TIMKEN COMPANY — Q2 2019 Form 10-Q
Period: Quarter and six months ended June 30, 2019. Timken designs and manufactures engineered bearings and power-transmission products. It reports Mobile Industries and Process Industries segments.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $1,000.0 million | $906.3 million | $1,979.7 million | $1,789.4 million |
| Gross profit / margin | $305.7 million / 30.6% | $267.4 million / 29.5% | $608.3 million / 30.7% | $532.3 million / 29.7% |
| Operating income | $145.1 million | $125.3 million | $295.0 million | $241.4 million |
| Net income attributable to Timken | $92.5 million | $91.0 million | $184.4 million | $171.2 million |
| Diluted EPS | $1.20 | $1.16 | $2.39 | $2.17 |
Q2 sales rose 10.3%; Timken-attributable net income rose 1.6%. For the first half, sales increased 10.6% and attributable net income 7.7%. Higher sales reflected acquisitions, stronger Process Industries demand and pricing, partly offset by unfavorable currency. Q2 gross margin expanded 110 basis points; first-half gross margin expanded 100 basis points.
- Segments, Q2: Mobile Industries sales were $493.7 million, up 0.9%, and EBIT was $59.1 million, up 8.4%; EBIT margin improved to 12.0% from 11.1%. Process Industries sales were $506.3 million, up 21.4%, and EBIT was $103.0 million, up 13.7%; margin narrowed to 20.3% from 21.7%. Excluding acquisitions, divestitures and currency, Q2 sales declined 1.3% in Mobile and increased 5.8% in Process.
- Cash flow, first half: Operating cash flow was $209.9 million versus $57.8 million; investing cash use was $119.8 million, including $83.0 million for acquisitions; financing cash use was $56.9 million. Cash, cash equivalents and restricted cash ended at $167.4 million.
- Debt and liquidity: Total debt was $1,688.9 million and net debt $1,521.5 million at June 30. Net debt-to-capital was 46.0%, down from 48.5% at year-end 2018. The $650 million revolving credit facility had $595.4 million available; the $100 million receivables facility was fully drawn. Management reported compliance with debt covenants; leverage and interest coverage ratios were 2.4x and 10.9x, respectively.
- Other metrics: Interest expense rose to $19.3 million in Q2 from $10.7 million, mainly reflecting debt used to fund the 2018 acquisitions. The Q2 effective tax rate was 26.1%, versus 24.7%; the first-half rate was 28.3%, versus 25.3%.
Material changes and notable items
- Timken acquired Diamond Chain on April 1 for $84.9 million, excluding cash acquired. The supplier had approximately $60 million in sales for the 12 months ended March 31, 2019; its results are reported in Process Industries. Purchase accounting remained preliminary.
- First-half revenue growth included $169 million from acquisitions and $74 million of higher organic revenue, offset partly by $53 million of currency impact. Q2 comparable sales included $98 million of acquisition benefit, $18 million of higher organic revenue and a $22 million adverse currency effect.
- First-half operating cash flow benefited from $117.3 million less cash used in working capital than in the prior-year period. Receivables and unbilled receivables nevertheless increased from year-end, primarily due to higher June sales.
- Higher material costs, including tariffs, partly offset operating gains. A Knoxville facility flood caused $6 million of property loss and related expense in the first half.
- Adoption of the lease accounting standard added $117.3 million of operating lease assets and $102.5 million of operating lease liabilities by June 30; adoption did not affect reported operating results or cash-flow statement captions.
Outlook, risks and contingencies
- Management expected 2019 sales to increase approximately 7%–9% from 2018 and earnings to be higher, citing price/mix, acquisitions, volume and manufacturing performance. It gave no specific full-year earnings figure. Segment sales outlook: Mobile flat to up 1%; Process up approximately 16%–17%.
- Management forecast approximately $510 million of 2019 operating cash flow and $150 million of capital expenditures. The outlook excluded pension and postretirement mark-to-market charges after June 30, which could arise from later events or annual remeasurement.
- Risks highlighted include economic and industrial-demand weakness, tariffs and trade disputes, raw-material and labor costs, foreign exchange, competition, acquisition integration and performance, financing and covenant requirements, pensions, and litigation or product claims.
- CADE’s Brazil antitrust investigation advanced to tribunal after a report recommended a violation finding against Timken do Brasil, among others. Timken recorded an expense and liability for its best estimate of probable loss; the amount is not stated in the filing text provided. Management did not expect the final resolution to materially affect consolidated financial position or liquidity, but period earnings could be affected.
- Environmental accruals were $5.4 million, including the Lovejoy Superfund matter. Wind-energy bearing warranty claims remain under evaluation; management said excess costs, if any, could materially affect a particular period. The company also disclosed an employee lawsuit, but did not consider a liability probable.
- Expected 2019 defined-benefit pension contributions and payments were approximately $34 million, including a $24 million deferred-compensation payout expected to trigger a Q3 remeasurement. Postretirement medical-plan changes effective in 2020 were also expected to trigger a Q3 remeasurement.
Investor verification priorities
- Check whether Process Industries organic demand and Mobile Industries trends support the full-year sales outlook, apart from acquisition and currency effects.
- Track debt, available revolving capacity, covenant headroom and higher interest expense as acquisition-related debt is managed.
- Verify operating cash-flow conversion, working-capital movements, planned capital spending and integration returns from recent acquisitions.
- Monitor the Brazil antitrust case, wind-energy warranty claims, environmental exposures and pension remeasurement outcomes for changes to accruals or guidance.
- Assess whether the forecast remains achievable given tariffs, foreign-exchange movements, raw-material costs and uncertain mark-to-market charges.