Business context and reporting period
The Timken Company manufactures bearings, power-transmission products and related services through its Mobile Industries and Process Industries segments. This Form 10-Q covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. Financial amounts are in millions of dollars except per-share data.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $906.3 | $750.6 | $1,789.4 | $1,454.4 |
| Gross profit | $267.4 | $201.1 | $532.3 | $383.3 |
| Gross margin | 29.5% | 26.8% | 29.7% | 26.4% |
| Operating income | $125.3 | $76.4 | $241.4 | $139.3 |
| Net income attributable to Timken | $91.0 | $82.5 | $171.2 | $120.7 |
| Diluted EPS | $1.16 | $1.04 | $2.17 | $1.53 |
| Operating cash flow | Not separately presented for the quarter | $57.8 | $114.5 |
Q2 sales rose 20.7%, attributed to organic growth and higher pricing, acquisitions and favorable foreign exchange. Timken attributed income rose 10.3% and diluted EPS rose 11.5%. Higher volume, price/mix, manufacturing performance and acquisitions supported earnings; higher taxes, materials, logistics and SG&A partly offset gains. For the first half, sales rose 23.0% and attributed income rose 41.8%.
Segment performance strengthened: Q2 Mobile Industries sales were $489.1 and EBIT was $54.5, with an 11.1% EBIT margin versus 8.4%. Process Industries sales were $417.2 and EBIT was $90.6, with a 21.7% margin versus 17.6%.
At June 30, cash and cash equivalents were $145.2; restricted cash was $1.4. Total debt was $1,046.4 and net debt was $899.8; net debt to capital was 36.7%, versus 36.2% at year-end 2017. Current assets were $1,699.8 and current liabilities $711.2. Six-month operating cash flow fell to $57.8, primarily as working capital used $204.9, including outflows for receivables, contract assets and inventories. Capital expenditures were $39.6.
Material changes and unusual items
- Gross margin expanded 270 basis points in Q2 and 330 basis points for the first half. Q2 gross profit benefited from volume, favorable price/mix, acquisitions and manufacturing performance, partly offset by $11 of higher material and logistics costs.
- 2018 adoption of the revenue standard resulted in $127.5 of contract assets at June 30 and a $7.7 cumulative increase to opening retained earnings. The adoption increased reported Q2 sales by $7.3 and diluted EPS by $0.02; management said it did not affect first-half operating cash flow. Comparative periods were not restated.
- Foreign-currency translation reduced first-half shareholders’ equity by $35.3, contributing to a $43.0 Q2 comprehensive loss despite net income. First-half interest expense increased to $20.7 from $16.4, primarily reflecting debt used to fund the Groeneveld acquisition and other cash needs.
- First-half 2017 tax expense was unusually low, including a $34 reversal of uncertain-tax-position accruals. The 2018 effective tax rate was 25.3% for the first half. Accounting for U.S. Tax Reform remained incomplete; further adjustments to provisional estimates could materially affect tax expense.
Outlook, liquidity and risks
Management expected full-year 2018 sales to increase approximately 21% versus 2017 and earnings to rise, citing demand, pricing, acquisitions and operational improvements, with higher material, logistics, SG&A and tax costs as offsets. It forecast approximately $370 of operating cash flow and capital spending of 3.0%–3.5% of sales. The outlook excluded second-half pension mark-to-market charges because their amount was not yet known. No specific EPS guidance is stated in the filing.
At June 30, $405.4 remained available under the $500 Senior Credit Facility, maturing in June 2020; the company reported compliance with debt covenants. The $100 receivables facility matured November 30, 2018, had $96.4 outstanding and only $3.6 available; the company was exploring refinancing. Most foreign subsidiary credit lines were uncommitted. Management said it believed liquidity was adequate through at least the Senior Credit Facility term. It also reported $136 of its $145 cash balance held outside the U.S.; repatriation may involve taxes or restrictions.
After quarter-end, Timken agreed to acquire Cone Drive, expected to generate 2018 sales just over $100, and Rollon, expected to generate about $140. The filing identifies risks including economic and trade conditions, tariffs, demand and input-cost changes, acquisition integration, currency and interest-rate movements, pension exposures, and tax uncertainty. Contingencies include environmental matters, including the Lovejoy site (environmental accruals totaled $5.1), a Brazilian antitrust investigation, and customer claims involving wind-energy bearings. Management stated that these matters were not expected to materially affect consolidated financial position, while noting some outcomes could materially affect results in an individual period.
Important facts for investors to verify
- Progress on refinancing the receivables facility before its November 2018 maturity and actual borrowing availability.
- Whether working-capital investment converts to cash and supports the $370 full-year operating-cash-flow forecast.
- Completion and financing of the Cone Drive and Rollon acquisitions, and their integration and earnings contribution.
- Final U.S. Tax Reform and GILTI accounting, including any material tax-expense adjustments.
- Any second-half pension mark-to-market charges and developments in environmental, antitrust and wind-bearing warranty matters.
- Whether demand, pricing and cost trends support the full-year sales and earnings outlook.