The Timken Company (10-Q): Quarter and Six Months Ended June 30, 2011
Timken designs, manufactures and services bearings, power-transmission products and alloy steel. This unaudited filing covers the second quarter and first six months of 2011, compared with the same periods in 2010; balance-sheet comparisons are with December 31, 2010. Amounts are in U.S. dollars.
Financial Performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $1,329.6 million | $1,011.4 million | $2,583.7 million | $1,925.1 million |
| Gross profit | $350.5 million | $268.3 million | $683.8 million | $491.0 million |
| Gross margin | 26.4% | 26.5% | 26.5% | 25.5% |
| Operating income | $190.6 million | $126.6 million | $372.5 million | $210.8 million |
| Net income attributable to Timken | $121.5 million | $85.6 million | $234.2 million | $114.2 million |
| Diluted EPS | $1.22 | $0.88 | $2.36 | $1.17 |
| Operating cash flow | Not stated separately for the quarter | $(162.9) million | $164.0 million |
Q2 sales increased 31.5% and six-month sales increased 34.2%. Growth reflected higher volume, surcharges, pricing and favorable mix, with currency also contributing. Q2 gross margin was nearly flat year over year; the six-month margin improved 100 basis points. Higher raw-material and logistics costs partly offset volume, pricing and surcharge benefits.
Segment results were uneven: Q2 sales rose 16.2% in Mobile, 45.7% in Process, 1.0% in Aerospace and Defense, and 49.2% in Steel. Q2 EBIT increased substantially in Process and Steel, while Mobile EBIT declined 2.6% and Aerospace and Defense EBIT declined 45.9%. For the first six months, Aerospace and Defense sales fell 7.0% and EBIT fell 69.4%; the other segments reported sales and EBIT growth.
Balance Sheet, Liquidity and Cash Flow
- At June 30, cash and cash equivalents were $632.8 million, down from $877.1 million at year-end. Total debt was $520.9 million, versus $513.7 million; net cash was $116.7 million, compared with $363.4 million at year-end.
- Current assets were $2,470.8 million and current liabilities were $755.9 million. Receivables rose to $718.8 million and inventory to $928.9 million, largely supporting higher sales and expected demand.
- Six-month operating cash use was $162.9 million, compared with cash generation of $164.0 million in the prior-year period. The filing attributes the reversal mainly to pension and postretirement contributions and payments of $331.8 million, and increased working-capital needs, partly offset by higher earnings.
- Investing cash use was $61.0 million, including $59.6 million of capital expenditures. Financing cash use was $41.9 million. Cash declined $244.3 million during the half.
- The amended $500 million revolving credit facility matures in May 2016. No borrowings were outstanding at June 30; $482.8 million remained available after letters of credit. The $150 million receivables facility was undrawn. The company reported compliance with debt covenants.
Material Changes, Outlook and Unusual Items
- Management forecast 2011 sales approximately 25%–30% above 2010, with improved operating performance, partly offset by higher SG&A. Segment forecasts included sales growth of 10%–15% for Mobile, 30%–35% for Process, a slight increase for Aerospace and Defense, and 40%–45% for Steel.
- The cash-generation outlook is inconsistent within the filing: the Outlook section estimates 2011 operating cash flow at approximately $275 million, while the Liquidity section says approximately $200 million. Both sections cite working-capital requirements and significant benefit-plan funding; investors should verify the intended forecast.
- Management expected 2011 pension contributions of approximately $245 million and postretirement contributions of approximately $75 million; capital expenditures of approximately $210 million; and dividends of approximately $76 million. The company had already contributed $233.8 million to pension plans and $75 million to a VEBA trust by June 30.
- In July 2011, after quarter-end, Timken completed its $200 million acquisition of Philadelphia Gear, which had approximately $85 million in trailing 12-month sales through March 2011. It will be reported in Process Industries.
- Q2 included $6.2 million of impairment and restructuring charges, primarily exit costs tied to the former Sao Paulo facility. The estimated environmental liability for that site ranged from $10.9 million to $20.9 million; $10.9 million was accrued/reserved, and management said estimates could change in the near term. Total potential closure costs could reach approximately $60 million.
- Timken expects approximately $32 million of LIFO expense for 2011, reflecting higher costs, especially scrap steel, and higher inventory quantities. A 1% increase in costs would raise the estimate by approximately $5.9 million.
- The company decided to exit certain non-strategic Aerospace and Defense aftermarket product lines within 12 months; inventory write-downs and equity-investment impairments were recorded. It sold its ICS investment for $4.8 million, recognizing a $0.5 million gain.
- Principal stated risks include global economic and customer-demand changes, pricing and competition, raw-material and energy costs, currency and financial-market changes, pension obligations, acquisition integration, labor relations, and litigation or environmental claims. Management said ordinary-course legal matters were not expected to materially adversely affect results or financial position, and reported no material change in previously disclosed risk factors.
Most Important Facts to Verify
- Reconcile the conflicting 2011 operating-cash-flow forecasts of approximately $275 million and $200 million.
- Track working-capital absorption and whether cash conversion improves as sales growth continues.
- Confirm the timing and total funding needs for pension and postretirement benefits, alongside planned capital spending and dividends.
- Monitor Sao Paulo environmental remediation estimates and the potential range of total site liability.
- Assess Philadelphia Gear’s integration, purchase economics and contribution to Process Industries results.
- Check whether higher raw-material costs and projected LIFO expense are offset by surcharges, pricing and mix, particularly in Steel.
- Monitor the continued weakness in Aerospace and Defense demand, margins and the planned product-line exits.