The Timken Company — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; comparisons are with the same 2017 periods unless stated otherwise. Dollar amounts are in millions, except per-share data.
Business context
Timken manufactures bearings and related power-transmission products and services. It reports Mobile Industries and Process Industries. During Q3, it acquired Rollon and Cone Drive and, through majority-owned Timken India, acquired ABC Bearings. It also sold the non-core ICT Business.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $881.3 | $771.4 | $2,670.7 | $2,225.8 |
| Gross profit | $253.3 | $216.1 | $785.6 | $599.4 |
| Operating income | $108.7 | $80.8 | $350.1 | $220.1 |
| Net income attributable to Timken | $71.6 | $53.5 | $242.8 | $174.2 |
| Diluted EPS | $0.91 | $0.68 | $3.09 | $2.21 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $195.0 | $142.9 |
Q3 sales increased 14.2%; nine-month sales increased 20.0%. Gross margin was 28.7% for Q3 versus 28.0%, and 29.4% for the nine months versus 26.9%. Q3 operating income included $2.6 of impairment and restructuring charges. Management attributed growth mainly to stronger demand, pricing and acquisitions; higher material and logistics costs, including tariffs, were offsets. Q3 net income rose 33.8%, while nine-month net income rose 39.4%.
Segments: Q3 Mobile Industries sales were $464.2 and EBIT was $50.6, with a 10.9% EBIT margin; Process Industries sales were $417.1 and EBIT was $81.8, with a 19.6% margin. Organic sales growth excluding acquisitions and currency was 10.8% for Mobile and 17.3% for Process. For the nine months, segment EBIT was $156.2 for Mobile and $254.0 for Process.
Liquidity, debt and cash flow
At September 30, cash and cash equivalents were $153.7; current assets were $1,786.3 and current liabilities $656.6. Total debt was $1,730.1, versus $962.3 at December 31, 2017; net debt was $1,575.1 versus $836.9, and net debt to capital increased to 49.0% from 36.2%. Cash, cash equivalents and restricted cash totaled $155.0 at period end.
Nine-month operating cash flow was $195.0, up from $142.9. Investing used $810.3, including $765.4 for acquisitions; financing provided $657.3, primarily reflecting borrowing. Working capital used $197.3 of cash. The $400 million 4.50% notes and $350 million variable-rate term loan issued in September funded the Cone Drive and Rollon acquisitions. The company reported compliance with debt covenants; its $500 million senior credit facility had $434.8 available and its renewed receivables facility had $6.8 available.
Changes, outlook and notable matters
- Aggregate 2018 acquisition purchase price, net of acquired cash, was $831.4; the acquired businesses were expected to contribute approximately $270 million in annual sales. Goodwill and intangible assets increased substantially as a result.
- Management forecast 2018 sales growth of approximately 19.5%, operating cash flow of approximately $375 million, and capital expenditures of approximately $115 million. It expected earnings to increase year over year, citing volume, price/mix, acquisitions and manufacturing performance, partly offset by costs, SG&A, taxes and interest. The earnings outlook excludes unknown Q4 pension mark-to-market charges.
- The company adopted the new revenue standard on a modified retrospective basis. It added $17.0 to nine-month sales and $3.3 to Timken-attributable net income; comparative periods were not restated. Approximately 9% of 2018 nine-month sales was recognized over time. The adoption did not affect nine-month operating cash flow.
- Interest expense increased to $12.5 for Q3 and $33.2 for nine months, primarily because of acquisition-related borrowing. Nine-month effective tax rate was 25.4%, versus 14.1%, largely reflecting 2017 reversals of uncertain-tax-position accruals; accounting for U.S. tax reform remained provisional.
- Foreign-currency translation reduced equity by $54 for the first nine months. Environmental accruals were $5.6, including the Lovejoy Superfund matter. The company was evaluating wind-sector bearing warranty claims; management said excess exposure beyond accruals was not expected to materially affect consolidated financial position, though costs in a particular period could be material.
- Key risks cited include economic and demand changes, trade disputes and tariffs, raw-material and logistics costs, acquisition integration and performance, currency movements, litigation and warranty claims, pension exposure, and debt refinancing. Management reported effective disclosure controls and no material change in risk factors from the 2017 Form 10-K.
Important facts for investors to verify
- Whether acquired businesses deliver expected sales, integration benefits and earnings accretion, and whether preliminary purchase-price allocations change.
- Progress toward 2018 sales, operating-cash-flow and capital-expenditure outlooks, including the effect of working-capital needs and Q4 pension mark-to-market charges.
- Debt and interest-cost trajectory, covenant headroom, and refinancing plans for facilities and maturities.
- Final U.S. tax-reform and GILTI accounting, and the resulting effective tax rate.
- Any developments in the Lovejoy environmental matter, wind-bearing warranty claims, or Brazilian antitrust investigation.
- Comparability of reported results given the revenue-standard adoption and the non-restated 2017 revenue figures.