The Timken Company — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Timken manufactures bearings, power-transmission products and related services, reporting through Mobile Industries and Process Industries.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $750.6 million | $673.6 million | $1,454.4 million | $1,357.6 million |
| Gross profit | $201.8 million | $184.5 million | $382.3 million | $367.6 million |
| Gross margin | 26.9% | 27.4% | 26.3% | 27.1% |
| Operating income | $77.2 million | $73.6 million | $136.4 million | $128.9 million |
| Net income attributable to Timken | $82.5 million | $48.2 million | $120.7 million | $114.1 million |
| Diluted EPS | $1.04 | $0.61 | $1.53 | $1.43 |
| Operating cash flow | Not separately stated | Not separately stated | $114.5 million | $204.1 million |
Q2 sales rose 11.4%, driven by higher demand and acquisitions; six-month sales rose 7.1%. Gross margin declined 50 basis points in Q2 and 80 basis points year to date. SG&A increased 14.6% in Q2, mainly from incentive compensation and acquisitions. Q2 earnings benefited from an $8.1 million income-tax benefit, including reversal of $34 million of uncertain-tax-position accruals and related interest; higher volume, acquisitions and currency effects also helped.
- Segments: Q2 Mobile Industries sales increased 11.0% to $408.4 million, while EBIT fell 8.0% to $34.4 million and margin fell to 8.4%. Process Industries sales increased 11.9% to $342.2 million; EBIT rose 25.7% to $60.2 million and margin rose to 17.6%.
- Cash and debt at June 30: Cash and cash equivalents were $445.1 million; total debt was $1,001.6 million and net debt was $553.7 million. Net debt-to-capital was 28.1%, versus 27.9% at year-end 2016. Cash increased substantially partly because borrowings were raised ahead of the Groeneveld acquisition.
- Liquidity: Availability was $116.0 million under the $500 million senior credit facility and $4.3 million under the accounts-receivable facility. Foreign credit lines had $214.4 million of aggregate availability, mostly uncommitted. The company reported compliance with debt covenants.
- Six-month cash uses: Investing activities used $108.9 million, including $64.1 million for acquisitions and $39.9 million of capital expenditures. Dividends paid were $41.4 million and share repurchases were $27.0 million.
Material changes and unusual items
- Operating cash flow fell $89.6 million year over year, primarily due to $78.3 million of unfavorable income-tax cash effects and a $31.7 million unfavorable working-capital change.
- Six-month 2016 results included $53.8 million of Continued Dumping and Subsidy Offset Act (CDSOA) income, which did not recur in 2017. Management says the likelihood of a clawback of prior distributions is remote, though legal challenges remain.
- Effective January 1, 2017, Timken retrospectively changed its pension accounting to recognize actuarial gains and losses more promptly and measure plan assets at fair value. The change increased reported Q2 2017 net income by $4.0 million and six-month net income by $11.4 million versus the previous method; it reduced opening retained earnings by $239 million, with a corresponding increase in accumulated other comprehensive loss, partly offset by inventory and tax effects.
- Two acquisitions completed in Q2—Torsion Control Products and PT Tech—had combined purchase consideration of approximately $63.4 million and trailing sales of approximately $41.5 million. On July 3, Timken completed the Groeneveld acquisition for an agreed enterprise value of approximately $285 million in cash, plus specified adjustments. Borrowings were increased in anticipation of the transaction. A proposed Timken India acquisition of ABC Bearings remained subject to approvals.
- Restructuring charges were $0.8 million in Q2 and $2.5 million for six months, below the respective prior-year amounts of $2.9 million and $13.4 million. The Pulaski plant closure was expected by the end of Q3 2017. Wind-sector bearing performance claims were under evaluation; related accruals were recorded, and management did not expect a material effect on consolidated financial position, while period-specific operating results could be affected.
Outlook, commentary and risks
Management expected 2017 full-year sales to increase approximately 11% over 2016, with higher industrial and off-highway volumes and acquisition contributions partly offset by lower rail volume. Earnings were expected to increase, supported by volume, acquisitions, lower restructuring and pension mark-to-market costs, and lower taxes, partly offset by unfavorable price/mix and the absence of 2016 CDSOA income. The outlook excluded potential second-half pension mark-to-market adjustments.
Management expected 2017 operating cash flow of approximately $325 million, about $79 million below 2016, reflecting no CDSOA receipts, higher tax payments and unfavorable working capital, partly offset by higher operating income. Capital expenditures were projected at 3.5%–4% of sales. The company cited demand and pricing, raw-material and operating costs, foreign exchange, pension remeasurement, acquisition integration, financing conditions, product claims and litigation among factors that could affect results. It expected sufficient liquidity through the senior credit facility’s term, while noting it may need to limit borrowings to maintain covenant compliance.
Important facts for investors to verify
- Whether the $34 million tax-accrual reversal and low reported tax rate are nonrecurring, and how normalized taxes affect full-year earnings.
- Whether gross-margin pressure, unfavorable price/mix and higher material, logistics and SG&A costs persist as volumes grow.
- Whether the $325 million operating-cash-flow outlook is achieved, given working-capital demands and higher tax payments.
- How Groeneveld integration and acquisition-related borrowing affect debt, liquidity, returns and covenant headroom.
- Potential outcomes and costs of wind-bearing customer claims, pension remeasurement and remaining CDSOA litigation or clawback risk.