TIMKEN COMPANY — Q2 2014 Form 10-Q
Business context and reporting period. This unaudited report covers the quarter and six months ended June 30, 2014. Timken completed the spinoff of its steel business as TimkenSteel on June 30; the steel business is presented as discontinued operations for all periods. Continuing operations comprise Mobile Industries, Process Industries and Aerospace.
Financial performance and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales, continuing operations | $789.2m | $791.3m | $1,526.0m | $1,554.5m |
| Gross profit / margin | $233.6m / 29.6% | $239.6m / 30.3% | $451.7m / 29.6% | $458.5m / 29.5% |
| Operating income | $91.4m | $93.5m | $163.8m | $177.4m |
| Income from continuing operations | $57.6m | $55.4m | $117.9m | $106.9m |
| Net income attributable to Timken | $62.7m | $82.8m | $146.2m | $157.9m |
| Diluted EPS, continuing operations | $0.61 | $0.57 | $1.26 | $1.10 |
| Diluted EPS, total | $0.68 | $0.86 | $1.58 | $1.63 |
Q2 sales were essentially flat year over year; first-half sales declined 1.8%. Q2 continuing-operations income rose 4.0%, while first-half continuing income rose 10.3%, helped by a $22.6m gain on the Brazil real-estate sale in the first quarter. Total net income fell in both comparisons as discontinued-operations income declined, including steel-spinoff costs. Q2 operating margin was approximately 11.6%, versus 11.8% a year earlier.
Cash flow and balance sheet. For the first half, operating cash flow was $116.1m, including $82.5m from continuing operations; capital expenditures were $48.5m and total cash declined $89.8m to $294.8m. At June 30, total debt was $490.8m, cash and restricted cash were $310.1m, and net debt was $180.7m (versus $46.0m at year-end 2013). Net debt to capital increased to 9.1% from 1.7%. Current assets were $1,562.1m and current liabilities $849.9m. The $251m current portion of long-term debt includes $250m of notes maturing in September 2014.
Material changes and management commentary
- The steel spinoff transferred the steel business and its assets and liabilities; shareholders received one TimkenSteel share for every two Timken shares. The filing reports $33.1m of second-quarter and $44.6m of first-half separation costs in discontinued operations.
- Segment trends diverged in Q2: Mobile Industries sales fell 5.4% and EBIT fell 24.4%, reflecting planned program exits and weaker light-vehicle and heavy-truck volume. Process Industries sales rose 6.0% and EBIT rose 23.5%, driven chiefly by wind-energy demand and lower manufacturing and material costs. Aerospace sales were nearly flat, but EBIT fell 64.1%, including an approximately $4m unfavorable inventory valuation adjustment.
- Timken repurchased approximately 2.6m shares for $151.3m in the first half and authorized an additional 10m shares for repurchase. The quarterly dividend was $0.25 per share.
- Two prior-period corrections were recorded in Q2: $3.8m for inventory valuation and $4.5m for a value-added tax accrual. Management considered each immaterial to the periods affected and to 2014.
Outlook, risks and contingencies
- Management expected 2014 sales to increase approximately 3% and continuing-operations earnings to exceed 2013, citing demand and cost-reduction initiatives. It forecast approximately $370m of cash from continuing operations, $120m of capital expenditures and $20m of pension contributions.
- Segment outlook: Mobile Industries sales down 2%–4%, with EBIT expected approximately flat; Process Industries sales up 10%–12%, with EBIT expected to increase; Aerospace sales approximately flat, with EBIT expected to decline. Timken was assessing Aerospace profitability and growth; significant non-cash impairment charges were possible, while expected cash restructuring charges were described as nominal.
- Management expected to refinance the $250m notes due September 2014. It reported no borrowings under its $500m senior credit facility, compliance with debt covenants, and stated it had sufficient liquidity through at least the facility’s May 2016 maturity. The asset-securitization facility had $40m drawn and $56.6m available at June 30.
- Risks include realizing the spinoff’s benefits, reduced business diversification and potentially greater volatility, possible credit-rating or funding effects, indemnification obligations, and the possibility that the spinoff could fail to qualify as tax-free. Other cited exposures include economic and customer-demand changes, competition, raw-material and operating costs, litigation, foreign exchange and pension performance. Ordinary-course legal matters were not expected by management to materially affect results or financial position.
Important facts for investors to verify
- Whether the expected refinancing of the September 2014 notes was completed on acceptable terms, and the resulting debt and liquidity profile.
- Progress against the 2014 sales, earnings and cash-flow outlook, especially Mobile Industries’ planned-program-exit effects and Process Industries’ expected second-half growth.
- The outcome of the Aerospace profitability review and whether impairment or restructuring charges were subsequently recorded.
- Post-spinoff costs, indemnification exposures and continuing tax-free status of the distribution.
- Cash conversion and working-capital needs: first-half cash use included higher receivables and inventories, alongside substantial share repurchases.