TIMKEN CO annual report, FY2012

Business context and reporting period

The Timken Company’s fiscal-year 2012 Form 10-K covers the year ended December 31, 2012, with comparisons primarily to 2011. Timken manufactures bearings, power-transmission products and engineered steel, serving mobile, process-industrial, aerospace and defense, and steel markets. Its reported segments are Mobile Industries, Process Industries, Aerospace and Defense, and Steel.

Key financial metrics

Cash exceeded debt by $107.4 million at year-end 2012, compared with net debt of $46.7 million a year earlier. Operating cash flow less capital expenditures was approximately $328.7 million in 2012, calculated from reported figures. Dividends were $0.92 per share for the year.

Material changes versus 2011

• Sales declined 3.5%, reflecting lower volume across most segments, reduced surcharges and currency effects, partly offset by pricing and acquisitions.
• Net income attributable to Timken rose 9.1% and diluted EPS rose 10.5%, despite lower sales. Results included $108.0 million of net Continued Dumping and Subsidy Offset Act (CDSOA) receipts, or $68.0 million after tax, approximately $0.69 per diluted share.
• Gross margin improved to 27.4% from 26.5%, while operating income declined. Lower surcharges, volume and plant utilization, and higher manufacturing costs weighed on results; favorable pricing and lower input costs partly offset these effects.
• Segment performance was mixed: Mobile Industries sales fell 5.3% and EBIT fell 20.5%; Process Industries sales rose 7.9% with nearly flat EBIT; Aerospace and Defense sales rose 7.0% and EBIT improved to $36.3 million from $5.1 million; Steel sales fell 11.6% and EBIT fell 5.8%.
• Operating cash flow increased substantially, helped by working-capital releases and lower pension and postretirement payments. Inventories fell 10.6% to $862.1 million.
• Backlog was $1,812.6 million at year-end, versus $2,262.1 million in 2011; the filing cautions that backlog comparisons are not a reliable indicator of future shipments.

Outlook, management commentary and risks

• Management expected 2013 sales to decline approximately 5% and earnings to be lower than in 2012, citing lower CDSOA receipts, surcharges and volume, plus higher manufacturing costs. Lower material costs were expected to provide a partial offset.
• 2013 operating cash flow was forecast at approximately $330 million. Planned pension and postretirement contributions were approximately $300 million, and capital expenditures approximately $360 million.
• Management forecast segment sales to decline 5%–10% in Mobile Industries and 7%–12% in Steel; Process Industries was expected to be relatively flat, while Aerospace and Defense sales were expected to rise 7%–12%.
• The St. Thomas, Ontario plant closure was expected to cost $55–$65 million pretax, including $20–$25 million of cash costs, and displace approximately 190 employees. About $28.8 million of costs had been incurred by year-end 2012.
• Timken announced a $225 million Faircrest Steel Plant expansion and continued other steel-capacity investments. It acquired Wazee for approximately $20.1 million and sold its interest in Advanced Green Components, recording a $2.0 million pretax loss.
• Key risks include cyclical demand and pricing pressure, steel-industry overcapacity, raw-material and energy costs and surcharge recovery, foreign exchange, operational disruptions, environmental obligations, and pension assumptions and funding needs. Defined-benefit pension obligations were approximately $3.5 billion against assets of approximately $3.1 billion; discount-rate changes materially affect funded status and equity.
• CDSOA distributions remain subject to litigation and possible clawback, although management considered that likelihood remote. Environmental remediation accruals were $7.5 million at year-end. The filing says ordinary-course legal matters were not expected to materially affect the consolidated financial statements.

Important facts for investors to verify

• How much of 2012 earnings and EPS growth depended on the $108.0 million pretax CDSOA receipt, and how 2013 results compare on a basis excluding it.
• Whether the sales, earnings and operating-cash-flow outlook was achieved, particularly given expected lower volume and higher manufacturing costs.
• Progress and final costs of the St. Thomas closure, and execution and returns on the Faircrest expansion and other capital spending.
• Pension funding, contribution requirements and sensitivity to discount rates and asset returns; the filing reported a $133.2 million after-tax pension and postretirement liability adjustment reducing 2012 equity.
• Developments in CDSOA litigation, environmental remediation and uncertain tax positions; gross unrecognized tax benefits were $112.6 million at year-end.
• Timken reported unqualified audit opinions on its financial statements and internal control over financial reporting; investors should still review the full audited statements and notes.