, but really what we have said is we are shrinking our automotive OE business. Today, 2025 comprised roughly 8% of sales, automotive OE, and we are targeting to reduce that by roughly half to about 4% of company sales through a phased transition out. We are working with our customers on an orderly transition, making sure that we are not leaving them high and dry. Between now and call it 2028, we will 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. 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 is nothing else we have talked about addressing, call it high single digits percentage of our total portfolio, which if you take this plus belts, you are pretty much there. It does not mean that we are done. What I would say is that we are implementing this 80/20 portfolio discipline. We will continue to look at the portfolio, continue to look for things that either do not fit, are better in someone else's portfolio as a natural owner from a divestiture standpoint. As we sit right now, don't have plans to address a significant portion of the portfolio that is left.
Okay.
Yeah, as Mike said, just the belts divestiture as well as the automotive OE exit is going to generate 150 basis points- 200 basis points of margin expansion in 2028 versus 2025 levels. About a third of the total margin expansion that we are expecting is from these two portfolio actions, so well underway, as Mike said, so have a high level of confidence in achieving that.
Yeah, right. I am sure you get this question quite a bit, the slope of the curve on that margin expansion is not like a big hockey stick. It is kind of reasonably pro rata by year.
Yeah, specifically on that, we will see the full benefit, if you will, of the belts divestiture next year, assuming we complete that transaction, which again, it's on target to do. The automotive margin expansion comes a little bit more gradually over time as we exit that business. We'll get some margin uplift next year through pricing actions on some of this. But of course, we've got some stranded costs that we're going to have to deal with, but in our margin targets, we've assumed those stranded costs. Yeah, this is not a hockey stick. We'll start to see benefits from these actions beginning next year.
Okay, good. One more on this 80/20 while I'm thinking about it. You've mentioned opportunity sort of strategic pricing a few times.
But I believe you only have about a point of price baked into your guide over the next three years.
Yeah.
Is that consistent, or is there some upside there?
Yeah. So, again, you are right. In our margin targets for 2028, we have assumed about 100 basis points a year of pricing. We have averaged, and maybe the way to answer that question is to say we have done better than that over the last, call it five years, we have averaged above 100 basis points of pricing. I think the opportunity absolutely exists for us to exceed that 100 basis points. But we felt, and I think we would say this generally about our targets, we wanted them to be credible, and we thought 100 basis point pricing assumption is credible. We have demonstrated that we can deliver it. Obviously we are focused on maximizing pricing, strategic pricing actions going on through 80/20.
Of course, not pricing related, but mix-up related, as we grow in some of our more profitable businesses, which are some of these businesses we are focusing on, we are going to see margin mix-up from that. Price mix for us absolutely has a chance to exceed that 100 basis points we have assumed.
The 200 basis points that you have gotten over the last five years, that did not include any specific sort of strategic pricing initiatives, right?
No. Nothing like 80/20 strategic pricing. Of course, we have a strategic pricing function inside the company that is focused on maximizing, but not a broad-based strategic pricing initiative, no.
Right.
Yeah. It is interesting, Steve, we were able to do that 200 basis points that you had mentioned, despite volumes being down three of those five years and the economy being sort of a sub 50 PMI environment for most of that time. I think the business has really good pricing power. We are going to continue to push pricing to offset inflation, and this year is running ahead of that 100 basis point s price outlook.
Right. Okay, great. Let us spend a few minutes on capital allocation and M&A. You have a reasonably strong balance sheet. You generate a fair amount of cash. Just talk about the opportunity on capital allocation.
Yeah. As you said, strong balance sheet, finished last year at 2x net levered. We finished the previous couple of years at 2x net levered. We expect to generate significant cash flow, as Neil just was showing. When we laid out our Investor Day targets, we said $1.3 billion of free cash flow generation over the timeframe. That is $200 million more than what we did in the previous three-year cycle. That is part of that unlock from 80/20 on the working capital. We think there is opportunity there. So with a strong balance sheet, strong free cash flow generation, we absolutely have capital allocation optionality. I will just point out that our investor day targets, again, the 2028 targets assume no additional capital deployment.
If you think about that $1.3 billion+ the additional EBITDA gives us tremendous firepower to act over the next three years. In terms of capital allocation priorities, we will maintain the disciplined framework that we have been using and that everyone should be accustomed to, which prioritizes the dividend and investing in organic growth first, and then a balanced approach to share buybacks and M&A. We have been active in share buybacks this year through the first half of the year, and then we did complete one acquisition this year, our Bijur Delimon acquisition, which has been a great acquisition for the company, strong fit with our lubrication business. So we will continue to remain balanced, but tremendous optionality given the free cash flow and EBITDA growth that we are going to see over the next two years.
You have been pretty balanced between repo and M&A. On the repo side, there is a slight sort of double-edged sword here, right? Because the stock is now actually a bit more expensive than it has been. Does that change your appetite for repurchases, or?
I still think it is a good deal.
All right.
It does not change my appetite. I would argue that the stock was undervalued for a long time, so we are getting a pretty good bargain on it. And we have seen a little bit of price expansion and multiple expansion, but still believe that with our growth potential, with what we can deliver and the capital allocation optionality, it is still a good opportunity. We will continue to stay active in share repo.
Yeah. As you know, Steve, we've bought back 25% of the total shares outstanding over the last 10- 12 years, and certainly would expect share buyback to remain an important avenue of capital allocation going forward, especially as we progress and achieve these 2028 targets. We feel like there's still significant upside to go from here.
On the M&A side, is there a funnel? Are there kind of things on deck here, and how should we think about valuations on that?
Yeah. There's always a funnel. We have an active pipeline we're always working in various stages of development, if you will. I think you can look for us to stay disciplined on kind of the prices we're willing to pay. We've been staying within a couple turns of our multiple, not overreaching. I think we'll continue to maintain that discipline. But yeah, good pipeline of candidates. We've made a lot of organizational changes in the last year since Lucian started with us. This is another area where we've reinvigorated our strategic and M&A functions to focus, especially now given our strategy. We know the strategic verticals we want to double down on. It gives us a lot clearer path in terms of candidates for M&A. We're always opportunistic.
We have a list of candidates that if they come available, we'll be ready to act on, but reinvigorating that business development pipeline and making sure we have an active list of opportunities really strong so that we can act when ready.
Okay.
Yeah.
Maybe we come up for air for a second here. Does anybody in the audience want to ask a question? It's early still. All right. I can keep going then. Yeah.
What percent of the current business is the robotics motion stack?
I'll repeat it.
What percent of the?
He is asking what percent of your business is related to humanoid robotics, if I got it right.
Yeah. Go ahead.
Yeah. I would say that it is still a relatively small percentage, just given that humanoids are in pre-commercial production at this point. Timken is working with several U.S. humanoid developers, delivering prototypes. As you think about our portfolio, high precision Engineered Bearings, broad portfolio of Industrial Motion products, we talked about Timken has a product portfolio that can address 25%-30% of the bill of materials of a humanoid. We set up a cross-functional team. We have a history of scaling in new markets. If you take our wind business we talked about earlier, that went from zero to over $350 million in a decade's time. We have ability to scale manufacturing quickly. We think we are well-positioned to capitalize on that opportunity when it does present itself, but still very early days.
And more broadly, automation robotics, as Mike mentioned, that has been growing very well. We have had some market share gains here in the Americas. Automation is a megatrend and in general is very exciting for Timken.
Yeah.
Do you have any, I get this robotics question, humanoid robotics question occasionally as well. Are there any contracts yet, or is it just too early in the process?
No, we are working with. We have prototypes and orders from OEMs. But as Neil said, it is still very early days. These are not, I will say, scaled contracts. But we are definitely active across multiple OEMs, both prototyping and production orders. So, it is not ethereal. It is real, but still early days is what I would say.
Anyone else?
Steve, if I may, before we run out of time, maybe, if you do not ask and if no one is thinking, I would be surprised, but, third quarter, how is that progressing? If I can just give a comment on that. So, we said on our second quarter call, that July came in kind of as expected. So, I would say August, now that it is complete, would be similar. So, between July and August, kind of running in line with to slightly above kind of our second half implied organic guidance. September is an important month, July and August, as you said, as you started, a lot of people just coming back from vacations, holidays. August is tough in Europe, so it is really difficult for us to extrapolate from July and August.
But again, running in line to slightly ahead from where we are and maybe the only finer point I would put on it, our Industrial Motion business is actually running maybe a little bit better than our expectations, and Engineered Bearings is running kind of in line to maybe slightly below, but again, hard to extrapolate much from July and August, but, comfortable with where we are through two months. Anything you would add?
Nope.
And the leakage you kind of mentioned on the belts business is not enough to offset the strengths you are seeing elsewhere?
No, I maybe answer that differently. We are still running again in line to slightly ahead of our second half implied. So, the weakness there has not accelerated more than we expected.
Right.
Yeah, it is not offsetting growth we are seeing elsewhere.
Super. All right. Well, I think that does it then. Thanks for that. Thank you all for your attention and wish you a great conference.
Thanks, Steve.
Thank you, Steve.
Thanks, everyone.