The Timken Company - Earnings Call - Q1 2025

Executive Summary

• Q1 2025 revenue was $1.14B (down 4.2% YoY), adjusted EPS $1.40, and adjusted EBITDA margin 18.2%; sequentially stronger than Q4 2024 on revenue and margins, but below Q1 2024 on profitability.
• Consensus context: Revenue modestly beat Wall Street while adjusted EPS was essentially in line-to-slight miss; estimates were $1.13B revenue and $1.42 EPS vs actual $1.14B and $1.40 EPS*.
• Guidance lowered on EPS and margins due to tariffs and softer demand: GAAP EPS now $3.90–$4.40 (from $4.30–$4.80) and adjusted EPS $5.10–$5.60 (from $5.30–$5.80); adjusted EBITDA margin outlook reduced to mid-to-high 17% from ~18.5%; free cash flow cut to ~$375M from ≥$400M.
• Management is moving with urgency to offset ~$25M net direct tariff headwind in 2025 through pricing/surcharges, supply chain actions, and cost reductions; expects full run-rate tariff offset by year end, with potential margin recovery in 2026.

What Went Well and What Went Wrong

What Went Well

• Execution on cost actions and initiatives helped deliver resilient performance in a soft demand environment; adjusted EBITDA margin improved sequentially to 18.2% in Q1.
• Strong momentum in renewable energy within Asia driven by wind; management now expects mid-single-digit growth in renewables for 2025 versus prior “flat” outlook.
• CGI acquisition continues to perform well and is accretive to margins, contributing ~$4M adjusted EBITDA in Q1.
  • “Our team executed well in the quarter, delivering on cost actions and other initiatives” — Richard Kyle, Interim CEO.

What Went Wrong

• YoY pressure from lower volumes, unfavorable mix/currency, and higher manufacturing costs reduced adjusted EPS to $1.40 (vs $1.77) and adjusted EBITDA margin to 18.2% (vs 20.7%).
• Tariff uncertainty led to reduced full-year EPS/margin guidance and a ~$25M net direct headwind assumed for 2025, predominantly affecting Q2 and Q3.
• Industrial Motion margins declined YoY to 17.7% (from 21.2%) on lower volume and manufacturing cost headwinds, including belt capacity ramp in Mexico and duplicative costs (e.g., Fort Scott), with step-change improvement only expected in H2.

Transcript

Operator (participant)

Good morning. My name is Emily, and I will be your conference operator today. At this time, I would like to welcome everyone to Timken's First Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press Star, then the number one on your telephone keypad. If you would like to withdraw your question, please press Star, then the number two on your telephone keypad. Thank you. Mr. Frohnapple, you may begin your conference.

Neil Frohnapple (VP of Investor Relations)

Thank you, Operator, and welcome everyone to our First Quarter 2025 Earnings Conference Call. This is Neil Frohnapple, Vice President of Investor Relations for the Timken Company. We appreciate you joining us today. Before we begin our remarks this morning, I want to point out that we have posted presentation materials on the company's website that we will reference as part of today's review of the quarterly results. You can also access this material through the download feature on the earnings call webcast link. With me today are the Timken Company's President and CEO, Rich Kyle, and Phil Fracassa, our Chief Financial Officer. We will have opening comments this morning from both Rich and Phil before we open up the call for your questions.

During the Q&A, I would ask that you please limit your questions to one question and one follow-up at a time to allow everyone a chance to participate. During today's call, you may hear forward-looking statements related to our future financial results, plans, and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today's press release and in our reports filed with the SEC, which are available on the Timken.com website. We have included reconciliations between non-GAAP financial information and its GAAP equivalent in the press release and presentation materials. Today's call is copyrighted by the Timken Company, and without express written consent, we prohibit any use, recording, or transmission of any portion of the call.

With that, I would like to thank you for your interest in the Timken Company, and I will now turn the call over to Rich.

Rich Kyle (President and CEO)

Thanks, Neil. Good morning, everyone, and it's good to be with you on the earnings call again through this leadership transition. I'll begin with a brief look at our first quarter results and updated outlook for 2025, then I will share a bit more about our near-term strategic priorities. Starting with the first quarter, we delivered solid results as the team executed well on cost actions and other initiatives to help offset challenging operating conditions. Overall, sales in the quarter were over $1.1 billion, with organic revenue down around 3% from last year. We saw lower demand in Europe and the Americas, while we were up in Asia driven by growth in wind energy. Overall, our total backlog was up low single digits compared to the fourth quarter.

This is significant since backlog was down sequentially in the first quarter, both in 2023 and 2024, so it does support that we are seeing stabilization in end market demand. Adjusted EBITDA margins came in at 18.2%, and adjusted earnings per share was $1.40, both below prior year driven primarily by lower volumes, higher manufacturing costs, and unfavorable mix.

Results in the quarter were helped by targeted cost actions and continued strong performance from the CGI acquisition. Finally, we generated higher free cash flow compared to the prior year and ended the quarter with a solid balance sheet. Turning to the outlook, we are focused on performing well through this environment while continuing to advance our strategy. Phil will take you through the updated outlook and assumptions in detail, but we expect industrial market conditions to remain challenging over the rest of the year.

The guide is our current best estimate given the trade situation and the heightened level of uncertainty that we and our customers are facing. I would add that we have not seen any significant change in demand. Orders and shipments in April remain in line with our expectations. However, the tariffs and pricing have not yet fully hit the marketplace, so like everybody else, we will continue to closely monitor and react to the situation as it develops. On tariffs, we are quickly responding and actively passing the cost into the market through repricing the portfolio.

Long term, we are confident in our ability to mitigate the direct impact from tariffs. We expect to fully offset the cost impact on a run rate basis by the end of the year, and we would expect to eventually recover margin on the incremental cost as well.

However, we estimate a net direct impact from tariffs currently in place of around $25 million this year. This accounts for the time it will take to implement pricing and other actions to offset the costs expected from tariffs. This is the tariff scenario as of today, and as we all know, it has been very fluid. Finally, we are reaffirming our commitment to deliver $75 million of cost savings in 2025 and are still planning to generate significant free cash flow this year, providing us with flexibility moving forward. While the tariff situation is presenting short-term headwinds and distractions, we have successfully navigated many similar macro headwinds while simultaneously advancing the company, and that is what we intend to do through the tariff dynamics as well.

With respect to the recent CEO transition, the board is continuing a comprehensive search process to identify the best person to lead Timken into the future. In the meantime, our strategic priorities and financial aspirations remain unchanged. We are focused on winning in the marketplace to deliver profitable growth, operating with excellence, and creating shareholder value through the disciplined allocation of capital. The board is confident that we have a proven strategy and a strong and tenured management team that is capable of executing that strategy to deliver shareholder value in the coming years. Product vitality and customer centricity are at the heart of our business model and drive our organic growth initiatives. It's how we differentiate, win, and compete in the marketplace.

We are staying close to our customers to support their short and long-term needs, and our portfolio solutions and technical expertise position us well to grow with them. Operational excellence is a core competency. Our strength in this area is an advantage that will help us operate through this unpredictable environment to deliver resilient performance in 2025 and to return to growth in 2026. Our disciplined approach to capital allocation is at the core of our strategy. It has diversified our portfolio and better positioned us to grow during normal times and to deliver more resilient performance through uncertain times. The company will continue to generate strong cash flow, and we are confident in our ability to create shareholder value. We are actively investing in the parts of the portfolio with the highest returns and the best growth potential.

Likewise, we are working on enhancing the profitability of the company as we have in the past. With respect to the portfolio, we are always looking at it from both a strategic and financial standpoint to strengthen the company and enhance our financial performance for the long term. Initial output of the portfolio review has us focused on a significant portion of our automotive OE business, which we have recently begun to address. We would not expect any material impact to 2025 results, but we do expect our actions to have a positive impact on margins in 2026 and 2027. While we are currently navigating and executing for the short term, I am confident that Timken will come out of this period stronger and will be back on track to achieve new levels of financial performance.

With that, let me turn the call over to Phil for a more detailed review of the numbers and outlook. Phil?

Phil Fracassa (EVP and CFO)

Thank you, Rich. Welcome back. Good morning, everyone. For the financial review, I'm going to start on slide 11 of the materials with a summary of our first quarter results. Overall, first quarter revenue came in at $1.14 billion, down 4.2% from last year. Adjusted EBITDA margins were 18.2%, and adjusted EPS for the quarter was $1.40. Turning to slide 12, let's take a closer look at our first quarter sales performance. Organically, sales were down 3.1% from last year, with volumes lower but pricing slightly higher. Looking at the rest of the revenue walk, the CGI acquisition contributed 1% of growth to the top line, while foreign currency translation was about a two-point headwind in the quarter. On the right, you can see organic growth by region.

This excludes both currency and acquisitions. Let me provide a little color on each region. In Asia-Pacific, we were up 10%, led by growth in China, with a significant improvement in renewable energy demand. India and the rest of the region were also up modestly compared to a year ago. In the Americas, our largest region, we were down about 4%. Most sectors were lower as we expected, with the auto, truck, and off-highway sectors seeing the largest declines. Industrial services revenue was also down, while we posted solid growth in marine during the quarter. Finally, we were down 11% in EMEA due to continued industrial softness in Western Europe. Most sectors were lower, with the largest declines in general and heavy industrial, automation, and auto, truck.

Turning to slide 13, adjusted EBITDA was $208 million, or 18.2% of sales in the first quarter, compared to $246 million, or 20.7% of sales last year. Looking at the change in adjusted EBITDA dollars, you can see that the decrease versus last year was driven mainly by the impact of lower sales volume, higher manufacturing costs, and unfavorable mix in currency, partially offset by the benefit of acquisitions and our ongoing cost reduction actions. Let me comment a little further on these drivers.

With respect to price mix, pricing was up slightly in the quarter, while mix was unfavorable. Pricing was also up slightly from the fourth quarter. Note that year-to-date pricing does not include any tariff-related pricing that will start in the second quarter. Looking at material and logistics, logistics costs were up versus last year, while material costs were down slightly.

On the manufacturing line, overall, our performance was in line with our expectations. Let me take you through the various puts and takes. The negative $10 million reflects the continued year-over-year impact of inflation and ramp costs associated with our facility expansions in Mexico and India. In addition, we reduced inventory during the quarter, which drove an unfavorable cost absorption impact. Collectively, these items more than offset the positive impact of savings from cost reduction actions in the quarter. Moving to the SG&A other line, expenses were down from last year, with cost reductions and other tactics more than offsetting the impact of wage inflation. Currency was negative $5 million, which corresponds to the negative sales impact and reflects the stronger U.S. dollar as compared to the same period a year ago.

Finally, our CGI acquisition continues to perform well, contributing $4 million of adjusted EBITDA in the quarter, which was accretive to company margins. Moving to slide 14, we posted first quarter net income of $78 million, or $1.11 per diluted share on a GAAP basis. The quarter includes $0.29 of net expense from special items, which is comprised of acquisition amortization and other net charges. On an adjusted basis, we earned $1.40 per share, down from $1.77 last year, but largely in line with our expectations.

With respect to some below-the-line items, interest expense in the first quarter was $5 million lower than last year, reflecting the benefit of debt paydown from free cash flow. Our adjusted tax rate for the quarter was 27%, in line with our expectations. Diluted shares were down slightly, reflecting net share buybacks over the past 12 months.

Finally, non-controlling interest, or NCI, was $6 million higher than last year. This was more than we anticipated and was driven by the impact of some tax-related benefits at Timken India. Now let's move to our business segment results, starting with engineered bearings on slide 15. Engineered bearing sales were $761 million in the first quarter, down 5.2% from last year.

Organically, sales were down 2.8%, driven by lower end market demand in Europe and the Americas, partially offset by higher sales in Asia. Among market sectors, heavy industries, auto, truck, and off-highway were lower versus last year. Rail was down slightly as well. On the positive side, renewable energy was up significantly in the quarter, off last year's low level, while revenue in other sectors was relatively flat. Currency was a headwind to segment revenue of more than 2% during the quarter.

Engineered bearings adjusted EBITDA was $159 million, or 20.9% of sales in the first quarter, compared to $181 million, or 22.6% of sales last year. The decline in segment margins reflects the impact of lower volume and unfavorable mix in currency, partially offset by the benefit of our cost reduction actions. Now let's turn to industrial motion on slide 16. Industrial motion sales were $380 million in the first quarter, down around 2% from last year. Organically, sales declined 3.8% as lower demand was partially offset by higher pricing. Most platforms posted lower revenue year-over-year. Lubrication systems and linear motion were down on continued weakness in Western Europe. Belts and chain continues to be impacted by lower ag demand in North America. Industrial services saw less demand, but our backlog in that business remains relatively strong.

On the positive side, our drive system platform was up significantly on higher military marine revenue in the quarter, while couplings, clutches, and seals revenue was relatively flat. The CGI acquisition contributed over 3% to the top line, while currency was a headwind of around 1.5%. Industrial motion adjusted EBITDA was $67 million, or 17.7% of sales in the first quarter, compared to $82 million, or 21.2% of sales last year, a tough comp. Our segment margin was impacted by lower volume, unfavorable mix, and higher manufacturing costs, including the impact of higher capitalized variances last year and ramp costs related to our new belt capacity in Mexico. On the positive side, SG&A and other costs were lower, driven by cost reduction actions, and the CGI acquisition was accretive to margins in the quarter.

Moving to slide 17, we generated operating cash flow of $59 million and free cash flow of $23 million in the first quarter, both higher than last year as improved working capital performance and lower CapEx spending more than offset the impact of lower earnings. From a capital allocation standpoint, we returned $48 million to shareholders during the quarter through the repurchase of 300,000 shares and the payment of our 411th consecutive quarterly dividend. I want to point out that we have continued our repurchases in April, about 200,000 shares at attractive prices. Looking at the balance sheet, we ended the first quarter with net debt to adjusted EBITDA at 2.2x, well within our targeted range for net leverage. Now let's turn to the updated outlook for full year 2025 with a summary on slide 18.

The tariff situation has complicated this, so let me take you through it piece by piece. On the revenue line, overall, you see an improvement in the outlook from down 2.5% at the midpoint in February to down just over 1% at the midpoint now. This improvement can be attributed entirely to currency, as our current expectation is for a headwind of 1% for the full year based on March 31 exchange rates. This compares to our February expectation for a headwind of just over 2%. For acquisitions, we expect CGI to contribute just under 1% to our revenue for the year. This is unchanged from February. Now moving to organic revenue, our current outlook is to be down 1% at the midpoint. While this looks unchanged on its face, we made two changes here.

First, we added some pricing to pass through the impact of tariffs over the course of the rest of the year. Second, we lowered our volume outlook by roughly an equal amount to reflect our expectation for slightly softer demand caused by trade-related economic uncertainty. Year-to-date, our demand and order intake rates are generally in line with our prior expectations, and our backlog is up versus the end of 2024. However, given the uncertainty and limited visibility, we are taking a cautious view on market demand, but we are not assuming any sort of global recession at this point. On the bottom line, we now expect adjusted earnings per share in the range of $5.10-$5.60 per share, down $0.20 at the midpoint from our prior guide.

You'll see a walk of the various puts and takes on a later slide, but the guide assumes a net unfavorable direct impact from tariffs of approximately $0.25 per share. I'll come back to this in a moment. Our revised outlook implies that our full year consolidated adjusted EBITDA margin will be in the mid-to-high 17% range. Note that this includes a net unfavorable direct impact from tariffs of $25 million. Our margin outlook would be close to unchanged versus our prior guide if you exclude the tariff impacts. As Rich mentioned, we are affirming our full year cost savings target of $75 million, which should more than offset continued inflation in labor and other input costs. Moving to acquisitions and currency, we expect CGI to be accretive to margins, while currency is expected to be unfavorable, albeit less than before.

Finally, we now anticipate net interest expense to be in the range of $95 million-$100 million for the year, while the outlook for the adjusted tax rate is unchanged at 27%. Moving to cash flow, we're looking for around $375 million of free cash flow at the midpoint, which is just under 130% conversion on GAAP net income. Versus last year, free cash flow is expected to benefit from improved working capital performance, reduced CapEx spending, and lower taxes, which should more than offset the impact of lower earnings. Moving to slide 19, here we provide some additional detail on the direct impact on Timken from tariffs. As we covered in February, the company imports less than $400 million of goods into the U.S. from all countries. This includes less than $80 million from China. Keep in mind that Timken serves the U.S.

market primarily from our significant U.S. manufacturing footprint, which we believe is an advantage for us in this environment. Based on the tariffs currently in place, we're estimating a gross unmitigated annualized cost impact of around $150 million. This reflects tariff rates in effect as of today. Note that most of this number is being driven by the escalation that has occurred between the U.S. and China, which has produced incremental tariffs of 145% and 125%, respectively. Our team is moving with urgency to mitigate this impact through pricing and other actions, and we expect to fully offset it on a run rate basis by the end of 2025. For the full year, we're assuming a net headwind of $25 million driven by timing, with most of this hitting in the second and third quarters.

On slide 20, we provide a bridge of the $0.20 per share change in our 2025 adjusted EPS outlook at the midpoint as compared to our prior guide. Here you can see the $0.25 negative impact from tariffs that I mentioned earlier. We also show a positive change for currency, which is offsetting a modest change related to organic sales volume. Finally, we're planning for lower interest expense, which is the favorable $0.05 per share that you see in the other bucket. In summary, we're executing well in an unpredictable environment right now. Our team is focused on offsetting the impact of tariffs and delivering resilient performance in 2025. While we remain hopeful that the trade situation will be resolved in the near term, we are prepared and confident in our ability to overcome any challenges that lie ahead.

This concludes our formal remarks, and we'll now open the line for questions. Operator.

Operator (participant)

Thank you. As a reminder, if you would like to ask a question today, please press star and then the number one on your telephone keypad. Our first question comes from Bryan Blair with Oppenheimer. Please go ahead, Bryan.

Bryan Blair (Managing Director)

Thank you. Morning, guys. Welcome back, Rich.

Phil Fracassa (EVP and CFO)

Morning, Bryan.

Rich Kyle (President and CEO)

Morning, Bryan.

Bryan Blair (Managing Director)

Morning. The guidance update, directionally contemplating higher price, lower volume, of course, makes sense. Are you willing to speak to the underlying assumptions there, what you're now baking in for volume and price respectively, netting to the 1% organic sales decline, and then within that, are there meaningful differences by segment, either with regard to better or worse performance, first minus 1%, or the split of volume and price?

Phil Fracassa (EVP and CFO)

Yeah, sure, Bryan, I'll take that. Relative to holding the minus one, pricing got a little bit better, as we said, for tariffs. Think of that as on the order of approaching 1.5%, probably not quite that big, but north of $60 million, if you will, and then an offsetting decline in volume. If you think about that, that was really us trying to be a little cautious on the demand outlook. Relative to the segment, just given the first quarter performance, we are assuming a little bit more of that volume change, if you will, going to industrial motion versus bearings, again, with industrial motion being a little more indexed to Europe.

Services was down in the first quarter, and we do expect that to be neutral for the year, but we did move that from up mid-single digits to neutral, and that also sits in industrial motion, and that was a piece of it as well.

Bryan Blair (Managing Director)

Yeah, that all makes sense. Maybe offer a little more detail on renewable energy trends, particularly in China. I know costs are easy there, but it seems like Q1 shook out pretty favorably. Was there any notable pull forward of shipment with all the goings-on? How do order rates look now, and what are you now contemplating for the full year in terms of renewable growth?

Phil Fracassa (EVP and CFO)

Yeah, you know, great question. I would say we were pleasantly surprised with the renewable energy demand in the first quarter. We were seeing order intake rates pick up as we moved through the second half of last year. The first quarter is sort of that low base, if you will, so we were up pretty significantly off that low base, but we think we are expecting that momentum to continue.

Coming into the year, we thought we'd be around flat in renewable energy, and now we're thinking we should be up mid-single digits with the momentum that we saw in the first quarter, which we're looking to extend as we move through the year. As we've said before, the outlook on wind remains positive. It should be a growth market for us long-term. As we said before, it'll probably be several years before we get back to where we were, but it's nice to see the improvement in Q1.

We also strongly believe in the long-term potential for the aftermarket as that continues to grow in wind. The only thing I would add is we've worked our way through what was the over-inventory situation in that channel, which was affecting the comps last year. Yeah, great. Thank you.

Bryan Blair (Managing Director)

That's good to hear. Thank you again.

Phil Fracassa (EVP and CFO)

Thanks much, Bryan. Thank you.

Operator (participant)

The next question comes from Angel Castillo with Morgan Stanley. Please go ahead.

Stefan Diaz (VP and Equity Research Analyst)

This is actually Stefan Diaz sitting in for Angel. Thanks for taking my question. Maybe to start, I know organic sales were down for the quarter, but do you have any sense that your customers pulled forward demand trying to get ahead of tariffs at all?

Phil Fracassa (EVP and CFO)

Yeah, I would say nothing that we could point to that would be material from a tariff standpoint. Obviously, we sell a lot of different products to our customers, particularly distributors, and those products mainly get produced in the U.S., and there's a small minority of imports. I would say overall, when you think of lead times and then the fact just the breadth of the mix that we sell to our various customers, I'd say nothing notable that we can point to and say, "Yeah, that was a buy ahead of tariffs," if you will.

Rich Kyle (President and CEO)

I would add that, as I said in my comments, April revenue was in line with expectations, and May backlog is in line, so we're not seeing any significant move up or down in the demand level in aggregate.

Stefan Diaz (VP and Equity Research Analyst)

Great. That's helpful. Maybe can you give more details on the actions you're planning on taking in your auto OE business that you mentioned in the prepared remarks? For example, you're planning on implementing a similar strategy for when you left the light vehicle industry in North America. Maybe does your planned actions include trucks, or is it more limited to light vehicles? Thank you.

Rich Kyle (President and CEO)

Yeah, it's focused on light vehicles, and it's focused on OEM, so it's not affecting our—we're not targeting aftermarket. To the point you raised of what we did before to go back in history on this, between the 2008 to 2013 timeframe, we exited over $1 billion of automotive and, at that time, truck revenue as well in the OEM space. We sold some of that off. We exited some platforms, restructured the portfolio and the manufacturing footprint that supported it, and saw a significant uplift in company margins as a result of that.

From that time, I would say to COVID, the margins, as we've said over the years, were below company average. They were more in line with our old mobile business margins. The business did not require much capital, generated good cash flow, and was acceptable margins. It wasn't the growth engine of the company, but we continued to stay in it and, again, with minimal investment. I would say since COVID and coming out of COVID with inflation, we've been chasing the margins suffered as everything did during COVID. Unlike other parts of our business where we recovered it, we've been chasing the margin since that time. It has not been acceptable. We're really now targeting what I would say is more than half of our automotive OE business, not all of it.

We still have some very strong technology niches there that are attractive and we get good returns on. It's too early to say how that will play out in regards to that, but we expect that by 2027, we will likely be a smaller player in that market. As a result, we would expect a material uplift in corporate margins from it in 2026 and then more in 2027.

Phil Fracassa (EVP and CFO)

Yeah, the only thing I would add, as Rich said, we're targeting more than half of that auto OE business. We have a pie chart in our investor deck, and that would show you that auto OE was around 8% of company sales last year. That would give you kind of an order of magnitude of what we're looking at. As Rich said, with the actions we're taking, probably not a 2025 impact, but certainly should be accretive to margins in 2026 and beyond.

Stefan Diaz (VP and Equity Research Analyst)

Thank you so much. I'll turn it over.

Phil Fracassa (EVP and CFO)

Thank you.

Operator (participant)

Thank you. The next question comes from Kyle Menges with Citigroup. Please go ahead.

Kyle Menges (VP and Equity Research Analyst)

Thank you. You're taking pricing, understandably, probably mostly in industrial distribution, I would gather, to offset some tariff impacts. Do you have some sense of the pricing that you're passing through just relative to competitors? Also, just looking at your supply chain in the U.S., what sense do you have, at least in your core businesses, just how you're positioned relative to competitors from a tariff impact that you might be seeing relative to your peers?

Rich Kyle (President and CEO)

Yeah, I would say that we are seeing competitors raise prices, and certainly the fastest impact is typically in distribution, but we are raising prices through OEM channels as well. I would say, in general, bearing prices are going up globally, but certainly more so in the U.S. I would say our footprint, we think, is at worst neutral and at best advantaged, and there's probably longer-term some opportunities for us with our heavier concentration of U.S. footprint. Short-term, until there's more stability in the tariff situation, our short-term objective is largely to hold share, pass the cost increases through, and get some settling on where the tariffs land, and then we'll look at is there an opportunity for us to capture some share and/or reposition some of our footprint.

Phil Fracassa (EVP and CFO)

Yeah, and maybe, Kyle, maybe if I could just maybe add a little bit more color because I do agree with what Rich said. We do believe our U.S. footprint should help us in an environment like this, and we think it will. The impact that we've talked about in the slides, the $150 million gross annualized impact, I mean, if I could break that down a little bit. I mean, first, when you talk about rates in China, we're assuming rates in effect as of today, and that includes the China-related rates of 145% and 125% respectively. Big numbers from China that we would hope those rates would certainly come down at some point. China is probably north of 80% of the impact for us, and obviously, given those rates, really driving the numbers.

Even if just the China de-escalates a bit and gets, say, cut in half, that impact goes down significantly. I think our net $25 million impact largely goes away, not zero, but largely goes away. That would be one. Number two, Rich talked about the lag. We've talked about the time lag for pricing before that with distribution, it can take a couple of months, typically less than a quarter. We're working to get the pricing in. OEMs can be a little bit longer because it's kind of one by one, customer by customer in many cases, and that's ongoing. Last time in 2018, it was probably two, three quarters before we got it in. The pricing that we put in is kind of what we expect for the rest of the year.

Working on other mitigation tactics as well, supply chain, etc., those also take time. We do think we'll get to a dollar on a run rate basis, offset it on a dollar basis by the end of the year at those rates, and then look to recapture the margin in 2026. The last point I want to make, too, is around inventory accounting. It's a minor point, but it's a big impact. Most of our U.S. business is on LIFO inventory accounting. Under LIFO, the tariff costs hit you right away. Compare that to FIFO, where they would kind of work their way through the inventory and typically hit you as the inventory turns, which can be a few months down the road. That's kind of exacerbating that timing impact. Bottom line, it's a fluid situation.

We've assumed the current rates, which I think most people would say is probably a worst-case scenario for China, and we're pricing for it. We'll keep monitoring as we go.

Kyle Menges (VP and Equity Research Analyst)

Helpful. Thanks. That LIFO accounting definitely not helping in the current environment. I guess just the follow-up of that, you said you plan to fully offset that $150 million. Just can you give us some sense on how much pricing surcharges versus sourcing supply chain initiatives should be of that $150 million?

Phil Fracassa (EVP and CFO)

Yeah, I mean, it'll predominantly be pricing and surcharges. As we talked about both distribution and OEMs, I think the supply chain mitigation tactics are a little more limited, and obviously, some are lower-hanging fruit than others. Obviously, we're working on the lower-hanging fruit stuff right away. I would say the vast majority would be pricing and surcharges.

That would be by the end of the year. That net $0.25 impact would mainly be affecting the second and third quarters and then dropping significantly in the fourth quarter.

Kyle Menges (VP and Equity Research Analyst)

Makes sense. Thank you.

Phil Fracassa (EVP and CFO)

Thanks, Kyle.

Rich Kyle (President and CEO)

Thanks, Kyle.

Operator (participant)

Thank you. The next question comes from Mike Shlisky with D.A. Davidson. Please go ahead.

Mike Shlisky (Managing Director and Senior Equity Research Analyst)

Yes, hi. Good morning. Thanks for taking my question. Just to follow up on that last answer there, I want to make sure I have this correct. If there is a $0.25 headwind this year on tariffs, which would catch up by the end of the year, again, if everything stays the exact same as far as tariffs are concerned, would you then say that for 2026, we should be modeling zero impact? I just want to make sure I have that exact—I have what you are trying to get clear for after 2025.

Phil Fracassa (EVP and CFO)

No, I think that's right, Mike. All else equal, by the end of the year, we will be offset on a dollar basis. The net impact would be zero in 2026. Obviously, we'd have the headwind of 2025 that would not repeat. That would be a year-over-year benefit, if you will. We should be fully offset by the end of the year.

Mike Shlisky (Managing Director and Senior Equity Research Analyst)

Okay. Great. Great. [crosstalk] I'm going to go forward. As a follow-up, I wanted to—got it. Thank you. Yes. I wanted to maybe take a step back from my other question here. Rich, you and the board, I'm sure, discussed in detail the kinds of things that the recently departed CEO was looking at or doing or changing at Timken when his plans were.

I guess I'm curious, was there a fully developed plan internally as to what he wanted to do when he left? Are you looking to, or will your successor be basically just implementing all those plans at this point? Do you and the board think you're going to have a fully clean slate for the next CEO who may or may not do what Tarak was hoping to do?

Rich Kyle (President and CEO)

I'd say a couple of things on the CEO transition. First, I'd say the team underneath the CEO is unchanged. Of our top 100 managers, I think there's been one departure in the last 12 months, and that was due to retirement. Obviously, there's a lot of continuity there. I would say during that time, there was not a strategy change or a proposed strategy change.

If anything, I would say there was confirmation of the path that we were on. I think the new thinking that was brought in was more around, could we go faster and bigger than any sort of pivot from the direction that we were going on? I think those were good thoughts. I mean, the biggest piece of that—I mean, there were certainly some things in the details of how we could execute the company better and things like that in retaining some of that.

On the big picture, it was around the portfolio. As said, we've really always done that portfolio work, but some of the thoughts were, could we go bigger and faster on it? As I said earlier, we are accelerating the automotive OE work now of what was identified. That was probably the—well, it was the biggest piece.

Other things would be smaller than that. I think I would say it's been, again, it's fairly consistent and nothing dramatic during the time and wouldn't expect anything that the new persons handled any immediate issues they have to grapple with. The last thing I'd say on the transition period is we're really focused on maintaining margins and what we expect to be a soft industrial market. We're looking to generate good, strong cash flow. That cash flow tends—is the primary driver of earnings growth beyond normal growth levels, the compounding of good capital allocation decisions. A lot of focus on that over this interim period. Also continuing to advance the company strategically on our path to achieve our financial targets so we're not standing still during the interim leadership period. Again, we've got a lot of tenured management.

Our objective is to come out of this tariff period a bigger and better version of ourselves.

Mike Shlisky (Managing Director and Senior Equity Research Analyst)

I appreciate that discussion. I'll pass it along. Thank you.

Phil Fracassa (EVP and CFO)

Thanks, Mike.

Operator (participant)

Thank you. Our next question comes from Chris Dankert with Loop Capital Markets. Chris, please go ahead.

Chris Dankert (SVP and Equity Research Analyst)

Hey, morning, guys. Thanks for taking the questions. I guess, first off, on the Fort Scott facility, is that fully closed? Are we running duplicative costs there? Is there any kind of ability to shift back and forth based on tariffs? Any comments on kind of the manufacturing footprint here?

Rich Kyle (President and CEO)

The facility is not fully closed, and it is a negative to first-quarter industrial motion margins. Expecting a little bit of improvement there in the second quarter, but then a step change on that in the third quarter. We are still marching down the path to have that facility closed fully in the third quarter. There is no change in the—to the point on tariffs, I mean, on tariffs—yeah, I was just saying on the point on tariffs, we have both U.S. and Mexico footprint within our belts business, so we do have some ability to do some things on both sides of the border. Most of what we do in Mexico as the tariff situation today is USMCA.

Phil Fracassa (EVP and CFO)

Yeah, exactly. I think that's an important point, Chris. The belts coming up from Mexico are USMCA compliant, so we're not getting hit at present on those. I would say a portion of the bearings are compliant as well, but not 100%.

Chris Dankert (SVP and Equity Research Analyst)

Understood. That's really helpful. Thanks, guys. I think just following up, really appreciate the color around tariffs and trying to get arms around it here. When we think about just raw materials, SBQ pricing, steel pricing kind of outside of tariffs, I assume the expectation is when we start renegotiating in fourth quarter, those prices are going to go up materially. It is fair to assume that higher pricing is here to stay into 2026 as well?

Rich Kyle (President and CEO)

I think that is a fair assumption. Where we buy steel in the U.S. on spot prices, it is higher today than it was a year ago. As you said, a lot of it is under contract. I would also say Timken did well with the bout of inflation that we had coming out of COVID, and inflation is not necessarily a negative force. If anything, I think it gives us more pricing power.

The unique part about this as compared to other rounds of cost increases is the tariff element of it. There is not enough—generally, there is not enough steel capacity or SBQ capacity in the U.S. to serve the U.S. market. There is pricing—there have been price increases in that space.

Chris Dankert (SVP and Equity Research Analyst)

Understood. Thanks for the color, and best of luck going forward, guys.

Phil Fracassa (EVP and CFO)

Thanks, Chris.

Rich Kyle (President and CEO)

Thanks, Chris.

Operator (participant)

Thank you. There are no remaining questions at this time. Sir, do you have any final comments or remarks?

Neil Frohnapple (VP of Investor Relations)

Thanks, Emily. Thank you, everyone, for joining us today. If you have any further questions after today's call, please contact me. Thank you, and this concludes our call.

Operator (participant)

Thank you for participating in Timken's first quarter earnings release conference call. You may now disconnect.