The Timken Company — Q1 2019 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2019. Timken designs and manufactures engineered bearings and power transmission products, reporting through Mobile Industries and Process Industries. Comparative figures are for the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2018. Amounts are in U.S. dollars.
Financial performance
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Net sales | $979.7 million | $883.1 million |
| Gross profit / margin | $302.6 million / 30.9% | $264.9 million / 30.0% |
| Operating income | $149.9 million | $116.1 million |
| Net income attributable to Timken | $91.9 million | $80.2 million |
| Diluted EPS | $1.19 | $1.02 |
| Cash from operating activities | $52.3 million | $(44.3) million |
Sales rose 10.9%; management attributed the increase to $71 million from acquisitions and $56 million of higher organic revenue, partly offset by $31 million of adverse currency effects. Gross margin improved 90 basis points. Segment results: Mobile Industries sales were $500.0 million and EBIT was $61.4 million (12.3% margin); Process Industries sales were $479.7 million and EBIT was $106.2 million (22.1% margin). Process sales increased 11.9% excluding acquisitions and currency; Mobile sales increased 1.9% on that basis.
Operating cash flow improved by $96.6 million year over year, but working capital still used $113.5 million, principally from receivables and accrued expenses. Investing cash outflow was $19.6 million, including $16.2 million of capital expenditures; financing provided $73.4 million. Cash and cash equivalents were $239.5 million at quarter-end.
Total debt was $1.782 billion and net debt was $1.541 billion; net debt to capital was 47.5%, versus 48.5% at year-end 2018. Long-term debt was $1.747 billion. The $500 million Senior Credit Facility had $358.8 million available, while the $100 million receivables facility was fully drawn. The company reported compliance with debt covenants; its leverage ratio was 2.50x and interest coverage ratio 12.49x.
Material changes and notable items
- Higher volume, favorable price/mix, acquisition benefits and manufacturing performance supported earnings. Higher interest expense ($18.0 million versus $10.0 million), material costs, taxes and flood-related costs partly offset the gains. The effective tax rate increased to 30.2% from 26.0%, including discrete accruals for uncertain tax positions related to U.S. tax reform.
- On April 1, 2019, after quarter-end, Timken completed its acquisition of Diamond Chain, which had approximately $60 million of sales for the twelve months ended March 31, 2019. Borrowings were increased to help fund the purchase.
- A severe flood at a Knoxville warehouse resulted in $6.0 million of property damage and related expense, net of expected insurance proceeds. Inventory disruption temporarily affected shipments; additional costs and business-interruption claims were still being assessed.
- Adoption of the lease accounting standard on January 1, 2019 added operating lease assets and liabilities to the balance sheet; management said it did not affect reported operating results or cash-flow statement captions.
Outlook, risks and contingencies
Management expected 2019 sales to increase approximately 8%–10% and earnings to be higher than in 2018. It forecast operating cash flow of approximately $510 million and capital expenditures of approximately $150 million. The earnings outlook cited price/mix, volume, acquisitions and manufacturing performance as supports, with currency, material costs, taxes and interest expense among offsets. The outlook excludes mark-to-market charges whose amount was not yet determinable.
Management expected Mobile Industries full-year sales growth of approximately 1%–3% and Process Industries growth of approximately 16%–18%. It also expected approximately $34 million of 2019 pension-plan contributions and payments, including an anticipated $24 million deferred-compensation payout to a former executive that could trigger a pension settlement in Q3.
Disclosed contingencies include environmental matters, including the Lovejoy-related Ellsworth Industrial Park site (environmental accruals were $5.4 million); a Brazilian antitrust investigation; and customer claims concerning bearings sold into the wind energy sector. Management did not expect these matters to materially affect consolidated financial position, but noted some outcomes could materially affect an individual period. Broader risks include economic and customer-demand changes, tariffs and trade disputes, competition, input costs, acquisition integration, debt refinancing and pension exposure. The Senior Credit Facility matures in June 2020; management expected to renew it before maturity.
Important facts for investors to verify
- Whether organic demand, especially in Process Industries, sustains growth after separating acquisition contributions and foreign-exchange effects.
- Whether working-capital performance supports the $510 million annual operating-cash-flow outlook.
- Diamond Chain integration, acquisition financing and the company’s plans to renew or refinance the Senior Credit Facility before its 2020 maturity.
- Final flood-related losses, insurance recoveries and any continuing shipment or customer impact.
- Developments in uncertain tax positions, pension settlement and mark-to-market exposure, and the environmental, antitrust and wind-energy warranty matters.
- Integration and internal-control assessment of the 2018 acquisitions: they represented 23% of total assets and 8% of Q1 sales, and were not yet included in the internal-control effectiveness assessment; inclusion was planned for year-end 2019.