Business context and reporting period
The Timken Company designs and sells engineered bearings and power-transmission products through its Mobile Industries and Process Industries segments. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods unless otherwise noted. Results reflect the effects of COVID-19 and related demand weakness, partly offset by acquisitions and growth in renewable energy.
Financial results and liquidity
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $894.6 million | $914.0 million | $2,621.5 million | $2,893.7 million |
| Gross profit / margin | $263.7 million / 29.5% | $277.5 million / 30.4% | $772.9 million / 29.5% | $885.8 million / 30.6% |
| Operating income | $119.0 million | $127.9 million | $356.1 million | $422.9 million |
| Net income attributable to Timken | $88.8 million | $64.2 million | $231.4 million | $248.6 million |
| Diluted EPS | $1.16 | $0.84 | $3.04 | $3.23 |
| Segment EBITDA | $173.2 million | $186.6 million | $520.9 million | $597.2 million |
Q3 sales fell 2.1%, while nine-month sales fell 9.4%. Q3 operating income declined despite higher net income: the latter benefited substantially from pension and postretirement remeasurement income of $15.3 million, versus expense of $14.4 million a year earlier, as well as lower SG&A and taxes. Nine-month net income attributable to Timken declined 6.9%.
For the nine months, net cash from operations was $457.2 million (versus $354.8 million); investing cash outflow was $101.4 million and financing cash outflow was $257.7 million. Capital expenditures were $85.7 million. Operating cash flow improved primarily with better working-capital cash effects, including use of VEBA trust assets for medical claims.
At September 30, cash and cash equivalents were $313.1 million; total debt was $1,608.6 million and net debt was $1,295.5 million, down from $1,730.1 million and $1,520.6 million, respectively, at year-end 2019. Net debt to capital was 38.2%, versus 43.8%. The company reported $535.7 million available under its revolving credit facility and $100 million under its accounts receivable facility; foreign subsidiary lines had $212.8 million available. It reported compliance with debt covenants. Current assets were $1,964.5 million and current liabilities $740.4 million.
Material changes versus prior comparable periods
- Q3 organic sales were down $47 million, partly offset by $29 million from acquisitions. For the first nine months, organic sales declined $336 million and currency reduced sales by $44 million, partly offset by $107 million from acquisitions.
- Q3 gross margin declined 90 basis points; nine-month gross margin declined 110 basis points. Lower volumes and currency were major pressures; cost reductions, manufacturing performance, lower material and logistics costs, and acquisitions provided offsets.
- Q3 restructuring and impairment charges rose to $12.0 million from $1.6 million; nine-month charges rose to $18.7 million from $3.5 million. SG&A fell 10.3% in Q3 and 13.3% year to date.
- Mobile Industries Q3 sales fell 5.8% and EBITDA fell 8.7%; Process Industries sales rose 1.5% but EBITDA fell 6.3%. On an organic, currency-adjusted basis, sales were down 9.6% for Mobile and 0.6% for Process in Q3.
- Q3 results also reflected a lower effective tax rate (22.6% versus 34.7%); the nine-month rate was 26.2% versus 30.1%.
Outlook, commentary, risks and unusual items
Timken did not provide detailed sales or earnings guidance because of continuing COVID-19 uncertainty. It expected Q4 2020 revenue to be below Q3 due to seasonality and below Q4 2019 due to reduced demand, mainly related to COVID-19. Management expected positive Q4 cash flow and operating margins above Q4 2019, supported by improved cost performance. Structural cost actions were expected to generate approximately $55–$60 million of year-over-year savings in the second half of 2020.
COVID-19 remained a material uncertainty for demand, operations, supply chains, margins and cash flow. Management said the duration and magnitude of the impact could not be reasonably estimated. Other disclosed risks include customer demand and industrial cycles, work stoppages, competition and pricing, input costs, acquisition integration, foreign currency, debt covenant compliance, pension assumptions, and litigation or environmental matters.
Unusual items include COVID-related headcount reductions of approximately 200 salaried positions; plant reorganizations and closures, including the Indianapolis chain plant and Canton and Gaffney bearing facilities; and pension remeasurement gains that materially influenced reported earnings. The company disclosed $5.1 million of environmental accruals, including the Lovejoy Superfund matter, for which its allocated future costs could be significant. Product warranty liabilities were $9.7 million. The company also noted that $260.7 million of its cash was held outside the U.S., where repatriation may involve taxes or restrictions.
Most important facts for investors to verify
- Whether demand recovery and the Q4 revenue and margin expectations materialized, given management’s limited guidance and COVID-19 uncertainty.
- How much of earnings and cash generation came from recurring operations versus pension remeasurement, tax effects, VEBA utilization and working-capital movements.
- Whether the targeted $55–$60 million second-half cost savings were achieved and what restructuring costs remain.
- Debt covenant headroom and liquidity, including the temporary net-debt covenant calculation that was scheduled to revert after June 30, 2021.
- Potential exposure from the Lovejoy environmental matter, warranty claims, and the final purchase-price allocation for BEKA.