The Timken Company — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010; filed August 5, 2010. The financial statements are unaudited. Dollar amounts are in millions except per-share data.
Business context and results
Timken manufactures bearings and power-transmission products, aerospace systems, and alloy steel. Its reportable segments are Mobile Industries, Process Industries, Aerospace and Defense, and Steel. The company completed the sale of its Needle Roller Bearings (NRB) operations in December 2009; 2009 NRB results are presented as discontinued operations.
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $1,011.4 | $736.8 | $1,925.1 | $1,603.4 |
| Gross profit | $268.3 | $125.4 | $491.0 | $280.0 |
| Gross margin | 26.5% | 17.0% | 25.5% | 17.5% |
| Operating income (loss) | $126.6 | $(53.3) | $210.8 | $(35.9) |
| Income (loss) from continuing operations | $82.0 | $(38.4) | $110.7 | $(39.8) |
| Net income (loss) attributable to Timken | $85.6 | $(64.5) | $114.2 | $(63.6) |
| Diluted EPS | $0.88 | $(0.67) | $1.18 | $(0.66) |
Sales increased 37.3% in Q2 and 20.1% for the first half. Management attributed the improvement principally to stronger Mobile and Steel demand, higher surcharges, and improved manufacturing utilization. Gross-margin gains also reflected favorable price mix, partly offset by higher material costs. SG&A rose 9.9% in Q2 and 8.9% for the half, principally because of higher incentive compensation; as a share of sales, it declined to 13.9% from 17.4% in Q2 and to 14.2% from 15.7% for the half. Impairment and restructuring charges fell to $1.0 million in Q2 and $6.5 million in the first half, from $50.7 million and $64.5 million, respectively, in 2009.
Segment performance and changes
| Segment | Q2 sales change | Q2 adjusted EBIT | Six-month adjusted EBIT |
|---|---|---|---|
| Mobile Industries | Up 37.0% to $400.4 | $68.5; prior-year loss $12.0 | $110.9; prior-year loss $14.3 |
| Process Industries | Up 2.2% to $211.0 | $28.9, down from $35.1 | $55.8, down from $78.6 |
| Aerospace and Defense | Down 24.3% to $82.7 | $7.2, down from $18.7 | $20.0, down from $36.8 |
| Steel | Up 146.0% to $317.3 | $43.0; prior-year loss $32.9 | $62.9; prior-year loss $40.2 |
Mobile benefited from higher volumes and utilization. Steel’s rebound reflected higher shipments and surcharges, alongside lower manufacturing costs; raw-material costs and LIFO expense partly offset those gains. Process results weakened due to lower first-half volumes, unfavorable pricing, and higher performance compensation. Aerospace and Defense continued to face soft demand and lower volume.
Cash flow, liquidity, and debt
- First-half operating cash flow was $164.0 million, versus $253.4 million in 2009. Higher pension and postretirement payments ($133.6 million versus $34.7 million) and cash absorbed by receivables and inventory contributed to the decline. Capital expenditures were $39.0 million; investing cash use was $37.4 million.
- Cash and cash equivalents were $796.2 million at June 30, compared with total debt of $493.4 million, giving net cash of $302.8 million. The reported net cash-to-capital ratio was negative 22.3%.
- There were no borrowings under the $500 million Senior Credit Facility or the $100 million receivables securitization agreement. Senior Credit Facility availability was $467.8 million after letters of credit. Timken reported covenant compliance, with a 0.9-to-1 leverage ratio against a 3.25 maximum and 13.5-to-1 interest coverage against a 4.0 minimum.
- First-half dividends paid were $21.3 million. The company repurchased approximately $29.2 million of shares during the first half.
Outlook, commentary, and notable items
- Management forecast 2010 sales approximately 25%–30% above 2009, driven mainly by Steel and Mobile growth and higher surcharges, partly offset by lower Aerospace and Defense sales. It expected operating cash flow above $380 million, pension contributions of approximately $135 million, and capital expenditures approximately 25% higher than in 2009.
- Segment outlook: Mobile sales expected to rise approximately 20%–25%; Process sales approximately 5% higher, with adjusted EBIT expected flat; Aerospace and Defense sales and adjusted EBIT expected to decline; Steel sales expected to rise 70%–80%, with adjusted EBIT significantly higher than its 2009 loss.
- First-half tax expense included a $21.6 million charge for the deferred-tax impact of U.S. health-care legislation; the six-month effective tax rate was 43.2%. Q2’s effective rate was 31.8%.
- The NRB sale generated a first-half after-tax gain of $4.5 million, mainly from a working-capital adjustment. In July, Timken received a $20 million insurance payment related to alleged irregularities in an investment in its U.S. pension trust; an investigation was ongoing.
- Timken announced an agreement to acquire QM Bearings and Power Transmission, a business with sales above $14 million over the preceding twelve months; closing was expected by the end of Q3, subject to customary conditions. A $54.3 million income-tax refund was received in July. The board declared a $0.13 quarterly dividend in August.
- Key risks cited include economic and customer-demand volatility, competition, raw-material and energy costs, the effectiveness of surcharges and restructuring, pension investment performance, financing conditions, and litigation or warranty, environmental, and tax claims. Management said ordinary-course legal matters were not expected to materially affect results; no material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether the strong Mobile and Steel volumes, pricing/surcharges, and margin recovery continue, particularly as raw-material costs rise.
- Whether weakness in Aerospace and Defense and uneven Process demand develop as management forecast.
- Progress toward the operating-cash-flow forecast, including working-capital needs, pension contributions, and planned capital spending.
- Pension-plan performance, future funding requirements, and the outcome of the investment investigation and related insurance recovery.
- Realization of restructuring savings and completion and financial impact of the proposed QM acquisition.
- Effects of the one-time health-care-related tax charge, tax settlements, and the July tax refund on reported and cash taxes.