The Timken Company — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This annual filing also reports fourth-quarter results. Timken engineers and manufactures bearings and mechanical power transmission products and provides related repair and rebuild services. It operates through Mobile Industries and Process Industries and serves customers in 28 countries.
Financial performance
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net sales | $2,669.8 million | $2,872.3 million |
| Gross profit / margin | $694.8 million / 26.0% | $793.9 million / 27.6% |
| Operating income (loss) | $195.0 million | $(151.4) million |
| Net income (loss) attributable to Timken | $152.6 million | $(70.8) million |
| Diluted EPS | $1.92 | $(0.84) |
| Cash from operating activities | $402.0 million | $374.8 million |
| Capital expenditures | $137.5 million | $105.6 million |
| Total debt / net debt | $659.2 million / $507.7 million | $656.5 million / $526.7 million |
| Cash and restricted cash | $151.5 million | $129.8 million |
Fourth-quarter 2016 sales were $654.8 million and net income attributable to Timken was $24.1 million, or diluted EPS of $0.31.
Net sales fell 7.1% year over year, reflecting lower organic demand, currency effects and divestitures, partly offset by acquisitions. Gross margin declined 160 basis points. Operating income rebounded from 2015’s loss, principally because pension settlement charges were $436.9 million lower and the company recorded $59.6 million of net Continued Dumping and Subsidy Offset Act (CDSOA) income. These items make the year-over-year profit comparison less indicative of underlying operating trends.
Operating cash flow increased $27.2 million. Cash and restricted cash rose $21.7 million during the year. Net debt to capital was 28.0%, versus 28.1% a year earlier. The company paid $1.04 per share in dividends and repurchased $101.0 million of shares.
Segments and material changes
- Mobile Industries: Sales were $1,446.4 million, down 7.2%; EBIT was $108.8 million, down 37.2%, and margin fell to 7.5% from 11.1%. Organic sales weakness was concentrated in rail, off-highway, aerospace and heavy truck, partly offset by automotive growth. Price/mix, lower volume and the prior-year Alcor divestiture gain weighed on EBIT.
- Process Industries: Sales were $1,223.4 million, down 6.9%; EBIT was $163.2 million, down 14.2%, and margin declined to 13.3% from 14.5%. Weakness in heavy industries, particularly oil and gas, industrial aftermarket, military marine and wind energy drove the decline.
- Timken acquired Lovejoy, an industrial couplings and universal-joints maker, for $63.5 million in cash plus $2.2 million of assumed debt, and acquired EDT for $10 million in cash. The acquisitions contributed approximately $99 million to reported sales across the company and were reported primarily in Process Industries.
- The company announced closures of bearing plants in Pulaski, Tennessee, and Altavista, Virginia, and manufacturing operations in Benoni, South Africa; closures and related footprint changes were expected to continue into 2017. It recorded $21.7 million in impairment and restructuring charges in 2016.
Outlook, risks and unusual items
- Management expected 2017 sales to be flat versus 2016, with acquisition benefits offset by adverse currency effects. Earnings were expected to decline, primarily because no CDSOA income was anticipated, partly offset by lower pension settlement charges.
- Management forecast approximately $310 million of 2017 operating cash flow, about 23% below 2016, and capital expenditures of approximately 4% of sales, versus 5% in 2016. Mobile Industries sales were expected to decline approximately 4%–5%; Process Industries sales were expected to increase approximately 4%–5%.
- The company planned to adopt mark-to-market accounting for defined benefit pension and other postretirement plans in 2017, subject to completion of its analysis. It expected retrospective application, but the impact on prior periods and earnings was still being evaluated.
- CDSOA income was based on distributions received in 2016; U.S. Customs advised that distributions could be subject to clawback, although management considered that possibility remote. No CDSOA income was expected in 2017.
- Key risks include cyclical industrial demand, competitive pricing, steel and other input costs, foreign currency movements, international operations, pension assumptions and funding, environmental obligations, product warranty or liability claims, and integration of acquisitions. Timken disclosed an ongoing Brazilian antitrust investigation and environmental matters; management did not expect ordinary-course legal matters to materially affect consolidated financial position, though a particular period’s results could be affected.
- Timken recorded a $28.1 million pension settlement charge in 2016, compared with $465.0 million in 2015. The company also reported $5.6 million of environmental accruals at year-end, including an amount related to Lovejoy’s acquired environmental exposure, and a $6.9 million product warranty liability.
Investor verification priorities
- Separate recurring operating performance from the $59.6 million CDSOA income and pension settlement charges; confirm the effects of the planned pension accounting change.
- Track whether 2017 sales, segment margins, operating cash flow and capital spending meet management’s stated outlook, particularly in Mobile Industries and Process Industries.
- Review the quality and sustainability of operating cash flow, including working-capital movements and the company’s tax-payment expectations.
- Monitor debt capacity, covenant compliance, overseas cash accessibility and planned shareholder returns. The company reported covenant compliance and $416.2 million available under its Senior Credit Facility at year-end.
- Follow closure and restructuring costs, acquisition integration and the Lovejoy environmental exposure, as well as the Brazilian antitrust investigation and wind-sector bearing claims.