TIMKEN CO — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Timken manufactures bearings, power-transmission products and related services, operating through Mobile Industries and Process Industries.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $673.6 million | $728.0 million | $1,357.6 million | $1,450.5 million |
| Gross profit | $182.3 million | $205.1 million | $363.2 million | $407.6 million |
| Gross margin | 27.1% | 28.2% | 26.8% | 28.1% |
| Operating income | $68.8 million | $72.9 million | $119.7 million | $(74.5) million |
| Net income attributable to Timken | $44.9 million | $36.7 million | $107.9 million | $(98.5) million |
| Diluted EPS | $0.57 | $0.43 | $1.35 | $(1.14) |
| Operating cash flow | Not presented quarterly | $202.6 million | $105.5 million |
Q2 sales fell 7.5%; six-month sales fell 6.4%. Lower demand and foreign exchange drove the declines, partly offset by acquisitions. Six-month gross margin contracted 130 basis points. Q2 operating income was down despite higher net income, which benefited from lower costs and taxes and $6.1 million of CDSOA income.
Segments and cash flow
- Mobile Industries: Q2 sales were $367.8 million, down 5.4%; EBIT was $35.3 million, down 1.9%, with a 9.6% margin. Weakness in off-highway, rail, aerospace and heavy truck was partly offset by automotive growth.
- Process Industries: Q2 sales were $305.8 million, down 9.9%; EBIT was $46.7 million, down 17.6%, with a 15.3% margin. Demand weakened in the industrial aftermarket and heavy industries, including oil and gas, metals and power generation.
- Six-month operating cash flow was $202.6 million; capital expenditures were $50.4 million. Cash and equivalents were $156.0 million at quarter-end, up from $129.6 million at year-end.
Balance sheet and liquidity
Total debt was $632.6 million and net debt was $476.4 million at June 30, compared with $656.5 million and $526.7 million, respectively, at December 31, 2015. Net debt to capital improved to 26.0% from 28.1%. The company reported $1.24 billion of current assets and $475.0 million of current liabilities.
Availability was $461.6 million under the $500 million senior credit facility and $13.4 million under the accounts receivable facility. Timken was in compliance with debt covenants; its reported leverage and interest-coverage ratios were 1.5x and 13.2x, respectively. Approximately $131 million of cash was held outside the U.S.; repatriation could incur taxes or be subject to restrictions.
Outlook, unusual items and risks
- Management forecast 2016 sales down approximately 6% versus 2015, reflecting lower volume and an estimated 1.5% foreign-exchange impact. Earnings were expected to rise year over year, primarily due to lower pension settlement charges and CDSOA income; excluding those items, earnings were expected to decline.
- Expected 2016 operating cash flow was approximately $365 million, about $10 million below 2015. Capital expenditures were forecast at approximately 5.0% of sales, versus 3.7% in 2015.
- Six-month 2016 results included $53.8 million of pretax CDSOA income, net of expenses. Timken received $48.1 million in April and recorded a receivable for a further $6.3 million distribution received in July. Management considered clawback risk remote, but noted legal challenges remained.
- The prior-year six-month loss included $219.6 million of pension settlement charges, a major reason 2016 earnings comparisons improved. 2016 pension settlement charges were $1.6 million for the six months.
- Wind-sector bearing warranty claims resulted in $3.4 million of six-month expense accruals. Management did not expect a material effect on consolidated financial position, but additional costs could materially affect an individual period.
- The Altavista bearing plant was scheduled to close in approximately a year, with production transferring to North Carolina. Six-month impairment and restructuring charges were $13.4 million, including $2.4 million of impairment and costs associated with workforce and footprint reductions.
- On July 8, 2016, after quarter-end, Timken acquired Lovejoy for $63.5 million cash and assumed debt of $2.5 million. Its reported sales were approximately $56 million for the twelve months ended March 31, 2016.
- Key disclosed risks include weaker global and end-market demand, pricing and product mix, currency movements, raw-material and operating costs, execution and integration of acquisitions, pension-asset performance, warranty claims, litigation, and retaining CDSOA distributions.
Important facts for investors to verify
- Whether demand, pricing and margins stabilize, particularly in Process Industries and the weak industrial end markets.
- How much of reported earnings and cash generation depends on CDSOA distributions and other nonrecurring pension-related comparisons.
- Whether the 2016 sales, earnings, operating cash flow and capital-spending outlook remains achievable.
- Potential cost exposure from wind-sector warranty claims, restructuring and the Altavista closure.
- Lovejoy acquisition integration and funding, and any effect of overseas cash restrictions or CDSOA litigation on liquidity.