The Timken Company — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Timken manufactures bearings, power-transmission products and related services, reporting through Mobile Industries and Process Industries. Unless stated otherwise, financial amounts are in millions of dollars.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $883.1 | $703.8 | +25.5% |
| Gross profit / margin | $264.9 / 30.0% | $182.2 / 25.9% | Margin +410 bps |
| Operating income | $116.1 | $62.9 | +84.6% |
| Net income attributable to Timken | $80.2 | $38.2 | +109.9% |
| Diluted EPS | $1.02 | $0.48 | +$0.54 |
| Operating cash flow | $(44.3) | $46.7 | $(91.0) |
Sales growth reflected $108 million of organic growth, $47 million from acquisitions and $24 million from favorable currency movements. Higher demand was led by industrial distribution and off-highway markets. Management attributed earnings improvement to volume, price/mix, manufacturing performance, acquisitions, lower pension mark-to-market charges versus 2017, and a lower tax rate, partly offset by higher SG&A and logistics costs.
- Mobile Industries: Sales $488.5 million, up 27.5%; EBIT $51.1 million, up 56.7%; EBIT margin 10.5%, versus 8.5%. Organic sales, excluding acquisitions and currency, increased 13.4%.
- Process Industries: Sales $394.6 million, up 23.0%; EBIT $81.6 million, up 85.0%; EBIT margin 20.7%, versus 13.7%. Organic sales, excluding acquisitions and currency, increased 17.6%.
Quarter-end cash and cash equivalents were $116.4 million, down from $121.6 million at year-end; including restricted cash, the cash-flow statement reports $120.3 million. Total debt was $1,066.3 million and net debt $946.0 million, compared with $962.3 million and $836.9 million, respectively, at December 31, 2017. Net debt to capital rose to 38.0% from 36.2%. Current assets were $1,645.8 million and current liabilities $702.3 million.
Operating cash use reflected $178.4 million of working-capital outflows, especially receivables, inventories and accrued expenses, partly offset by higher earnings. Investing cash use was $14.0 million, including $17.8 million of capital expenditures. Financing provided $52.3 million, including net borrowings; Timken paid $21.1 million in dividends and purchased $22.7 million of treasury shares.
Material changes and comparability
- Effective January 1, 2018, Timken adopted the new revenue standard using the modified retrospective method. Adoption increased Q1 reported sales by $4.0 million and Timken-attributable net income by $1.3 million (diluted EPS by $0.02); the opening retained-earnings adjustment was $7.7 million. Prior-year revenue figures were not restated.
- The new standard moved revenue recognized in excess of billings from accounts receivable to contract assets. Contract assets were $111.4 million at March 31, including $74.8 million reclassified from accounts receivable under the new standard.
- Timken retrospectively adopted a pension-cost presentation standard and revised affected 2017 income-statement amounts. Other pension-cost components were presented outside operating income; the 2017 comparison therefore reflects revised presentation.
- The effective tax rate was 26.0%, down from 28.9%, primarily reflecting U.S. Tax Reform. Q1 2018 included no change to the provisional 2017 estimates for the tax on unremitted foreign earnings or deferred-tax remeasurement.
Outlook, risks and contingencies
Management expected full-year 2018 sales to increase approximately 17% versus 2017 and earnings to be higher, citing demand, acquisitions, favorable price/mix, manufacturing performance and currency. Offsetting factors included higher SG&A, material and logistics costs, and a higher income tax rate inclusive of discrete items. The outlook excludes 2018 pension mark-to-market charges because their amount is unknown. Management forecast operating cash of approximately $370 million and capital expenditures of approximately 3.5% of sales.
Liquidity was supported by $413.7 million available under the $500 million Senior Credit Facility, which matures in June 2020. The $100 million receivables facility matures November 30, 2018; borrowings of $98.9 million left only $1.1 million available, and management said it was exploring refinancing. Foreign subsidiary credit lines had $242.5 million of aggregate availability, mostly under uncommitted arrangements. Timken reported compliance with debt covenants; the senior-facility leverage and interest-coverage ratios were 1.97x and 14.53x, respectively.
- Environmental accruals were $5.1 million, including the Lovejoy matter at the Ellsworth Industrial Park site; the company said its allocated share of remediation costs could be significant.
- A Brazilian antitrust investigation remained pending. Management considered the low end of potential penalties immaterial, but an outcome could affect results in the period recognized.
- Timken was evaluating wind-energy bearing performance claims; warranty accruals totaled $5.9 million. Management said costs beyond accruals could be material to an individual period, though not expected to materially affect consolidated financial position.
- Accounting for U.S. Tax Reform remained incomplete; further adjustments, including assessment of GILTI and foreign earnings, could materially affect tax expense.
- Other cited risks included economic and customer-demand changes, raw-material and operating costs, acquisition integration, currency and interest-rate movements, litigation, product warranties, environmental matters and pension exposure. The filing reported no material changes to the prior 10-K risk factors.
Most important facts for investors to verify
- Whether the forecast 17% full-year sales growth and approximately $370 million operating cash flow are achieved, particularly given Q1 working-capital cash use.
- Refinancing of the receivables facility before its November 2018 maturity and the cost and availability of replacement funding.
- Whether stronger segment margins persist as material, logistics and SG&A costs rise.
- Final tax accounting under U.S. Tax Reform, including GILTI and any revisions to provisional estimates.
- Developments in the Lovejoy environmental matter, Brazilian antitrust investigation and wind-energy warranty claims, including any charges above existing accruals.