The Timken Company — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless noted. Timken manufactures bearings, power-transmission products and related services. Its reportable segments are Mobile Industries and Process Industries.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $771.4m | $657.4m | $2,225.8m | $2,015.0m |
| Gross profit | $217.0m | $169.7m | $599.3m | $537.3m |
| Gross margin | 28.1% | 25.8% | 26.9% | 26.7% |
| Operating income | $81.7m | $57.1m | $218.1m | $186.0m |
| Net income attributable to Timken | $53.5m | $33.6m | $174.2m | $147.7m |
| Diluted EPS | $0.68 | $0.43 | $2.21 | $1.86 |
| Operating cash flow | Not reported by quarter in the supplied text | $142.9m | $278.7m |
Q3 sales rose 17.3%, and attributable net income rose 59.2%. Nine-month sales rose 10.5%, while attributable net income rose 17.9%. Q3 sales growth reflected $61m higher organic revenue, $44m from acquisitions and favorable currency; nine-month growth included $121m higher organic revenue and $86m from acquisitions.
At September 30, 2017, cash and cash equivalents were $137.2m; total debt was $1,005.9m and net debt was $865.4m, compared with $659.2m and $507.7m, respectively, at year-end 2016. Net debt to capital increased to 37.3% from 27.9%. Current assets were $1,474.3m and current liabilities were $568.7m. The company reported $408.8m available under its $500m Senior Credit Facility and only $5.5m available under its Accounts Receivable Facility. It was in compliance with debt covenants.
Nine-month capital expenditures were $62.5m; acquisition spending, net of cash received, was $347.2m. Cash declined $11.6m during the period. Receivables and inventory rose $104.2m and $133.8m, respectively, from December 31, 2016. Approximately $137.0m of cash was held outside the U.S.
Segments and material changes
- Mobile Industries: Q3 sales were $422.8m, up 19.7%; EBIT was $34.9m, up 34.7%, with an 8.3% margin versus 7.3%. Nine-month EBIT increased 5.0% to $100.1m.
- Process Industries: Q3 sales were $348.6m, up 14.6%; EBIT was $61.7m, up 46.9%, with a 17.7% margin versus 13.8%. Nine-month EBIT increased 33.3% to $164.9m.
- Higher volume, acquisitions and manufacturing performance supported results. Unfavorable price/mix, higher material and logistics costs, and increased SG&A partially offset gains. Q3 SG&A increased 25.0% to $134.0m.
- Nine-month operating cash flow fell $135.8m, primarily from higher income-tax payments and working-capital use. Working capital used $75.4m, versus $3.9m in the prior period.
- The company adopted a pension accounting change retrospectively, recognizing actuarial gains and losses in earnings upon remeasurement and measuring plan assets at fair value. The change increased reported Q3 2017 net income by $5.9m and revised Q3 2016 net income upward by $13.0m; comparisons should be read using the revised figures.
Outlook, risks and unusual items
- Management expected full-year 2017 sales to increase approximately 12% from 2016 and earnings to be higher, citing volume, manufacturing performance and acquisitions. Expected offsets included unfavorable price/mix, higher material and logistics costs, increased SG&A and no repeat of 2016 CDSOA income.
- Management forecast approximately $280m of 2017 operating cash flow, down about 31% from 2016, due to the absence of CDSOA receipts, higher taxes and unfavorable working capital. Capital expenditures were expected at 3%–3.5% of sales.
- The nine-month 2017 effective tax rate was 14.1%, including a $33.9m reversal of prior-year uncertain-tax-position accruals. The nine-month 2016 comparison included $53.6m of CDSOA income, which did not recur.
- Three 2017 acquisitions—Groeneveld, PT Tech and Torsion Control Products—had a combined net purchase price of $346.6m and contributed goodwill and intangible assets. A proposed Timken India acquisition of ABC Bearings remained subject to approvals, expected in the first half of 2018.
- Customer claims concerning bearings used in the wind-energy sector were under evaluation. Management said the outcome was not expected to materially affect consolidated financial position, but costs beyond accruals could materially affect an individual period. CDSOA distributions could theoretically face clawback; management considered that likelihood remote.
- Other stated risks include demand and pricing volatility, raw-material and logistics costs, acquisition integration, currency and interest-rate movements, pension remeasurement, litigation and product warranty claims. Management reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether sales and margin momentum persists after separating organic growth from acquisitions and currency, particularly across the two segments.
- Whether working-capital needs, tax payments and acquisition-related spending permit management to meet its $280m operating-cash-flow outlook.
- Debt growth, facility availability, covenant headroom and the effect of acquisition financing on interest expense and leverage.
- The impact of the unusually low nine-month tax rate and the nonrecurrence of 2016 CDSOA income on full-year earnings comparisons.
- Integration, purchase-price allocation and expected returns from the 2017 acquisitions; status and terms of the proposed ABC Bearings transaction.
- Potential costs from wind-energy customer claims, pension remeasurement and restructuring, including the planned Pulaski plant closure.