Business context and reporting period
The Timken Company’s Form 10-K covers the fiscal year ended December 31, 2014. Timken designs and manufactures bearings and mechanical power-transmission products and provides related repair services. On June 30, 2014, it spun off its steel business as TimkenSteel; steel results are presented as discontinued operations for all periods. Beginning in the fourth quarter, Timken reported two segments: Mobile Industries and Process Industries.
Key financial metrics
| Metric | FY 2014 | FY 2013 |
|---|---|---|
| Net sales from continuing operations | $3,076.2 million | $3,035.4 million |
| Gross profit / gross margin | $898.0 million / 29.2% | $868.4 million / 28.6% |
| Operating income | $208.4 million | $305.9 million |
| Income from continuing operations | $149.3 million | $175.5 million |
| Net income attributable to Timken | $170.8 million | $262.7 million |
| Diluted EPS, continuing operations / total | $1.61 / $1.87 | $1.82 / $2.74 |
| Cash from operating activities, continuing operations | $281.5 million | $292.8 million |
| Cash and cash equivalents at year-end | $278.8 million | $384.6 million |
| Total debt / net debt | $530.1 million / $236.0 million | $445.7 million / $46.0 million |
Operating cash flow including discontinued operations was $307.0 million, versus $430.0 million in 2013. Capital expenditures were $126.8 million. Year-end total assets were $3.00 billion and shareholders’ equity was $1.59 billion. The net-debt-to-capital ratio rose to 12.9% from 1.7%. FY 2014 dividends were $1.00 per share.
Fourth-quarter 2014 sales were $762.2 million, compared with $749.5 million in Q4 2013. Continuing-operations income was $41.6 million versus $33.8 million; diluted total EPS was $0.52 versus $0.55. Q4 2014 included $33.0 million in pension settlement charges.
Material changes versus the prior comparable period
- Full-year sales increased 1.3%, mainly on higher Process Industries volume, partly offset by lower Mobile Industries volume and foreign-exchange effects. Continuing-operations diluted EPS fell 11.5%, and attributable net income declined 35.0%.
- Mobile Industries sales fell 5.1% to $1,685.4 million and EBIT fell to $65.6 million from $193.7 million; the segment recorded substantial aerospace impairment and restructuring charges. Process Industries sales rose 10.4% to $1,390.8 million and EBIT increased to $267.1 million from $189.3 million.
- Impairment and restructuring charges rose to $113.4 million from $8.7 million, principally including $86.3 million of goodwill impairment and $9.9 million of intangible-asset impairment in aerospace reporting units. A $18.7 million aerospace-related inventory valuation adjustment also reduced gross profit.
- Cash fell by $105.8 million during 2014. The company repurchased 5.2 million shares for $270.9 million, issued $350 million of 3.875% notes due 2024, and repaid $250 million of notes due in September 2014.
- The spin-off reduced the scale and diversification of the continuing company; reported year-over-year balance-sheet comparisons also reflect the removal of the steel business.
Outlook, management commentary, risks and unusual items
- Management expected 2015 sales to increase approximately 1%, with higher demand in light vehicles, wind energy, marine and industrial aftermarket markets largely offset by currency effects. It expected earnings to be lower, primarily because of non-cash pension settlement charges, partly offset by higher demand and lower impairment and restructuring charges.
- Management forecast approximately $345 million of 2015 cash from continuing operations, pension contributions of approximately $15 million and capital expenditures of about 4% of sales.
- In January 2015, a group annuity contract transferred about $600 million of pension obligations and $635 million of pension assets to Prudential, covering approximately 5,000 U.S. retirees. Timken expected a roughly $220 million pension settlement charge in the first half of 2015.
- Liquidity included a $500 million senior credit facility with no borrowings and $491.4 million available after letters of credit, plus $72.7 million available under the receivables securitization facility. The company reported compliance with credit covenants and said it expected sufficient liquidity through at least the credit facility’s May 2016 maturity.
- Principal risks include cyclical industrial demand, competitive pricing, steel and other input costs and supply, currency movements, pension assumptions and funding, environmental and product-liability exposures, and execution of acquisitions and restructuring. The company also identified risks associated with the TimkenSteel spin-off, including indemnification obligations and the possibility that the distribution’s tax-free treatment could be challenged.
- Other notable items: an October 2014 Brazilian antitrust investigation included Timken’s Brazilian subsidiary; management said the low end of potential penalties, if any, would be immaterial. The company reported $57.5 million of gross unrecognized tax benefits and expected a $40–$45 million decrease over the following 12 months, primarily from settlements and statute expirations. The filing also notes that the 2014 annual report’s tax provision was adjusted by $4.6 million after the January earnings release, increasing reported net income.
Important facts for investors to verify
- Reconcile the 2014 audited results with the January earnings release and understand the $4.6 million tax adjustment.
- Assess the sustainability of Process Industries’ growth and Mobile Industries’ recovery, including aerospace restructuring, remaining facility closure plans and impairment assumptions.
- Track the 2015 pension annuity transaction, expected settlement charge, funded status and sensitivity to discount rates and investment returns.
- Review post-spin-off cash generation, capital allocation and debt maturity/refinancing needs, including the 2016 credit facility maturity.
- Monitor exposure from the spin-off agreements and tax-free status, the Brazilian antitrust investigation, and unrecognized tax benefits.