TIMKEN CO — Q1 2016 Form 10-Q Summary
Business context and reporting period
The Timken Company engineers and manufactures bearings and power-transmission products and provides related services. It reports Mobile Industries and Process Industries segments. This filing covers the three months ended March 31, 2016; comparisons are with Q1 2015 unless otherwise noted. Amounts are in U.S. dollars, millions except per-share data.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Net sales | $684.0 | $722.5; down 5.3% |
| Gross profit / margin | $180.9 / 26.4% | $202.5 / 28.0% |
| Operating income (loss) | $50.9 | $(147.4) |
| Net income (loss) attributable to Timken | $63.0 | $(135.2) |
| Diluted EPS | $0.78 | $(1.54) |
| Operating cash flow | $47.1 | $17.0 |
| Capital expenditures | $24.2 | $19.7 |
| Cash and cash equivalents, March 31 | $137.3 | $129.6 at Dec. 31, 2015 |
| Total debt / net debt, March 31 | $688.7 / $551.2 | $656.5 / $526.7 at Dec. 31, 2015 |
Q1 net income included $47.7 of pretax Continued Dumping and Subsidy Offset Act (CDSOA) income, net of related expenses. The prior-year quarter included $215.2 of pension settlement charges. These unusual items substantially affect the year-over-year earnings comparison. The 2016 tax provision was $27.6, or a 30.5% effective tax rate, versus a $21.3 tax benefit in Q1 2015.
Segment results: Mobile Industries sales were $383.2, down 2.5%, and EBIT was $30.2, down 14.7%; EBIT margin was 7.9% versus 9.0%. Process Industries sales were $300.8, down 8.7%, and EBIT was $32.6, down 27.9%; EBIT margin was 10.8% versus 13.7%.
Net debt to capital was 28.6%, versus 28.1% at year-end 2015. The company reported compliance with debt covenants; its leverage ratio was 1.56x against a 3.5x maximum and interest coverage was 13.99x against a 3.5x minimum. Approximately $132 of cash was held outside the United States, and repatriation could incur taxes or face restrictions.
Material changes and management commentary
- Sales fell primarily because of lower end-market demand and currency effects. Management quantified organic sales lower by $44, foreign-exchange effects of $20, and divestitures of $5, partly offset by $30 from acquisitions. Automotive and wind energy grew; demand was weaker across most other markets.
- Gross margin declined 160 basis points. Lower volume, unfavorable price/mix and foreign exchange reduced gross profit, partly offset by lower raw-material and operating costs.
- Impairment and restructuring charges rose to $10.5 from $6.2, primarily severance and footprint-reduction costs. The company announced closure of its Altavista, Virginia bearing plant, with production expected to move to Lincolnton, North Carolina, in about a year; the quarter included a $2.4 impairment charge.
- Operating cash flow improved year over year, supported by working-capital and tax movements. The $48.1 CDSOA receivable was recorded in Q1 but collected on April 1, so it was not Q1 cash receipt.
- The company repurchased 1.2 million shares for approximately $35.0 and paid $20.7 in dividends. A new authorization permits repurchase of up to 5 million shares through January 31, 2017.
Outlook, risks and contingencies
Management expected 2016 sales to decline approximately 5% from 2015. Earnings were expected to rise year over year mainly due to lower pension settlement charges and CDSOA income; excluding those items, earnings were expected to decline because of lower volume, unfavorable price/mix, currency effects and higher restructuring costs, partly offset by lower input, operating and SG&A costs. Expected 2016 operating cash flow was approximately $340, down about $35 from 2015; pension contributions were expected to be about $15, and capital expenditures about 4.5% of sales.
Segment outlook: Mobile Industries sales were expected to decline approximately 6%, with EBIT also expected lower. Process Industries sales were expected to decline approximately 4%, with EBIT lower. Key risks include economic and customer-demand weakness, competition and pricing, raw-material and labor costs, currency and financial-market changes, execution of restructuring and acquisition plans, pension assumptions, litigation, and retention of CDSOA distributions. Although management considered clawback of distributions remote, legal challenges remained. Ordinary-course legal matters were not expected by management to have a material adverse effect. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of reported earnings and the 2016 outlook depends on the $47.7 CDSOA income and reduced pension settlement charges, and whether any distributions could be clawed back.
- Whether demand, pricing and segment margins stabilize, particularly in heavy industries, industrial aftermarket, rail, off-highway and aerospace markets.
- Progress and expected costs or savings from the Altavista closure and broader workforce and footprint actions.
- Cash-flow conversion against the $340 full-year outlook, including working-capital needs and the timing of CDSOA cash receipts.
- Debt, covenant headroom, and practical access to cash held outside the United States, alongside continued share repurchases and dividend payments.