The Timken Company (NYSE: TKR) — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Timken designs and sells engineered bearings and power-transmission products through Mobile Industries and Process Industries. The period was materially affected by the COVID-19 pandemic and related demand declines and operating restrictions.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $803.5 million | $1,000.0 million | $1,726.9 million | $1,979.7 million |
| Gross profit | $230.3 million | $305.7 million | $509.2 million | $608.3 million |
| Gross margin | 28.7% | 30.6% | 29.5% | 30.7% |
| Operating income | $115.4 million | $145.1 million | $237.1 million | $295.0 million |
| Net income attributable to Timken | $61.9 million | $92.5 million | $142.6 million | $184.4 million |
| Diluted EPS | $0.82 | $1.20 | $1.88 | $2.39 |
Q2 sales fell 19.7% year over year, primarily from $201 million of lower organic revenue and $26 million of unfavorable currency effects, partly offset by $31 million from acquisitions. Six-month sales declined 12.8%, reflecting $289 million lower organic revenue and $42 million unfavorable currency, partly offset by $79 million from acquisitions. Q2 gross margin contracted 190 basis points; lower volume and factory utilization were partly offset by lower material and logistics costs and favorable price/mix. SG&A declined 29.6% in Q2, largely from lower employee costs, discretionary spending and performance compensation.
Q2 Mobile Industries sales were $342.6 million, down 30.6%, and segment EBITDA was $38.8 million, down 50.3%; EBITDA margin fell to 11.3% from 15.8%. Process Industries sales were $460.9 million, down 9.0%, while EBITDA rose slightly to $126.3 million and margin increased to 27.4% from 24.8%. Management attributed the relative resilience of Process Industries partly to renewable-energy demand, cost actions and favorable price/mix.
Cash flow, debt and liquidity
- Six-month operating cash flow was $303.6 million, versus $209.9 million a year earlier; management cited a $99.9 million year-over-year improvement in working-capital cash effects. Capital expenditures were $56.5 million.
- Cash and cash equivalents were $415.6 million at June 30, 2020, compared with $209.5 million at year-end 2019. Total debt was $1,791.4 million and net debt was $1,375.8 million, versus $1,730.1 million and $1,520.6 million, respectively, at year-end. Net debt to capital was 41.1%, down from 43.8%.
- The company had $332.2 million available under its $650 million revolving credit facility and $86.9 million under its receivables facility. Foreign subsidiary lines had approximately $224.4 million of remaining availability. Timken reported compliance with debt covenants; its leverage and interest-coverage ratios were 2.12x and 9.74x, respectively.
- Cash generation benefited in part from deferred payroll taxes under the CARES Act; deferred amounts are payable in installments in 2021 and 2022. Some cash was held outside the U.S. and repatriation may be subject to taxes or restrictions.
Outlook, risks and unusual items
- Timken did not provide detailed sales or earnings guidance because of pandemic uncertainty. It expected revenue to remain below 2019 levels for the rest of 2020 and second-half operating margins to be below first-half margins, citing timing of savings, seasonality and higher restructuring charges.
- Management expected approximately $50–60 million of year-over-year cost savings in the second half of 2020. It also expected $8–10 million of additional charges for pandemic-related cost initiatives during the remainder of 2020, plus charges for other initiatives.
- COVID-19 reduced demand and disrupted customer operations and production, especially in Q2; management said the pandemic’s duration and financial impact could not be reasonably estimated. Its outlook assumed Q2 was the revenue low point and markets would gradually improve.
- Q2 included $8.8 million of pension actuarial losses following a plan remeasurement, contributing to higher non-service pension expense. Restructuring and impairment charges were $3.1 million for Q2 and $6.7 million for the six months.
- Planned footprint actions include the Gaffney, South Carolina bearing-plant reorganization, expected to affect about 150 employees, and the Indianapolis chain-plant closure, expected to affect about 240 employees and transfer production to Fulton, Illinois. The filing also discusses environmental remediation exposure, including the Lovejoy Superfund site; environmental accruals were $5.2 million. The company noted product-warranty liabilities of $10.4 million and a pending former-employee lawsuit with no specific damages asserted.
Important facts for investors to verify
- Whether demand and customer activity improved as management’s outlook assumed, and whether revenue remained below 2019 levels.
- Whether planned cost savings were realized and restructuring costs, including further initiatives, remained within expected ranges.
- Whether cash flow and liquidity remained adequate after considering debt, deferred payroll taxes, pension contributions and cash held outside the U.S.
- Whether the amended debt-covenant calculation, which uses net debt through June 30, 2021, and covenant headroom remain appropriate as conditions change.
- Any changes in COVID-19 impacts, environmental exposure, warranty estimates, or the status and costs of the plant actions and legal matters.