Perfect. Thank you all, and good afternoon. It's my pleasure today to have Lucian Boldea, CEO and President of Timken, as well as Mike Discenza, EVP and CFO of Timken. Before we just get started here, just a quick disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representatives. With that, again, thank you, gentlemen, for joining me.
Thank you.
Thanks for having us.
It would be great to just start out with the "Elevate to Outperform" strategy that you laid out at Investor Day. A pretty significant step up in growth margins, earnings profile through 2028. Just for those that may be less familiar with the shift in strategy and, Lucian, what you've laid out in terms of the key pillars, the targets, where you want to take the business here, both through 2028 and your vision for longer term. Can you just give us a walk-through some of those basics?
Absolutely. First of all, thank you for having us. It is really great to be here. When we look at "Elevate to Outperform" and why we launched the strategy and what we are trying to accomplish with it really deploys this 80/20 mindset as a foundational way of approaching and solving the problem. The problem that we are trying to solve is really to accelerate profitable growth, expand margins, and then drive value to shareholders as a result. We do this by really focusing on three different pillars. First of all, our portfolio. Really holding ourselves accountable to be a disciplined and active portfolio manager of our own portfolio. Making sure we analyze that portfolio on a frequent basis and we ask ourselves what belongs. We apply an 80/20 mindset to that. What do we need more of, what do we need less of, and really manage that actively.
We then look at the markets that we focus on and make sure that we have appropriate revenue exposure to high-growth markets so that we can really outperform by having the market tailwind help us outperform. Last but not least, there is a third pillar that involves regional penetration. Our business is unique from the standpoint that our Industrial Motion portfolio of businesses that represents over a third of the company is really mostly constituted of regional businesses. Really being able to expand these businesses from one region to another affords kind of, I call it a bucket of self-help, but really revenue that we can generate growth from, that we can then help ourselves outperform above the market.
No, that is very helpful. I tend to think about Timken as a firm that is already made a lot of transformation going from low teens EBITDA margin to high teens EBITDA margin, and you are proposing taking the business into the 20s, right? This 80/20 is a big aspect of that. I was hoping you could help us kind of understand maybe a little bit more into that 80/20, unpack that a bit more in terms of gross profit margins impact, working capital needs impact, or just even at the operating culture level within the firm. What does this mean to Timken?
Yeah. I will ask Mike also to offer his view here, but I think if I step back from overall the goal that we have laid out at Investor Day just a few months ago, we said we are going to structurally improve margins by 500 basis points. That is a significant number because it is not by sometime out there, it is by 2028. The clock starts pretty soon on 2028, so we are not that far away. We understand the timing. But we laid out a very credible roadmap on how we get there, and it is really across the three pillars. It is really looking at structurally improving margins from belts, then it is looking at the markets and outperforming with the markets, and then finally, the regional penetration.
Underpinning all that, which is what I'd like Mike to comment on, is your 80/20 question of what we can do to really support the cost structure to be able to do that.
Yeah. Thanks, Lucian. A couple of things on that. First of all, we're well underway. As you said, we've launched 80/20. By the end of this quarter, we'll have more than 75% of our organization trained and initiatives underway. Some of those initiatives that started earlier are going to start producing results. You'll see that show up in margin uplift as early as the first half of next year. Certainly our own help on 80/20, just from the initiatives that are underway, pricing, et cetera. Secondly, we're getting to the point now where we're looking at our cost structures and going through the Zero Up process. Anyone familiar with 80/20, we're now looking at our cost structures, identifying where simplification creates capacity, if you will, and it frees up resources. Part of our growth strategy is around redeploying those resources into the growth areas.
Of course, it provides an opportunity for margin uplift as well. Next year, we'll be looking at how to carry those simplification savings into the business, reinvest where it makes sense, and then look to expand margins as well. Then you mentioned the last thing, working capital. We do believe there's a working capital unlock through simplification. In our 2028 targets, we communicated we thought there was about 1% of sales per year kind of unlock on working capital to sales. We do think there's an opportunity to generate cash as part of this 80/20 initiative as well.
You mentioned pricing as one of those aspects or those levers that you can ultimately pull with 80/20. Can you just help us understand how does the deployment of that play out? Is it across the business as a whole? Is it in very specific with specific customers? Just ultimately how we should think about the flow-in of that in the P&L.
Yeah, look, I appreciate that question. I think often when people hear 80/20, it is called 80/20 and not 20/80 for a reason because the 80s is why you do it. That is where you want to focus, and the 20s is where the resources come from so that you can afford to take better care of the 80s. Pricing is one of those avenues. If you think about the world of 80s customers and 20s customers and 80s products and 20s products, we have been very transparent to share that in our Engineered Bearings business. Our half of our customers, our bottom half of our customers account for less than 1% of the revenue, and half of our products account for less than 1%, about 1% of the revenue.
Now you might say, "Well, that is easy. Why do not you take action immediately?" Because you have to look at it by quadrant, and your large customers buying your fast-moving product, you want more of that. You want to delight those customers. You want to have better delivery terms. You want to really take care of and grow that business. Your small customers buying the one-off products, that is not business we will ever be able to be profitable with. That is business that you have to, over time, shed in an appropriate way. Your small customers buying fast-moving products, that is why you have channel partners. That is why you have e-commerce. That is why you have distributors. You ask them to consolidate purchases, and so on. You manage them that way.
Your large customers buying your one-off products, that is where you have to have that conversation very carefully because some of those small products may be very valuable to your large customers. You have to have a logical transition. Treating these quadrants differently is key. But then inside those quadrants, you have certain places where price increases are absolutely one way to do that, one way to, I would not say test for the value, but to make sure you are appropriately getting paid for the service that you are offering. Because one of the things, just fact of life, your accounting systems will never be able to keep up appropriately with allocating sufficient cost to the customer that literally places a $100 or $200 order versus a customer that is a $20 million customer.
You cannot allocate enough cost to the small customer with normal cost allocation, which means your profit will always be overstated on the small customer and understated on the large ones. You have to account for that and prices wanted to do that. We are looking at price increases for those quadrants to be able to get them to at least some better return, but over time, really push the message of, okay, maybe we are not the best supplier for those really one-off products.
And I think kind of embedded in that is ultimately how you go to market with each of these customers. But the commercial side of your organization is an area that you've made a lot of changes of late to just, as well as at the Investor Day, you talked about more of a systems approach to selling. One, could you just help us understand and unpack that? What does that strategy look like in terms of implementation? And then as you think about the customer's perspective, how does that ultimately also help add value to the-
Yeah. Thank you. So, yeah. So one of the things that we've done, and it's a pretty dramatic change in the org structure. So we went from really two verticals on Engineered Bearings and Industrial Motion to two horizontals that report to me directly. So one, we have a single storefront for Timken, which is the commercial organization led by a Chief Commercial Officer. That's where the entire sales team, field marketing, all the market-facing resources are. And then we have sort of the back of the store, the P&Ls, the operations, that's all aligned with a single Chief Operating Officer. And we've done that so that we achieve operational efficiencies. We apply 80/20 in a consistent way. We have a business operating model in a consistent way. But most importantly, we present ourselves to the market in a consistent way. And why would we have done that?
We realized very quickly that the fundamental sales motion in selling a component like a bearing, fulfilling demand to a person that already knows they need a bearing, is very different from the sales motion of engineering a system and designing a system. One is a procurement RFP, the other one is an engineer-to-engineer conversation. We have both sales motions in both businesses, but the predominant sales motion in Industrial Motion is the engineer to engineer, and the predominant one in bearings is more of that component supply. Then when you put this together, the aha moment, at least for me, was this has to be an IM first and not an EB first. And the reason is IM involves, usually is involved earlier in the design cycle.
It's involved when somebody's thinking of the next big piece of machinery, the next industrial automation machine, the next excavator, the next combine, whereas EB sometimes comes in when we're selling components. And it's good to be involved early. It's good to be involved in the design process. So IM allows us to do that. So putting that story together has been kind of the first step and no regrets. Now, under that, we've put together platforms that are complementary technologies to the same solution. So if you think about our Spinea acquisition or our Cone Drive, or CGI or others, those capabilities can be somewhat interchangeable. So being able to present ourselves to the customer to say, "You have this problem, you can use solutions A, B, or C. Here are the trade-offs," also gives us more credibility.
When you step back and you look at it, what I'm really very, very excited about is we have a lot of early proof that this is working. We've now had a number of quarters in a row where Industrial Motion and Engineered Bearings numbers are quite different. Growth rates are different, profitability is different, and that really illustrates the fact that this one Timken approach does help, and then the regional translations help as well.
No, that's very helpful. I guess another area of ultimately the "Elevate to Outperform", but it was maybe a little bit further down the line, was M&A and inorganics role to ultimately continue to grow the Industrial Motion business, but just your broader capabilities and business. Can you just help us understand the role of M&A in your strategy, the fact that your multiple has started to move up, does that kind of accelerate your ability to actually take some advantage of some of the opportunities there? Yeah, just particular kind of pockets where you think there's more opportunities or capabilities.
Yeah. Look, what I hope "Elevate to Outperform" does for everybody is lay out a roadmap that, y ou can hold us accountable too, and it's a mirror for ourselves on what M&A should make sense. Is it accretive to our portfolio? If you look at that lever, that pillar of the strategy, then does it align with focus markets and does it enhance our position in a market that's of rapid growth? Last but not least, does it have a regional footprint that puts us in a unique position to deliver some synergy? Are we, in other words, the natural owner of this target? To the extent that we have targets, then we do have several that we're excited about. We're going to see what materialize or not in the world of M&A. You can't really count on some.
But we are constantly looking at a rich pipeline of opportunities that really meet these criteria, that are accretive to the portfolio, that we are uniquely positioned to deliver value from. You can't answer M&A without the context of just capital allocation. So maybe turn it over to Mike to talk about our philosophy on how we think about capital allocation in the context of M&A, because it's really a key driver.
Sure. And maybe just a couple of points before I get to the capital allocation. I want to reiterate, we talked about M&A, but portfolio management overall is an important part of what we look at. So M&A, we think about what goes in, but we're also very much focused on making sure we know what doesn't belong, and as we've announced, we've taken several actions on our portfolio already. So that discipline of portfolio review is something that we're committed to. So M&A is important in portfolio management overall. As it relates to M&A, look, we have been and will remain a disciplined allocator of capital. I think we've done that well, both allocated capital, both share buyback, where over the last 10 plus years, we've bought back 25% of our shares. As Lucian said, several acquisitions, 15 plus acquisitions. So we've balanced that capital approach. We'll stay disciplined.
The good news is we have a really good balance sheet. So our leverage finished last year at 2x . We are generating significant cash this year, and as we look out over the next three years, expect to generate $1.6 billion of cash. So between our strong balance sheet and the cash generation, we have lots of optionality. We're committed to our investment-grade balance sheet. We're committed to that disciplined allocation. Dividend, we're a consistent dividend payer. Well over 400 quarters of consistent quarterly dividend payments. Increasing our annual dividend now for over 11 years. So we'll continue to balance that approach and maintain the discipline.
No, that's very helpful, and I think that's one of the things that I found exciting about Investor Day, right? That with that $1.6 billion, none of that was included in your $8.50 target by 2028.
Right.
That seemed like all kind of upside opportunity. Maybe just to continue down the line of potential areas of white space or technology that you could ultimately take advantage of, wanted to talk about market share gains, in terms of Timken continuing to evolve and grow faster. Part of that, I'm assuming, comes from penetrating deeper into or getting higher content with a customer, some market share gains. Can you talk about what that opportunity set looks like? The magnitude and is it just about your commercial organization being more direct about targeting those, or is there capabilities or technology that you would need in order to break into some of those opportunities?
Yeah, look, it's a little bit of both. I think if you look at market share gains, there are certain, all these, the entire third pillar of the strategy, the regional penetration, you could call that a market share gain because we are going into new regions where we're underrepresented or completely underrepresented, and we're gaining share there. That's certainly that entire vector. No apologies. That's a share gain. There's an element of create demand as you create the share gain, but in the end, it is a share gain. But outside of those geographic approaches, it's more of a share of wallet play with your 80s customers.
When we present ourselves differently to our 80s customers, and we tell them that we will treat them differently, and we honor that commitment with better lead times, better service, faster access to new products and innovation, faster access to prototypes and samples and so on, they see value in that, and as a result, they reward us with more of their share of wallet. We bring in more solutions that we didn't have. Maybe they were a loyal bearings customer for the last 50 years, but they weren't aware we have an automatic lubrication system business because that was more of a European business. Their footprint is in the U.S. We can bring that across. There are a number of approaches, but really in the end, yes, we have focused markets, yes, we have regions, but who buys product is customers.
The rubber meets the road at the large customers, at our 80s customers, which is who we need to grow a share of wallet with.
Yeah. Maybe just continuing down that line in Industrial Motion, I guess, this is where you have the faster growth aspects of your business and exposure to some interesting and secular themes like automation, robotics, medical. Can you just help us understand, ultimately, as you think about these verticals that not only have faster growth but better economics, what is the size of your exposure today? What is the opportunity set? As you think about the business and the portfolio evolving, which of these are a bigger focus?
Yeah, look, it's very hard not to very quickly go to automation and robotics as the front of the list because let's face it, we're kind of at the beginning of an investment cycle and a revolution in that space that's maybe a once in a generation opportunity, not to be overly dramatic, but it is.
It is that sizable because in the end, artificial intelligence has evolved. AI is starting to enter the industrial space, but when people talk about physical AI, they are talking about mechanical engineering with a lot of precision. We still need to make things. We need to move things. The robots have gotten good, the cameras have gotten good, the brains have gotten good, but there's still room in the precision of the motion to capture and really be able to affect the motion at that level with the accuracy that's needed. We tend to sometimes over-index talking about humanoids, but that's certainly a very exciting opportunity for us. But before humanoids, you just have the field of industrial automation, the trend that factory work today, it's more difficult to recruit resources in a factory. It's more difficult to train over time.
That means automation, cobots, industrial robots, that will be the name of the game. That really very quickly goes to the front of the list. Defense and aerospace right behind it with different macro trends driving either one of those subsegments, but both of them just growing very significantly still with a lot of unmet demand out there. So those are really the two, and then if you think about power generation utilities, that has to underpin all this because there's no AI without more megawatts. So those are the three. If you look at what technologies we need, certainly there's still a lot more to be industrialized and scaled up in the robotics and automation side. So we have, if you look at our technologies that are addressable, we can address 25% of the bill of materials of a robot or of a humanoid.
But can that be done at scale? Can that be done at a cost-effective way to where these things are affordable? That's still ground to be developed, and that's not just by us, that's in general. That's still work to be done.
C an you talk about that? Because I think in a little bit more detail, I think one of the dynamics that you've talked about is maybe having a team internally that's just very focused on this. As you think about Timken again and trying to position yourself so that you're able to take advantage of these opportunities and be well-positioned, what are you doing internally to really set yourself up?
Yeah. First, what we've done is we're setting up. One of the things we did structurally late last fall, we announced the Chief Technology Officer. We didn't have that function for the company. It's for the whole company. We had technology leaders in the different businesses, but we didn't have a one Timken CTO organization. We've now had that for a number of months. We've put together a compelling technology portfolio overall, and then we're looking at centers of excellence and having one of those to start with, versus each business trying to tackle humanoids on their own, or robotics. We now are underway putting that in place. The good news is we have a very rich pipeline, over $100 million worth of pipeline with customers. We're engaged with customers directly in prototyping and co-innovation, so that's also exciting what's going on.
Now it's for us to do two things in there. One is we're looking at the applicability of our technologies and how do we scale those up. But two, we're also doing a lot of screening externally to see what other technologies are needed, and then we'll be faced with a make versus buy. Do we invest more time and continue to develop it ourselves, or is there something that we can acquire that can get us to market quickly? Obviously, speed is of the essence. That all is already underway for that space, but it's with a general lens of automation, part of that, obviously humanoids being a subset.
No, that's very helpful. And just a reminder for the audience, I forgot to mention this earlier, but if you have any questions, raise your hand and we can get a mic over to you. At any point, feel free to just raise your hand. Maybe just continuing along the lines of areas where you're investing is aerospace and defense. You talked about making some investments into that business in this past quarter, and I think in the past you've said it takes maybe six to nine months ultimately to bring on new aerospace capacity and labor fully online. Can you just help us understand what are the bottlenecks in terms of the supply chain and what completed, as you think about these investments, kind of the strategic vertical expected, what the benefits are for this business from that?
Yeah. Look, I think we're already seeing some impact from that. What I would tell you, and I think almost anybody who's in the aerospace and defense business now, their quarterly forecast is done by the factory and not by the sales team. Because you're going to sell what you can make. You're not going to sell the orders that you book because you're booking more orders than what you're shipping. That's still the case. Our book-to-bill is still favorable in aerospace. What it also says is if your business is growing year-over-year on a revenue basis, that means you're making more in your factories.
You're starting to see that high single-digit growth in our business, and it comes through more production. But we are, at this point, adding, don't want to call it more of the same, but it's a little bit of that, which is more labor, training more people faster, adding more equipment, adding more shifts where possible, putting in financial incentives so that we can work more effectively and have an incentive for our operations role people to produce more per hour. Those are all incremental investments that are starting to pay off. But we have more backlog and past use than that, so we have more opportunity to really generate more revenue without booking another order, just from the orders that we have. Then obviously, we're excited about some of the growth prospects in that business as well.
They're unique opportunities, but it is an entire supply chain, whether it's ourselves or our suppliers or our customers. Everybody's trying to solve almost exactly the same problem.
No, that's very helpful. I want to pivot to maybe a little bit more of a near-term question because we've been getting a lot of inbounds on this in terms of your second half organic guidance. I think there was a little bit of confusion because it implied a slowdown into, I think, the 2.5% range of organic growth versus the kind of 4% that you've done in the first half. I think, I want to say last week you talked about trends continuing to actually potentially come in a little bit better than that 2.5% that you kind of guided to. Can you just help us understand one, kind of putting guardrails around what does that mean that it's doing a little bit better? What are you seeing so far in September?
To the extent that you can help us gauge or really understand what that slowdown actually says about the business versus what you're seeing in terms of orders, that would be helpful.
Yeah. No. I'll let Mike answer most of it here. I just want to frame a little bit the problem, what we're trying to solve for, and then we'll go to answering it. We grew year- over- year 420 bps front half, then we increased our guide to 350 instead of 300 for the year, which meant the back half mathematically works out to 250. So now we're trying to explain 170 between front half and back half. We've been saying for some time that price is over 100 of that's simply timing of when we recover the tariff pricing last year. So pricing is 1% year over year back half over 2% year over year front half. So that's part of the difference.
So now we're left with 70 bps as the delta between the front half and the second half, which is $9 million of revenue at the size of our company. So that's the per quarter. That's the size of what we're talking about in terms of is it decelerating, is it not? Let me let Mike talk about what's behind that.
Yeah. As you said, Angel, last week, we indicated that kind of July came in maybe a little bit better than expected. August came in about where we expected, typical August, which is a lot of holiday shutdowns, et cetera. We do not put a lot on August performance. But net-net, we are running slightly ahead of that 2.5% second half implied guide. The split though was really between Industrial Motion, which is running stronger than we expected, and our Engineered Bearings business, which is running at a slightly below where we expected. One of the challenges we are seeing in the Engineered Bearings business relates to our wind energy market, which historically has been more lumpy, unfortunately. A lot of government incentive effect, et cetera. Last year at this time, third quarter, fourth quarter, we were really growing.
Double digit growth in our wind energy business in Engineered Bearings. The comp is tough, and then some of that lumpiness we are seeing show up in this quarter. That renewable energy sector and wind energy in particular is causing us a little bit of challenge in the Engineered Bearings business in the segment. But it is too early to comment on September, but we still think we are in the early stages of an industrial recovery. Still very optimistic that growth rate will continue into next year. Again, too early to comment on September, but running through July and August slightly ahead of that 2.5%.
I do want to go a little bit further into the 2027, like you said, the recovery. But before we do, I guess last one on second half, just with inflation between interest rates news we just got plus what we have been seeing on the 10-year and what we have been seeing in diesel prices or just freight, just any implications or any risk to margins that you had guided to in the second half or 3Q?
Yeah. Look, I think we have learned a lot since 2021, and we have learned a lot even in the last 12 to 18 months about what type of contracts we need, what type of arrangements do we need with customers, what type of conversations to have, how to have them to where we feel good about being able to pass through additional inflation as needed. Where we are so far is our price minus costs. We are ahead of cost with price for the year, so that is still going okay. Our exposure to inflation is different maybe from what you would think intuitively. The type of steel we buy, the places where we buy it from, how we buy it gives us a good position to where we do not have an inflation on our materials. We have exposure to freight. It is larger in certain regions than in others.
For example, in India, we would be more exposed to Middle East supply of energy. There, we have already passed through price increases, so we're doing price increases. We've done some price increases in Europe as well. North America is a little bit different. We've had some tariff tailwinds here from a year-over-year standpoint, so that's taken the immediate pressure up just a little bit. It still allowed us to continue to work with our customers. But to the extent that we continue to see inflationary pressures in energy and in logistics, which is really the two big places where we're going to likely see an impact, we are well prepared and very confident that we'll be able to get those.
Mike, I want to go back to your comment about starting to see maybe early innings of a cyclical recovery or industrial recovery. I think part of what I love about the 2028 outlook is how much of it is self-help and ultimately in your hands. Can you help us understand, one, how the business would behave in a cyclical recovery, what you would kind of anticipate? And then two, what are all the kind of pieces you have between divestitures, 80/20 benefits, and how we should think about 2027?
Yeah. Maybe a quick comment on how we're performing now. As you look at our organic incremental implied for the year, it's above 30%, which for us in the early innings of an industrial recovery would be a really good organic print. Our incremental, excuse me. Price cost positive this year, so we're in a good spot from a margin standpoint. Then as we look forward, to your point, a lot of self-help. The belts divestiture, which we expect to close still in the third quarter, on a pro forma basis, provides 200 bps of uplift to the Industrial Motion segment next year. We get that right away. A lot of that already in motion and should show up right away. We do have some capital allocation options for next year as well. We have strong cash flow this year.
We should generate strong cash flow next year. Another positive for 2027, expect continued positive strong cash flow. Then volume, as I said, early stages of the recovery. We were down up until the first quarter this year-over-year on volume for 10 quarters. First quarter this year was the first quarter of volume year-on-year growth for us. We do believe we're in the early stages of recovery. Expect that to continue next year and with that volume growth, expect to continue to lever well on that. One negative, we did benefit and are benefiting from IEEPA tariff refunds this year. Don't expect those to repeat next year. Certainly inflation, as you mentioned, a lot of talk on inflation. The inflationary environment is certainly there. Next year we'll have the pricing challenge again with inflation.
Net net, look for margins to continue to expand next year, and a lot of it well underway with our self-help.
Yeah, that's very much helpful and looking forward to that, given again, how much is self-help. Maybe just to tie it all together, perhaps three minutes is not fair, Lucian, to give you for a longer-term question, but I did want to touch on so much of this through 2028 is just a lot of your self-help again. A lot of it also feels like it's just starting to lay the groundwork for what ultimately could be a longer-term vision for Timken. So maybe can you just touch on how you think about that longer-term dynamic and any reason to believe Timken at that point beyond 2028 couldn't be above your 21% to 23% EBITDA target?
Yeah, you're not going to get a new target out of me today, but nice try.
Figured I'd try.
But no, look, I am very bullish about the story and very excited about it. When you look at what we have tried to build with our story, and we were very inspired by some of our competitors that, and not direct competitors, but other industrial players that have the same strategy on the wall that they have had when their stock was one tenth what it is today. I will let you guess who in Cleveland that is. When a strategy lasts that long and it is that successful and it outlives CEO changes, that tells you that there is something special about that. So we try to put our three pillars together the same way that they would age well, so to speak. Being a disciplined steward of the portfolio, that is never going to be kind of out of style.
Focusing on the right markets, again, doesn't go out of style, and then how do you apply your multinational footprint in a way that takes advantage of that and gives you regional growth. So with that, then you couple that with the fact that we are exposed to some trends I talked about once in a generation investment in automotive, a lot of reshoring of manufacturing, an industrial rebirth in this country where a lot of forces are now aligned to bring manufacturing back. With the labor and the skill gap that we have, that means yet more automation, means more investment. It means more roads, which means more infrastructure, which means more heavy equipment. So we are very much aligned with the macro trends that are happening.
We are putting together a business model, and we are putting together a strategy and a motion and a discipline behind it that is tried and true that, yes, I think 2028 is the first signpost that we put out there, but the best is yet to come after 2028 is what we expect.
Amazing. Looking forward to it. I think that brings us to the end of time. So Lucian, Mike, really appreciate your time.
Thank you very much. Thank you.