TIMKEN CO quarterly report, Q2 FY2015

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The Timken Company — Q2 2015 Form 10-Q

Business context and reporting period

Timken engineers and manufactures bearings, power-transmission products and related services. It reports Mobile Industries and Process Industries segments. This filing covers the quarter and six months ended June 30, 2015. Comparisons are with 2014 continuing operations; TimkenSteel was spun off on June 30, 2014 and is presented as discontinued operations.

Financial performance

  • Q2 revenue and earnings: Net sales were $728.0 million, down 7.8% from $789.2 million. Continuing-operations income was $37.7 million versus $57.6 million; diluted continuing-operations EPS was $0.43 versus $0.61. Net income attributable to Timken was $36.7 million versus $62.7 million.
  • First-half performance: Net sales were $1,450.5 million, down 4.9%. Timken reported a continuing-operations net loss of $97.1 million and diluted loss per share of $1.14, versus income of $117.9 million and diluted EPS of $1.26 in 2014. The 2015 loss primarily reflects a $219.6 million pension settlement charge.
  • Margins: Gross margin was 28.2% in Q2 versus 29.6%; first-half gross margin was 28.1% versus 29.6%. Q2 segment EBIT was $92.7 million versus $107.1 million. Mobile Industries’ Q2 EBIT margin was 9.3% versus 9.5%; Process Industries’ was 16.7% versus 18.9%.
  • Cash flow and investment: First-half operating cash flow from continuing operations was $105.5 million versus $82.5 million. Capital expenditures were $43.5 million. Cash and cash equivalents were $236.8 million at June 30, down from $278.8 million at year-end.
  • Debt and liquidity: Total debt was $637.8 million; cash plus restricted cash was $255.9 million, leaving net debt of $381.9 million versus $236.0 million at December 31, 2014. Net debt to capital rose to 21.8% from 12.9%. The $500 million credit facility had $464.3 million available; the $100 million receivables facility was fully drawn, with $82.0 million outstanding and no remaining availability. Timken reported compliance with debt covenants.
  • Capital returns: Timken repurchased approximately 4.3 million shares for $177.2 million and paid $44.0 million in dividends during the first half. The quarterly dividend was $0.26 per share.

Material changes and management commentary

  • Q2 sales fell primarily from $39 million of unfavorable foreign-exchange impact and $23 million of lower volume. First-half sales were reduced by $73 million from currency and $10 million from lower volume, partly offset by $9 million from acquisitions.
  • Mobile Industries’ Q2 sales declined 13.1%; excluding currency, they fell 7.6%, reflecting weakness in aerospace, agriculture/off-highway and automotive. Process Industries’ reported sales declined 0.8%, but rose 2.9% excluding currency and acquisitions, led by wind energy, industrial services and military marine.
  • Management cited lower raw-material, logistics and manufacturing costs as partial offsets to foreign exchange, lower volumes and unfavorable mix. Q2 SG&A declined 7.8%, mainly due to lower incentive compensation and currency effects.
  • The pension transaction transferred approximately $575 million of obligations and $635 million of assets to Prudential to cover future benefits for about 5,000 U.S. retirees. The related first-half settlement charge was $219.6 million, including lump-sum distributions and Canadian-plan settlements. The charge was primarily non-cash.
  • First-half operating cash flow improved despite the reported loss, reflecting pension-related noncash expense and lower pension contributions and benefit payments. Working-capital movements were a partial offset.

Outlook, risks and contingencies

  • Management forecast 2015 sales down approximately 7%–8% versus 2014, primarily due to foreign exchange, and lower earnings from continuing operations, citing pension settlements, unfavorable volume and mix, and currency. Lower restructuring charges, raw-material and logistics costs, and SG&A were expected to partly offset these pressures.
  • Management expected approximately $300 million of 2015 operating cash flow from continuing operations, approximately $15 million of pension contributions, and capital expenditures around 4% of sales. Quarterly effective tax rates were expected to remain volatile.
  • Segment outlook: Mobile Industries sales were expected to decline 8%–9%, with aerospace and agriculture weakness partly offset by rail growth. Process Industries sales were expected to decline 6%–7%, with wind energy and military marine growth and acquisitions partly offset by weaker industrial aftermarket and heavy-industry demand.
  • Key stated risks include economic and customer-demand weakness, currency movements, competitive pricing, input and labor costs, execution of operating plans and acquisitions, litigation and product-liability claims, financing-market changes, and pension funding assumptions and investment performance. Management said there were no material changes to previously disclosed risk factors; ordinary-course legal matters were not expected to have a material adverse effect.
  • Other unusual items include a $3.0 million impairment of assets held for sale at a U.S. repair business and $3.0 million of exit costs related to ending a Colombian sales-representative relationship. The filing reported no material changes in market risk, no material changes in internal control, and no off-balance-sheet arrangements with unconsolidated entities or other persons.

Important facts for investors to verify

  • Whether expected sales, earnings and operating cash flow track management’s 2015 forecast, particularly as foreign exchange and end-market volumes change.
  • How much of the pension settlement charge is nonrecurring, and how pension obligations, funded status, expense and future contributions evolve after the Prudential transaction.
  • Whether the fully drawn receivables facility is renewed or replaced before its November 30, 2015 maturity, and how debt and liquidity change.
  • Whether the lower volumes and weaker margins in Mobile Industries, and unfavorable mix and manufacturing costs in Process Industries, persist.
  • The effects of continued share repurchases and dividends on cash, net debt and financial flexibility.
  • Potential tax-rate volatility and the degree to which foreign cash—approximately $182 million, or 77% of cash and equivalents—can be repatriated without taxes or restrictions.