UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2012 | |
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from______to_______ | |
Commission file number: 1-1169
THE TIMKEN COMPANY
(Exact name of registrant as specified in its charter)
Ohio | 34-0577130 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
1835 Dueber Avenue, S.W., Canton, Ohio | 44706 | |
(Address of principal executive offices) | (Zip Code) | |
(330) 438-3000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, without par value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | x | Accelerated filer | o | Non-accelerated filer | o | Smaller reporting company | o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of June 30, 2012, the aggregate market value of the registrant’s common shares held by non-affiliates of the registrant was $4,029,384,828 based on the closing sale price as reported on the New York Stock Exchange.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at January 31, 2013 | |
Common Shares, without par value | 95,937,115 shares | |
DOCUMENTS INCORPORATED BY REFERENCE
Document | Parts Into Which Incorporated | |
Proxy Statement for the Annual Meeting of Shareholders to be held on or about May 7, 2013 (Proxy Statement) | Part III | |
THE TIMKEN COMPANY
INDEX TO FORM 10-K REPORT
PAGE | |||
I. | |||
Item 1. | |||
Item 1A. | |||
Item 1B. | |||
Item 2. | |||
Item 3. | |||
Item 4. | |||
Item 4A. | |||
II. | |||
Item 5. | |||
Item 6. | |||
Item 7. | |||
Item 7A. | |||
Item 8. | |||
Item 9. | |||
Item 9A. | |||
Item 9B. | |||
III. | |||
Item 10. | |||
Item 11. | |||
Item 12. | |||
Item 13. | |||
Item 14. | |||
IV. | |||
Item 15. | |||
Exhibit 12 | Computation of Ratio of Earnings to Fixed Charges | ||
Exhibit 21 | Subsidiaries of the Registrant | ||
Exhibit 23 | Consent of Independent Registered Public Accounting Firm | ||
Exhibit 24 | Power of Attorney | ||
Exhibit 31.1 | Principal Executive Officer’s Certifications | ||
Exhibit 31.2 | Principal Financial Officer’s Certifications | ||
Exhibit 32 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
Exhibit 101 | Extensible Business Reporting Language (XBRL) | ||
PART I.
Item 1. Business
General:
As used herein, the term “Timken” or the “Company” refers to The Timken Company and its subsidiaries unless the context otherwise requires. The Timken Company, a global industrial technology leader, engineers, manufactures and markets mechanical components and high-performance steel. Timken® bearings and engineered steel bars and tubes, as well as transmissions, gearboxes, chain, related products and services, support diversified markets worldwide.
The Company was founded in 1899 by Henry Timken, who received two patents on the design of a tapered roller bearing. Timken grew to become the world's largest manufacturer of tapered roller bearings and leveraged its expertise to further expand its portfolio of bearing products to include cylindrical, spherical, needle and precision ball bearings. Based on its engineering capabilities and technical knowledge, Timken built its reputation as a global leader and applied its knowledge of metallurgy, friction management and mechanical power transmission to increase the reliability and efficiency of its customers' equipment, improving productivity, uptime and performance across a wide range of applications and markets. The Company's broadened portfolio includes power transmission components and systems, engineered surfaces and coatings, lubricants, seals, as well as aftermarket services including bearing and gearbox remanufacture and repair. The Company also manufactures helicopter transmissions, high-performance engineered alloy steels bars and seamless mechanical tubing, as well as finished and semi-finished steel components made to exact specifications to meet the increasing demands for reliability and efficiency. The Company's global footprint consists of 62 manufacturing facilities, 10 technology and engineering centers, 12 distribution centers and warehouses, supported by a team comprised of nearly 20,000 employees. Timken operates in 30 countries and territories around the globe.
Industry Segments and Geographical Financial Information:
Information required by this item is incorporated herein by reference to Note 14 – Segment Information in the Notes to the Consolidated Financial Statements.
Major Customers:
The Company sells products and services to a diverse customer base globally including customers in the following market sectors: industrial equipment, construction, agriculture, rail, aerospace and defense, automotive, heavy truck and oil and gas. The Company does not have any sales to a single customer that are 5% or more of total sales.
Products:
The Timken Company manufactures and manages global supply chains for multiple product lines including anti-friction bearings, mechanical power transmission solutions, engineered steel and related precision steel components designed to operate in demanding environments. The Company leverages its technical knowledge, research expertise and production and engineering capabilities across all of its products and end markets to deliver high-performance products to its customers. Differentiation of product lines is achieved by either: (1) product type or (2) the targeted applications utilizing the product.
Bearings and Power Transmission Solutions. Selection and development of bearings for customer applications and demand for high reliability require sophisticated engineering and analytical techniques. Deep knowledge of friction management combined with high precision tolerances, proprietary internal geometries and premium quality materials, provide Timken bearings with high load-carrying capacity, excellent friction-reducing qualities and long service lives. The uses for bearings are diverse and can be found in transportation applications that include passenger cars and trucks, heavy trucks, helicopters, airplanes and trains. Ranging in size from precision bearings the size of a pencil eraser to those roughly three meters in diameter, high-performance Timken components are also used in a wide variety of industrial applications, ranging from paper and steel mills, mining, oil and gas extraction and production, gear drives, health and positioning control, wind mills and food processing. Timken manufactures or in some cases purchases the required components and then sells them assembled or as individual components in a wide variety of configurations and sizes. In addition to bearings, Timken provides mechanical power transmission components, including chains, augers, gear boxes, seals, lubricants and related products and services.
1
Tapered Roller Bearings. The tapered roller bearing is the Company's original entrant to the anti-friction bearing segment. Tapered rollers permit ready absorption of both radial and axial load combinations. For this reason, tapered roller bearings are particularly well-adapted to reducing friction where shafts, gears or wheels are used. Bearings generally consist of four components: (1) the cone or inner race; (2) the cup or outer race; (3) the rollers, which roll between the cup and cone; and (4) the cage, which serves as a retainer and maintains proper spacing between the rollers. They can be found wherever gears and shafts turn in a wide variety of markets including construction and mining, metal and paper-making mills, commercial truck and power generation.
Precision Cylindrical and Ball Bearings. The Company's aerospace facilities produce high-performance ball and cylindrical bearings for ultra high-speed and/or high-accuracy applications in space and robotic vehicles, including Curiosity, the newest Mars rover. Customers for these precision bearings also include manufacturers of medical and health equipment, machine tools, critical motion control systems and precision robotics. These bearings utilize ball and straight rolling elements and are in the super-precision end of the general ball and straight roller bearing product range in the bearing industry. A majority of these bearings products are custom-designed bearings and spindle assemblies. They often utilize specialized materials and coatings in applications that subject the bearings to extreme operating conditions of speed and temperature.
Spherical and Cylindrical Roller Bearings. Timken produces spherical and cylindrical roller bearings for large gear drives, rolling mills and other industrial and infrastructure development applications. These products are sold worldwide to original equipment manufacturers and industrial distributors serving major end-markets, including construction and mining, natural resources, defense, pulp and paper production, rolling mills and general industrial goods. The same rigorous analysis and development apply to these products.
Chains and Augers. Through the acquisition of Drives LLC (Drives) in 2011, Timken manufactures American National Standards Institute (ANSI) precision roller chain, pintle chain, agricultural conveyor chain, engineering class chain, oil field roller chain and auger products. These highly engineered products are vital to a wide range of mobile and industrial machinery applications, including agriculture, oil and gas, aggregate and mining, primary metals, forest products and other heavy industries. They also are utilized in the food and beverage and packaged goods sectors, which often require high-end, specialty products including stainless-steel and corrosion-resistant roller chains.
Gear-Drive Systems. Through the acquisition of the assets of Philadelphia Gear Corp. (Gears and Services) in 2011, Timken provides aftermarket gear box repair services and gear-drive systems for the industrial, energy and military marine sectors, including refining and pipeline systems, mining, cement, pulp and paper making and water management systems.
Services. Timken offers a broad array of industrial services including bearing reconditioning and repair; condition monitoring and reliability services designed to maximize performance, durability and maintenance intervals for industrial and railroad customers, both domestically and internationally. Other services include maintenance and rework of large industrial equipment used in metal-making mills and the energy sectors. The total services accounted for less than 5% of the Company’s net sales for the year ended December 31, 2012.
Aerospace Products and Services. The Company's portfolio of parts, systems and services for the aerospace market has grown to include products used in helicopters and fixed-wing aircraft for the military and commercial aviation industries. Timken designs, manufactures and tests a wide variety of power transmission and drive train components including bearings, transmissions, turbine engine components, gears and rotor-head assemblies and housings. Other parts include airfoils (such as blades, vanes, rotors and diffusers), nozzles and other precision flight-critical components.
In addition to original equipment, Timken provides a wide range of aftermarket products and services for global customers, including complete engine overhaul, bearing repair, component reconditioning and replacement parts for gas turbine engines, transmissions and fuel controls, gearboxes and accessory systems in helicopters and fixed-wing aircraft.
2
Engineered Steel. Timken manufactures more than 450 grades of high-performance carbon, micro-alloy and alloy steel, sold as ingots, bars and tubes in a variety of chemistries, lengths and finishes. The segment's metallurgical expertise and unique operational capabilities drive customized, high-value solutions for the mobile, industrial and energy sectors. Timken® specialty steels are featured in a wide variety of end products including: oil country drill pipe, bits and collars, gears, hubs, axles, crankshafts and connecting rods, bearing races and rolling elements, bushings, fuel injectors, wind energy shafts and other demanding applications, where mechanical power transmission is critical to the end customer.
The Timken steel segment provides premium value in the market by leveraging the team's deep metallurgical and application knowledge to develop solutions that provide lower total cost of ownership for our customers. The Company develops clean, high-performance alloy steels that consistently meet or exceed customer's product specifications. In addition, exceptional responsive and flexible supply chain capabilities offer high on-time delivery rates and the ability to produce small quantity orders to custom specifications.
Precision Steel Components. Timken also produces custom-made steel products, including steel components for automotive and industrial customers. Steel components provide the Company with the opportunity to further expand its market for tubing and capture higher value-added steel sales by streamlining customer supply chains. It also enables traditional Timken tubing customers in the automotive and bearing industries to take advantage of ready-to-finish components that cost less than other alternatives. Customization of products is an important element of the Company's steel business where mechanical power transmission is critical to the end customer.
Sales and Distribution:
Timken products are sold principally by its own internal sales organizations. A portion of each segment's sales are made through authorized distributors.
Customer collaboration is central to the Company's sales strategy. Therefore, Timken goes where its customers need them, with sales engineers primarily working in close proximity to customers rather than at production sites. In some cases, Timken may co-locate with a customer at their facility to ensure optimized collaboration. The Company's sales force constantly updates the team's training and knowledge regarding all friction management products and market sector trends, and employees assist customers during development and implementation phases and provide ongoing service and support.
The Company has a joint venture in North America focused on joint logistics and e-business services. This alliance, CoLinx, LLC, includes five equity members: Timken, SKF Group, the Schaeffler Group, Rockwell Automation and Gates Corporation. The e-business service focuses on information and business services for authorized distributors in the Process Industries segment.
Most orders for Timken's steel products are customized to satisfy customer-specific applications and are shipped directly to customers from the Company's steel manufacturing plants. Less than 10% of the Timken Steel segment's net sales are intersegment sales. In addition, sales are made to other anti-friction bearing companies and to the automotive and truck, forging, construction, industrial equipment, oil and gas drilling, aircraft industries and to steel service centers.
Timken has entered into individually negotiated contracts with some of its customers. These contracts may extend for one or more years and, if a price is fixed for any period extending beyond current shipments, customarily include a commitment by the customer to purchase a designated percentage of its requirements from Timken. Timken does not believe that there is any significant loss of earnings risk associated with any given contract.
3
Competition:
The anti-friction bearing business is highly competitive in every country where Timken sells products. Timken competes primarily based on total value, including price, quality, timeliness of delivery, product design and the ability to provide engineering support and service on a global basis. The Company competes with domestic manufacturers and many foreign manufacturers of anti-friction bearings, including SKF Group, Schaeffler Group, NTN Corporation, JTEKT Corporation (JTEKT) and NSK Ltd.
The steel industry, both domestically and globally, is highly competitive and is expected to remain so. Maintaining high standards of product quality and reliability, while keeping production costs competitive, is essential to the Company's ability to compete with domestic and foreign manufacturers of mechanical components and alloy steel. Principal bar competitors include foreign-owned domestic producers Gerdau Special Steel North America (a unit of Brazilian steelmaker Gerdau, S.A) and Republic Steel (a unit of Mexican steel producer ICH), along with domestic steel producers Steel Dynamics, Inc. and Nucor Corporation. Seamless tubing competitors include foreign-owned domestic producers ArcelorMittal Tubular Products (a unit of Luxembourg-based ArcelorMittal, S.A.), V&M Star Tubes (a unit of Vallourec, S.A.), and Tenaris, S.A. Additionally, Timken competes with a wide variety of offshore producers of both bars and tubes, including Sanyo Special Steel and Ovako. Timken also provides value-added steel products to its customers in the energy, industrial and automotive sectors. Competitors within the value-added market segment include Linamar, Jernberg and Curtis Screw Company.
Joint Ventures:
Investments in affiliated companies accounted for under the equity method were approximately $1.1 million and $2.0 million, respectively, at December 31, 2012 and 2011. The amount at December 31, 2012 was reported in other non-current assets on the Consolidated Balance Sheets.
Backlog:
The following table provides the backlog of orders of the Company's domestic and overseas operations at December 31, 2012 and 2011:
December 31, | ||||||
(Dollars in millions) | 2012 | 2011 | ||||
Segment: | ||||||
Mobile Industries | $ | 708.5 | $ | 808.7 | ||
Process Industries | 387.8 | 479.5 | ||||
Aerospace & Defense | 404.7 | 443.2 | ||||
Steel | 311.6 | 530.7 | ||||
Total Company | $ | 1,812.6 | $ | 2,262.1 | ||
Prior to 2012, the Company only included backlog that was expected to ship in the next six months for the Mobile Industries and Process Industries segments. Backlog at December 31, 2011 was revised to include all backlog for the entire Company. Approximately 90% of the Company’s backlog at December 31, 2012 is scheduled for delivery in the succeeding twelve months. Actual shipments depend upon customers' ever-changing production. Accordingly, Timken does not believe that its backlog data and comparisons thereof, as of different dates, reliably indicate future sales or shipments.
4
Raw Materials:
The principal raw materials used by Timken in steel manufacturing are scrap metal, nickel, molybdenum and other alloys. The availability and costs of raw materials and energy resources are subject to curtailment or change due to, among other things, new laws or regulations, changes in global demand levels, suppliers’ allocations to other purchasers, interruptions in production by suppliers, changes in exchange rates and prevailing price levels. For example, the consumption cost of scrap metal increased 59.0% from 2009 to 2010, increased 23.4% from 2010 to 2011 and decreased 6.1% from 2011 to 2012.
The Company continues to expect that it will be able to pass a significant portion of cost increases through to customers in the form of price increases or surcharges.
Disruptions in the supply of raw materials or energy resources could temporarily impair the Company’s ability to manufacture its products for its customers or require the Company to pay higher prices in order to obtain these raw materials or energy resources from other sources, which could affect the Company’s revenues and profitability. Any increase in the costs for such raw materials or energy resources could materially affect the Company’s earnings. Timken believes that the availability of raw materials and alloys is adequate for its needs, and, in general, it is not dependent on any single source of supply.
Research:
Timken operates a network of technology and engineering centers to support its global customers with sites in North America, Europe and Asia. This network develops and delivers innovative friction management and mechanical power transmission solutions and technical services. The largest technical center is located in North Canton, Ohio, near Timken's world headquarters. Other sites in the United States include Mesa, Arizona; Manchester, Connecticut; Keene and Lebanon, New Hampshire; and King of Prussia, Pennsylvania. Within Europe, the Company has technology facilities in Ploiesti, Romania; and Colmar, France; and in Asia, it operates technology and engineering facilities in Bangalore, India; and Shanghai, China.
Expenditures for research, development and application amounted to approximately $52.6 million, $49.6 million and $49.9 million in 2012, 2011 and 2010, respectively. Of these amounts, approximately $0.8 million, $0.3 million and $1.6 million were funded by others in 2012, 2011 and 2010, respectively.
Environmental Matters:
The Company continues its efforts to protect the environment and comply with environmental protection laws. Additionally, it has invested in pollution control equipment and updated plant operational practices. The Company is committed to implementing a documented environmental management system worldwide and to becoming certified under the ISO 14001 standard where appropriate to meet or exceed customer requirements. As of the end of 2012, 21 of the Company’s plants had obtained ISO 14001 certification.
The Company believes it has established appropriate reserves to cover its environmental expenses and has a well-established environmental compliance audit program for its domestic and international units. This program measures performance against applicable laws, as well as against internal standards that have been established for all units worldwide. It is difficult to assess the possible effect of compliance with future requirements that differ from existing ones. As previously reported, the Company is unsure of the future financial impact to the Company that could result from the United States Environmental Protection Agency’s (EPA’s) final rules to tighten the National Ambient Air Quality Standards for fine particulate and ozone. In addition, the Company is unsure of the future financial impact to the Company that could result from the EPA instituting hourly ambient air quality standards for sulfur dioxide and nitrogen oxide. The Company is also unsure of the potential future financial impact to the Company that could result from possible future legislation regulating emissions of greenhouse gases.
5
The Company and certain of its U.S. subsidiaries have been identified as potentially responsible parties for investigation and remediation at off-site disposal or recycling facilities under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), known as the Superfund, or state laws similar to CERCLA. In general, such claims for investigation and remediation have also been asserted against numerous other entities, which are believed to be financially solvent and are expected to substantially fulfill their proportionate share of the obligation.
Management believes any ultimate liability with respect to pending actions will not materially affect the Company’s operations, cash flows or consolidated financial position. The Company is also conducting environmental investigation and/or remediation activities at a number of current or former operating sites. The costs of such investigation and remediation activities, in the aggregate, are not expected to be material to the operations or financial position of the Company.
New laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean-up requirements may require Timken to incur costs or become the basis for new or increased liabilities that could have a materially adverse effect on the Company's business, financial condition or results of operations.
Patents, Trademarks and Licenses:
Timken owns numerous U.S. and foreign patents, trademarks and licenses relating to certain products. While Timken regards these as important, it does not deem its business as a whole, or any industry segment, to be materially dependent upon any one item or group of items.
Employment:
At December 31, 2012, Timken had nearly 20,000 employees. Approximately 9% of Timken’s U.S. employees are covered under collective bargaining agreements.
Available Information:
The Company uses its Investor Relations website, www.timken.com, as a channel for routine distribution of important information, including news releases, analyst presentations and financial information. The Company posts filings as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC, including its annual, quarterly and current reports on Forms 10-K, 10-Q and 8-K; its proxy statements; and any amendments to those reports or statements. All such postings and filings are available on the Company’s website free of charge. In addition, this website allows investors and other interested persons to sign up to automatically receive e-mail alerts when the Company posts news releases and financial information on the Company’s website. The SEC also maintains a web site, www.sec.gov, which contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The content on any website referred to in this Annual Report on Form 10-K is not incorporated by reference into this Annual Report unless expressly noted.
6
Item 1A. Risk Factors
The following are certain risk factors that could affect our business, financial condition and results of operations. The risks that are highlighted below are not the only ones that we face. These risk factors should be considered in connection with evaluating forward-looking statements contained in this Annual Report on Form 10-K because these factors could cause our actual results and financial condition to differ materially from those projected in forward-looking statements. If any of the following risks actually occur, our business, financial condition or results of operations could be negatively affected.
The bearing industry is highly competitive, and this competition results in significant pricing pressure for our products that could affect our revenues and profitability.
The global bearing industry is highly competitive. We compete with domestic manufacturers and many foreign manufacturers of anti-friction bearings, including SKF Group, Schaeffler Group, NTN Corporation, JTEKT and NSK Ltd. The bearing industry is also capital intensive and profitability is dependent on factors such as labor compensation and productivity and inventory management, which are subject to risks that we may not be able to control. Due to the competitiveness within the bearing industry, we may not be able to increase prices for our products to cover increases in our costs. In many cases we face pressure from our customers to reduce prices, which could adversely affect our revenues and profitability. In addition, our customers may choose to purchase products from one of our competitors rather than pay the prices we seek for our products, which could adversely affect our revenues and profitability.
Competition and consolidation in the steel industry, together with potential global overcapacity, could result in significant pricing pressure for our products.
Competition within the steel industry, both domestically and worldwide, is intense and is expected to remain so. Global production overcapacity has occurred in the recent past and may recur in the future, which would exert downward pressure on domestic steel prices and result in, at times, a dramatic narrowing, or with many companies the elimination, of gross margins. High levels of steel imports into the United States could exacerbate this pressure on domestic steel prices. In addition, many of our competitors are continuously exploring and implementing strategies, including acquisitions and the addition or repositioning of capacity, which focus on manufacturing higher margin products that compete more directly with our steel products. Depending upon prevailing market conditions in the United States and abroad, the value of the U.S. dollar relative to other currencies, and other similar variables beyond our control, import activity into the United States and/or domestic production could continue to increase. These factors could lead to significant downward pressure on prices for our steel products or a reduction in sales, which could have a material adverse effect on our revenues and profitability.
Our business is capital intensive, and if there are downturns in the industries that we serve, we may be forced to significantly curtail or suspend operations with respect to those industries, which could result in our recording asset impairment charges or taking other measures that may adversely affect our results of operations and profitability.
Our business operations are capital intensive, and we devote a significant amount of capital to certain industries. If there are downturns in the industries that we serve, we may be forced to significantly curtail or suspend our operations with respect to those industries, including laying-off employees, recording asset impairment charges and other measures, which may adversely affect our results of operations and profitability.
7
Weakness in global economic conditions or in any of the industries or geographic regions in which we or our customers operate, as well as the cyclical nature of our customers' businesses generally or sustained uncertainty in financial markets, could adversely impact our revenues and profitability by reducing demand and margins.
Our results of operations may be materially affected by the conditions in the global economy generally and in global capital markets. There has been extreme volatility in the capital markets and in the end markets and geographic regions in which we and our customers operate, which has negatively affected our revenues. Our revenues may also be negatively affected by changes in customer demand, additional changes in the product mix and negative pricing pressure in the industries in which we operate. Margins in those industries are highly sensitive to demand cycles, and our customers in those industries historically have tended to delay large capital projects, including expensive maintenance and upgrades, during economic downturns. As a result, our revenues and earnings are impacted by overall levels of industrial production.
Our results of operations may be materially affected by the conditions in the global financial markets or in any of the geographic regions in which we operate. If an end user cannot obtain financing to purchase our products, either directly or indirectly contained in machinery or equipment, demand for our products will be reduced, which could have a material adverse effect on our financial condition and earnings.
If a customer becomes insolvent or files for bankruptcy, our ability to recover accounts receivable from that customer would be adversely affected and any payment we received during the preference period prior to a bankruptcy filing may be potentially recoverable by the bankruptcy estate. Furthermore, if certain of our customers liquidate in bankruptcy, we may incur impairment charges relating to obsolete inventory and machinery and equipment. In addition, financial instability of certain companies in the supply chain could disrupt production in any particular industry. A disruption of production in any of the industries where we participate could have a material adverse effect on our financial condition and earnings.
Any change in the operation of our raw material surcharge mechanisms, a raw material market index or the availability or cost of raw materials and energy resources could materially affect our revenues and earnings.
We require substantial amounts of raw materials, including scrap metal and alloys and natural gas to operate our business. Many of our customer contracts contain surcharge pricing provisions. The surcharges are generally tied to a widely-available market index for that specific raw material. Recently many of the widely-available raw material market indices have experienced wide fluctuations. Any change in a raw material market index could materially affect our revenues. Any change in the relationship between the market indices and our underlying costs could materially affect our earnings. Any change in our projected year-end input costs could materially affect our last-in, first-out (LIFO) inventory valuation method and earnings.
Moreover, future disruptions in the supply of our raw materials or energy resources could impair our ability to manufacture our products for our customers or require us to pay higher prices in order to obtain these raw materials or energy resources from other sources, and could thereby affect our sales and profitability. Any increase in the prices for such raw materials or energy resources could materially affect our costs and therefore our earnings.
Warranty, recall or product liability claims could materially adversely affect our earnings.
In our business, we are exposed to warranty and product liability claims. In addition, we may be required to participate in the recall of a product. A successful warranty or product liability claim against us, or a requirement that we participate in a product recall, could have a material adverse effect on our earnings.
8
We may incur further impairment and restructuring charges that could materially affect our profitability.
We have taken $262.5 million in impairment and restructuring charges during the last five years. Changes in business or economic conditions, or our business strategy, may result in additional restructuring programs and may require us to take additional charges in the future, which could have a material adverse effect on our earnings.
Environmental laws and regulations impose substantial costs and limitations on our operations and environmental compliance may be more costly than we expect.
We are subject to the risk of substantial environmental liability and limitations on our operations due to environmental laws and regulations. We are subject to extensive federal, state, local and foreign environmental, health and safety laws and regulations concerning matters such as air emissions, wastewater discharges, solid and hazardous waste handling and disposal and the investigation and remediation of contamination. The risks of substantial costs and liabilities related to compliance with these laws and regulations are an inherent part of our business, and future conditions may develop, arise or be discovered that create substantial environmental compliance or remediation liabilities and costs.
Compliance with environmental, health and safety legislation and regulatory requirements may prove to be more limiting and costly than we anticipate. To date, we have committed significant expenditures in our efforts to achieve and maintain compliance with these requirements at our facilities, and we expect that we will continue to make significant expenditures related to such compliance in the future. From time to time, we may be subject to legal proceedings brought by private parties or governmental authorities with respect to environmental matters, including matters involving alleged property damage or personal injury. New laws and regulations, including those which may relate to emissions of greenhouse gases, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean-up requirements could require us to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our business, financial condition or results of operations.
Unexpected equipment failures or other disruptions of our operations may increase our costs and reduce our sales and earnings due to production curtailments or shutdowns.
Interruptions in production capabilities, especially in our Steel segment, would inevitably increase our production costs and reduce sales and earnings for the affected period. In addition to equipment failures, our facilities and information technology systems are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions. Our manufacturing processes are dependent upon critical pieces of equipment, such as furnaces, continuous casters and rolling equipment, as well as electrical equipment, such as transformers, and this equipment may, on occasion, be out of service as a result of unanticipated failures. In the future, we may experience material plant shutdowns or periods of reduced production as a result of these types of equipment failures.
The Company may be subject to risks relating to its information technology systems.
The Company relies on information technology systems to process, transmit and store electronic information and manage and operate its business. A breach in security could expose the Company and its customers and suppliers to risks of misuse of confidential information, manipulation and destruction of data, production downtimes and operations disruptions, which in turn could adversely affect the Company's reputation, competitive position, business or results of operations.
9
The global nature of our business exposes us to foreign currency fluctuations that may affect our asset values, results of operations and competitiveness.
We are exposed to the risks of currency exchange rate fluctuations because a significant portion of our net sales, costs, assets and liabilities, are denominated in currencies other than the U.S. dollar. These risks include a reduction in our asset values, net sales, operating income and competitiveness.
For those countries outside the United States where we have significant sales, devaluation in the local currency would reduce the value of our local inventory as presented in our Consolidated Financial Statements. In addition, a stronger U.S. dollar would result in reduced revenue, operating profit and shareholders' equity due to the impact of foreign exchange translation on our Consolidated Financial Statements. Fluctuations in foreign currency exchange rates may make our products more expensive for others to purchase or increase our operating costs, affecting our competitiveness and our profitability.
Changes in exchange rates between the U.S. dollar and other currencies and volatile economic, political and market conditions in emerging market countries have in the past adversely affected our financial performance and may in the future adversely affect the value of our assets located outside the United States, our gross profit and our results of operations.
Global political instability and other risks of international operations may adversely affect our operating costs, revenues and the price of our products.
Our international operations expose us to risks not present in a purely domestic business, including primarily:
• | changes in tariff regulations, which may make our products more costly to export or import; |
• | difficulties establishing and maintaining relationships with local OEMs, distributors and dealers; |
• | import and export licensing requirements; |
• | compliance with a variety of foreign laws and regulations, including unexpected changes in taxation and environmental or other regulatory requirements, which could increase our operating and other expenses and limit our operations; |
• | disadvantages of competing against companies from countries that are not subject to U.S. laws and regulations, including the Foreign Corrupt Practices Act; |
• | difficulty in staffing and managing geographically diverse operations; and |
• | tax exposures related to cross-border intercompany transfer pricing and other tax risks unique to international operations. |
These and other risks may also increase the relative price of our products compared to those manufactured in other countries, reducing the demand for our products in the markets in which we operate, which could have a material adverse effect on our revenues and earnings.
The underfunded status of our defined benefit and other postretirement plans has caused and may in the future cause a significant reduction in our shareholders' equity.
We recorded a decrease in shareholders' equity related to pension and postretirement benefit liabilities in 2012 primarily due to a decrease in discount rates, partially offset by higher than expected returns on pension and postretirement assets. In the future, we may be required to record additional charges related to pension and other postretirement liabilities as a result of asset returns, discount rate changes or other actuarial adjustments. These charges may be significant and would cause a significant reduction in our shareholders' equity.
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The underfunded status of our pension plans may require large contributions which may divert funds from other uses.
The underfunded status of our pension plans may require us to make large contributions to such plans. We made cash contributions of approximately $326 million, $291 million and $230 million in 2012, 2011 and 2010, respectively, to our defined benefit pension plans and currently expect to make cash contributions of approximately $250 million in 2013 to such plans. However, we cannot predict whether changing economic conditions, the future performance of assets in the plans or other factors will lead us or require us to make contributions in excess of our current expectations, diverting funds we would otherwise apply to other uses.
Our defined benefit plans' assets and liabilities are substantial and expenses and contributions related to those plans are affected by factors outside our control, including the performance of plan assets, interest rates, actuarial data and experience, and changes in laws and regulations.
Our defined benefit pension plans had assets with an estimated value of approximately $3.1 billion and liabilities with an estimated value of approximately $3.5 billion, both as of December 31, 2012. Our future expense and funding obligations for the defined benefit pension plans depend upon a number of factors, including the level of benefits provided for by the plans, the future performance of assets set aside in trusts for these plans, the level of interest rates used to determine the discount rate to calculate the amount of liabilities, actuarial data and experience and any changes in government laws and regulations. In addition, if the various investments held by our pension trusts do not perform as expected or the liabilities increase as a result of discount rates and other actuarial changes, our pension expense and required contributions would increase and, as a result, could materially adversely affect our business. Due to the value of our defined benefit plan assets and liabilities, even a minor decrease in interest rates, to the extent not offset by contributions or asset returns, could increase our obligations under such plans. We may be legally required to make contributions to the pension plans in the future in excess of our current expectations, and those contributions could be material.
Work stoppages or similar difficulties could significantly disrupt our operations, reduce our revenues and materially affect our earnings.
A work stoppage at one or more of our facilities could have a material adverse effect on our business, financial condition and results of operations. Also, if one or more of our customers were to experience a work stoppage, that customer would likely halt or limit purchases of our products, which could have a material adverse effect on our business, financial condition and results of operations.
We are subject to a wide variety of domestic and foreign laws and regulations that could adversely affect our results of operations, cash flow or financial condition.
We are subject to a wide variety of domestic and foreign laws and regulations, and legal compliance risks, including securities laws, tax laws, employment and pension-related laws, competition laws, U.S. and foreign export and trading laws, and laws governing improper business practices. We are affected by new laws and regulations, and changes to existing laws and regulations, including interpretations by courts and regulators.
Compliance with the laws and regulations described above or with other applicable foreign, federal, state, and local laws and regulations currently in effect or that may be adopted in the future could materially adversely affect our competitive position, operating results, financial condition, and liquidity.
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If we are unable to attract and retain key personnel our business could be materially adversely affected.
Our business substantially depends on the continued service of key members of our management. The loss of the services of a significant number of members of our management could have a material adverse effect on our business. Our future success will also depend on our ability to attract and retain highly skilled personnel, such as engineering, finance, marketing and senior management professionals. Competition for these employees is intense, and we could experience difficulty from time to time in hiring and retaining the personnel necessary to support our business. If we do not succeed in retaining our current employees and attracting new high quality employees, our business could be materially adversely affected.
We may not realize the improved operating results that we anticipate from past and future acquisitions and we may experience difficulties in integrating acquired businesses.
We seek to grow, in part, through strategic acquisitions and joint ventures, which are intended to complement or expand our businesses, and expect to continue to do so in the future. These acquisitions involve challenges and risks. In the event that we do not successfully integrate these acquisitions into our existing operations so as to realize the expected return on our investment, our results of operations, cash flow or financial condition could be adversely affected.
Our operating results depend in part on continued successful research, development and marketing of new and/or improved products and services, and there can be no assurance that we will continue to successfully introduce new products and services.
The success of new and improved products and services depends on their initial and continued acceptance by our customers. Our businesses are affected, to varying degrees, by technological change and corresponding shifts in customer demand, which could result in unpredictable product transitions or shortened life cycles. We may experience difficulties or delays in the research, development, production, or marketing of new products and services which may prevent us from recouping or realizing a return on the investments required to bring new products and services to market. The end result could be a negative impact on our operating results.
Item 1B. Unresolved Staff Comments
None.
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Item 2. Properties
Timken has manufacturing facilities at multiple locations in the United States and in a number of countries outside the United States. The aggregate floor area of these facilities worldwide is approximately 14,386,000 square feet, all of which, except for approximately 1,467,000 square feet, is owned in fee. The facilities not owned in fee are leased. The buildings occupied by Timken are principally made of brick, steel, reinforced concrete and concrete block construction. All buildings are in satisfactory operating condition to conduct business.
Timken’s Mobile Industries and Process Industries segments’ manufacturing facilities in the United States are located in Bucyrus, Canton and Niles, Ohio; Hueytown, Alabama; Sante Fe Springs, California; Broomfield and Denver, Colorado; New Castle, Delaware; Ball Ground, Georgia; Carlyle, Fulton and Mokena, Illinois; South Bend, Indiana; Lenexa, Kansas; Randleman and Iron Station, North Carolina; Gaffney, Union and Honea Path, South Carolina; Pulaski and Knoxville, Tennessee; Ogden, Utah; Altavista, Virginia; Ferndale and Pasco, Washington; and Casper, Wyoming. These facilities, including warehouses at plant locations and a technology center in Canton, Ohio that primarily serves the Mobile Industries and Process Industries business segments, have an aggregate floor area of approximately 5,770,000 square feet.
Timken’s Mobile Industries and Process Industries segments’ manufacturing plants outside the United States are located in Benoni, South Africa; Villa Carcina, Italy; Colmar, France; Northampton, England; Ploiesti, Romania; Belo Horizonte, Sao Paulo and Sorocaba, Brazil; Jamshedpur and Chennai, India; Sosnowiec, Poland; Prince George and St. Thomas, Canada; and Wuxi, Xiangtan and Yantai, China. These facilities, including warehouses at plant locations, have an aggregate floor area of approximately 3,849,000 square feet.
Timken’s Aerospace and Defense segment’s manufacturing facilities in the United States are located in Mesa, Arizona; Los Alamitos, California; Manchester, Connecticut; Keene and Lebanon, New Hampshire; New Philadelphia, Ohio; and Rutherfordton, North Carolina. These facilities, including warehouses at plant locations, have an aggregate floor area of approximately 1,017,000 square feet.
Timken’s Aerospace and Defense segment’s manufacturing facilities outside the United States are located in Wolverhampton, England; and Chengdu, China. These facilities, including warehouses at plant locations, have an aggregate floor area of approximately 290,000 square feet.
Timken’s Steel segment’s manufacturing facilities in the United States are located in Canton and Eaton, Ohio; Columbus, North Carolina; and Houston, Texas. These facilities have an aggregate floor area of approximately 3,460,000 square feet. The Steel segment also has a ferrous scrap and recycling operation in Akron, Ohio.
In addition to the manufacturing and distribution facilities discussed above, Timken owns or leases warehouses and steel distribution facilities in the United States, Canada, United Kingdom, France, Mexico, Singapore, Argentina, Australia, Brazil and China.
The plant utilization for the Mobile Industries segment was between approximately 50% and 60% in 2012. The plant utilization for the Process Industries segment was between approximately 60% and 70% in 2012. The plant utilization for the Aerospace and Defense segment was between approximately 60% and 70% in 2012. Finally, the Steel segment plant utilization was between approximately 60% and 70% in 2012. Plant utilization for all of the segments, except Aerospace and Defense, was lower in 2012 than in 2011.
Item 3. Legal Proceedings
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position or results of operations.
Item 4. Mine Safety Disclosures
Not applicable.
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Item 4A. Executive Officers of the Registrant
The executive officers are elected by the Board of Directors normally for a term of one year and until the election of their successors. All executive officers have been employed by Timken or by a subsidiary of the Company during the past five-year period. The executive officers of the Company as of February 13, 2013 (except as otherwise noted below) are as follows:
Name | Age | Current Position and Previous Positions During Last Five Years | ||
Ward J. Timken, Jr. | 45 | 2005 Chairman of the Board | ||
James W. Griffith | 59 | 2002 President and Chief Executive Officer; Director | ||
William R. Burkhart | 47 | 2000 Senior Vice President and General Counsel | ||
Christopher A. Coughlin | 52 | 2008 Senior Vice President—Supply Chain Management | ||
2009 President—Process Industries | ||||
2010 President—Process Industries & Supply Chain | ||||
2011 President—Process Industries | ||||
2012 Group President | ||||
Glenn A. Eisenberg | 51 | 2002 Executive Vice President—Finance and Administration | ||
Richard G. Kyle | 47 | 2008 Vice President—Manufacturing—Mobile Industries | ||
2009 President—Mobile Industries | ||||
2011 President—Mobile Industries & Aerospace | ||||
2012 Group President | ||||
J. Ted Mihaila | 58 | 2006 Senior Vice President and Controller | ||
Salvatore J. Miraglia, Jr. | 62 | 2005 President-Steel Group; retired on December 31, 2012 | ||
Donald L. Walker | 56 | 2004 Senior Vice President—Human Resources and Organizational Advancement | ||
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PART II.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock is traded on the New York Stock Exchange under the symbol “TKR.” The estimated number of record holders of the Company’s common stock at December 31, 2012 was 5,053. The estimated number of beneficial shareholders at December 31, 2012 was 50,783.
The following table provides information about the high and low sales prices for the Company’s common stock and dividends paid for each quarter for the last two fiscal years.
2012 | 2011 | ||||||||||||||||||
Stock prices | Dividends | Stock prices | Dividends | ||||||||||||||||
High | Low | per share | High | Low | per share | ||||||||||||||
First quarter | $ | 54.87 | $ | 38.92 | $ | 0.23 | $ | 52.69 | $ | 44.32 | $ | 0.18 | |||||||
Second quarter | $ | 57.94 | $ | 41.81 | $ | 0.23 | $ | 57.83 | $ | 45.77 | $ | 0.20 | |||||||
Third quarter | $ | 46.49 | $ | 32.59 | $ | 0.23 | $ | 52.86 | $ | 31.16 | $ | 0.20 | |||||||
Fourth quarter | $ | 48.12 | $ | 36.15 | $ | 0.23 | $ | 45.45 | $ | 30.17 | $ | 0.20 | |||||||
Issuer Purchases of Common Stock:
The following table provides information about purchases of its common stock by the Company during the quarter ended December 31, 2012.
Period | Total number of shares purchased (1) | Average price paid per share (2) | Total number of shares purchased as part of publicly announced plans or programs | Maximum number of shares that may yet be purchased under the plans or programs (3) | |||||
10/1/2012 - 10/31/2012 | 872 | $ | 37.88 | — | 7,500,000 | ||||
11/1/2012 - 11/30/2012 | 1,908 | 40.54 | — | 7,500,000 | |||||
12/1/2012 - 12/31/2012 | 3,842 | 46.29 | — | 7,500,000 | |||||
Total | 6,622 | $ | 43.53 | — | 7,500,000 | ||||
(1) | The shares purchased in October, November and December represent common shares of the Company that were owned and tendered by employees to exercise stock options, and to satisfy withholding obligations in connection with the exercise of stock options and vesting of restricted shares. |
(2) | For shares tendered in connection with the vesting of restricted shares, the average price paid per share is an average calculated using the daily high and low of the Company’s common shares as quoted on the New York Stock Exchange at the time of vesting. For shares tendered in connection with the exercise of stock options, the price paid is the real-time trading stock price at the time the options are exercised. |
(3) | On February 10, 2012, the Board of Directors of the Company approved a new share purchase plan pursuant to which the Company may purchase up to ten million of its common shares in the aggregate. This new share purchase plan replaced the Company’s 2006 common share purchase plan and this authorization expires on December 31, 2015. The Company may purchase shares from time to time in open market purchases or privately negotiated transactions. The Company may make all or part of the purchases pursuant to accelerated share repurchases or Rule 10b5-1 plans. |
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Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities (continued)
*Total return assumes reinvestment of dividends. Fiscal years ending December 31.
Assumes $100 invested on January 1, 2008, in Timken Common Stock, the S&P 500 Index, and the S&P 400 Industrials.
2008 | 2009 | 2010 | 2011 | 2012 | |||||||||||
Timken | $ | 61.58 | $ | 76.44 | $ | 156.30 | $ | 129.01 | $ | 162.61 | |||||
S&P 500 | 63.00 | 79.68 | 91.68 | 93.61 | 108.59 | ||||||||||
S&P 400 Industrials | 63.38 | 83.42 | 109.30 | 108.03 | 131.83 | ||||||||||
The line graph compares the cumulative total shareholder returns over five years for The Timken Company, the S&P 500 Stock Index, and the S&P 400 Industrials Index.
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Item 6. Selected Financial Data
Summary of Operations and Other Comparative Data
(Dollars in millions, except per share and per employee data) | 2012 | 2011 | 2010 | 2009 | 2008 | ||||||||||
Statements of Income | |||||||||||||||
Net sales | $ | 4,987.0 | $ | 5,170.2 | $ | 4,055.5 | $ | 3,141.6 | $ | 5,040.8 | |||||
Gross profit | 1,366.3 | 1,369.7 | 1,021.7 | 582.7 | 1,151.9 | ||||||||||
Selling, administrative and general expenses | 643.9 | 626.2 | 563.8 | 472.7 | 657.1 | ||||||||||
Impairment and restructuring charges | 29.5 | 14.4 | 21.7 | 164.1 | 32.8 | ||||||||||
Operating income (loss) | 692.9 | 729.1 | 436.2 | (54.1 | ) | 462.0 | |||||||||
Other income (expense), net | 101.3 | (1.1 | ) | 3.8 | (0.1 | ) | 16.2 | ||||||||
Interest expense, net | (28.2 | ) | 31.2 | 34.5 | 40.0 | 38.6 | |||||||||
Income (loss) from continuing operations | 495.9 | 456.6 | 269.5 | (66.0 | ) | 282.6 | |||||||||
Income (loss) from discontinued operations, net of income taxes | — | — | 7.4 | (72.6 | ) | (11.3 | ) | ||||||||
Net income (loss) attributable to The Timken Company | $ | 495.5 | $ | 454.3 | $ | 274.8 | $ | (134.0 | ) | $ | 267.7 | ||||
Balance Sheets | |||||||||||||||
Inventories, net | $ | 862.1 | $ | 964.4 | $ | 828.5 | $ | 671.2 | $ | 1,000.5 | |||||
Property, plant and equipment—net | 1,405.3 | 1,308.9 | 1,267.7 | 1,335.2 | 1,517.0 | ||||||||||
Total assets | 4,244.7 | 4,327.4 | 4,180.4 | 4,006.9 | 4,536.0 | ||||||||||
Total debt: | |||||||||||||||
Short-term debt | 14.3 | 22.0 | 22.4 | 26.3 | 91.5 | ||||||||||
Current portion of long-term debt | 9.6 | 14.3 | 9.6 | 17.1 | 17.1 | ||||||||||
Long-term debt | 455.1 | 478.8 | 481.7 | 469.3 | 515.3 | ||||||||||
Total debt | $ | 479.0 | $ | 515.1 | $ | 513.7 | $ | 512.7 | $ | 623.9 | |||||
Net (cash) debt | |||||||||||||||
Total debt | 479.0 | 515.1 | 513.7 | 512.7 | 623.9 | ||||||||||
Less: cash and cash equivalents and restricted cash | (586.4 | ) | (468.4 | ) | (877.1 | ) | (755.5 | ) | (133.4 | ) | |||||
Net (cash) debt: (1) | $ | (107.4 | ) | $ | 46.7 | $ | (363.4 | ) | $ | (242.8 | ) | $ | 490.5 | ||
Total liabilities | 1,998.1 | 2,284.9 | 2,238.6 | 2,411.3 | 2,873.0 | ||||||||||
Shareholders’ equity | $ | 2,246.6 | $ | 2,042.5 | $ | 1,941.8 | $ | 1,595.6 | $ | 1,663.0 | |||||
Capital: | |||||||||||||||
Net (cash) debt | (107.4 | ) | 46.7 | (363.4 | ) | (242.8 | ) | 490.5 | |||||||
Shareholders’ equity | 2,246.6 | 2,042.5 | 1,941.8 | 1,595.6 | 1,663.0 | ||||||||||
Net (cash) debt + shareholders’ equity (capital) | $ | 2,139.2 | $ | 2,089.2 | $ | 1,578.4 | $ | 1,352.8 | $ | 2,153.5 | |||||
Other Comparative Data | |||||||||||||||
Income (loss) from continuing operations / Net sales | 9.9 | % | 8.8 | % | 6.6 | % | (2.1 | )% | 5.6 | % | |||||
Net income (loss) attributable to The Timken Company / Net sales | 9.9 | % | 8.8 | % | 6.8 | % | (4.3 | )% | 5.3 | % | |||||
Return on equity (2) | 22.1 | % | 22.4 | % | 13.9 | % | (4.1 | )% | 17.0 | % | |||||
Net sales per employee (3) | $ | 243.5 | $ | 253.5 | $ | 222.2 | $ | 168.8 | $ | 244.3 | |||||
Capital expenditures | 297.2 | 205.3 | 115.8 | 114.1 | 258.1 | ||||||||||
Depreciation and amortization | 198.0 | 192.5 | 189.7 | 201.5 | 200.8 | ||||||||||
Capital expenditures / Net sales | 6.0 | % | 4.0 | % | 2.9 | % | 3.6 | % | 5.1 | % | |||||
Dividends per share | $ | 0.92 | $ | 0.78 | $ | 0.53 | $ | 0.45 | $ | 0.70 | |||||
Basic earnings (loss) per share - continuing operations (4) | $ | 5.11 | $ | 4.65 | $ | 2.76 | $ | (0.64 | ) | $ | 2.90 | ||||
Diluted earnings (loss) per share - continuing operations (4) | $ | 5.07 | $ | 4.59 | $ | 2.73 | $ | (0.64 | ) | $ | 2.89 | ||||
Basic earnings (loss) per share (5) | $ | 5.11 | $ | 4.65 | $ | 2.83 | $ | (1.39 | ) | $ | 2.78 | ||||
Diluted earnings (loss) per share (5) | $ | 5.07 | $ | 4.59 | $ | 2.81 | $ | (1.39 | ) | $ | 2.77 | ||||
Net debt to capital (1) | (5.0 | )% | 2.2 | % | (23.0 | )% | (17.9 | )% | 22.8 | % | |||||
Number of employees at year-end (6) | 19,769 | 20,954 | 19,839 | 16,667 | 20,550 | ||||||||||
Number of shareholders (7) | 50,783 | 44,238 | 39,118 | 27,127 | 47,742 | ||||||||||
(1) | The Company presents net debt because it believes net debt is more representative of the Company’s financial position than total debt due to the amount of cash and cash equivalents. |
(2) | Return on equity is defined as income from continuing operations divided by ending shareholders’ equity. |
(3) | Based on average number of employees employed during the year. |
(4) | Based on average number of shares outstanding during the year. |
(5) | Based on average number of shares outstanding during the year and includes discontinued operations for all periods presented. |
(6) | Adjusted to exclude NRB operations for all periods. |
(7) | Includes an estimated count of shareholders having common stock held for their accounts by banks, brokers and trustees for benefit plans. |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Dollars in millions, except per share data)
OVERVIEW
The Timken Company, a global industrial technology leader, applies its deep knowledge of materials, friction management and mechanical power transmission to improve the reliability and efficiency of industrial machinery and equipment all around the world. The Company engineers, manufactures and markets high-performance mechanical components and engineered steel. Timken® bearings, alloy steel bars and tubes as well as transmissions, gearboxes, chain, and related products and services, support diversified markets worldwide through the original equipment manufacturers and aftermarket channels. The Company operates under four segments: (1) Mobile Industries; (2) Process Industries; (3) Aerospace and Defense; and (4) Steel. The following further describes these business segments:
• | Mobile Industries provides bearings, power transmission components, engineered chain, augers and related products and services to original equipment manufacturers and suppliers of agricultural, construction and mining equipment; passenger cars, light trucks, medium- and heavy-duty trucks; rail cars and locomotives; as well as to the aftermarket through its automotive and heavy truck distributors. |
• | Process Industries supplies bearings, power transmission components, engineered chains, and related products and services to original equipment manufacturers and suppliers of power transmission, energy and heavy industrial machinery and equipment. This includes rolling mills, cement and aggregate processing equipment, paper mills, sawmills, printing presses, cranes, hoists, drawbridges, wind energy turbines, gear drives, drilling equipment, coal conveyors, coal crushers, marine equipment and food processing equipment. This segment also serves the aftermarket through its global network of authorized industrial distributors. |
• | Aerospace and Defense provides bearings, helicopter transmission systems, rotor head assemblies, turbine engine components, gears and other precision flight-critical components for commercial and military aviation applications. It also provides aftermarket services, including repair and overhaul of engines, transmissions and fuel controls, as well as aerospace bearing repair and component reconditioning. Additionally, this segment manufactures precision bearings, complex assemblies and sensors for manufacturers of health and critical motion control equipment. |
• | Steel produces more than 450 grades of high-performance carbon and alloy steel, sold as ingots, bars and tubes in a variety of chemistries, lengths and finishes. The segment's metallurgical expertise and unique operational capabilities drive customized solutions for the mobile, industrial and energy sectors, sold directly to original equipment manufacturers or through its authorized steel distributors. Timken® specialty steels feature prominently in a wide variety of end products including: oil country drill pipe, bits and collars; gears, hubs, axles, crankshafts and connecting rods; bearing races and rolling elements; and bushings, fuel injectors and wind energy shafts. |
The Company's strategy balances corporate aspirations for sustained growth and a determination to optimize the Company's existing portfolio of business, thereby generating strong earnings and cash flows. The Company pursues its strategy to create value by:
• | Applying its knowledge of metallurgy, friction management and mechanical power transmission to create unique solutions used in demanding applications that create value for its customers. The Company seeks to grow in attractive market sectors, with particular emphasis on those industrial markets that value the reliability and efficiency offered by the Company's products and that create significant aftermarket demand, thereby providing a lifetime of opportunity in both product sales and services. |
• | Differentiating its businesses and its products, offering a broad array of mechanical power transmission components, high-performance steel and related solutions and services. This year the Company extended the Timken® spherical bearing and housed unit bearing lines and developed new crankshaft steels as well as incorporated Drives® chain and Philadelphia Gear® repair services into its offerings. |
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• | Expanding its reach, extending its knowledge, products, services and channels to meet customer needs wherever they are in the world. The Company continues to expand its presence in new geographic spaces with an emphasis in Asia and other emerging markets including Russia, where it opened two new offices in 2012. |
• | Performing with excellence, delivering exceptional results with a passion for superior execution. The Company drives execution by embracing a continuous improvement culture that is charged with lowering costs, eliminating waste, increasing efficiency, encouraging organizational agility and building greater brand equity. As part of this effort, the Company may also reposition underperforming product lines and segments and divest non-strategic assets. |
The following items highlight certain of the Company's more significant strategic accomplishments in 2012:
• | In December 2012, the Company completed the acquisition of the assets of Wazee Companies, LLC (Wazee) for $20.1 million. Wazee is a regional leader providing motor, generator, and uptower wind services to diverse end markets including oil and gas, wind, agriculture, material handling and construction. Based in Denver, Colorado, Wazee employs over 100 people and had sales of approximately $30 million in 2012. Wazee results will be included in the Process Industries segment. |
• | In 2012, the Company continued to advance planned investments to bring its intermediate steel tube finishing line on-stream and start up its in-line forge press to produce new large-diameter sound-center bars. These two investments reinforce the Company's position of offering the broadest special bar quality (SBQ) steel capabilities in North America. |
• | In May 2012, the Company announced that it will close its plant in St. Thomas, Ontario, Canada (St. Thomas) in approximately one year and consolidate bearing production within its existing U.S. operations to better align the Company's manufacturing footprint and customer base. The Company will also move customer service for the Canadian market to its offices in Toronto. Production is expected to be transferred to the Company's operations in Ohio, North Carolina and South Carolina by mid-2013. |
• | In April 2012, the Company broke ground on a $225 million expansion for a new vertical continuous caster at its Faircrest Steel Plant in Canton, Ohio, after securing a new five-year basic labor agreement with members of the United Steelworkers of America, which will provide large bar capabilities unique in America. |
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RESULTS OF OPERATIONS
2012 compared to 2011
Overview:
2012 | 2011 | $ Change | % Change | ||||||||
Net sales | $ | 4,987.0 | $ | 5,170.2 | $ | (183.2 | ) | (3.5 | )% | ||
Income from continuing operations | 495.9 | 456.6 | 39.3 | 8.6 | % | ||||||
Income attributable to noncontrolling interest | 0.4 | 2.3 | (1.9 | ) | (82.6 | )% | |||||
Net income attributable to The Timken Company | $ | 495.5 | $ | 454.3 | $ | 41.2 | 9.1 | % | |||
Diluted earnings per share | $ | 5.07 | $ | 4.59 | $ | — | 10.5 | % | |||
Average number of shares—diluted | 97,602,481 | 98,655,513 | — | (1.1 | )% | ||||||
The Company reported net sales for 2012 of $5.0 billion, compared to $5.2 billion in 2011, a 3.5% decrease. The decrease in sales was primarily due to lower volume across all business segments except for the Aerospace and Defense segment, lower surcharges and the effect of currency rate changes, partially offset by favorable pricing and the impact of acquisitions. In 2012, net income per diluted share was $5.07, compared to $4.59 in 2011. The Company's earnings for 2012 reflect Continued Dumping and Subsidy Offset Act (CDSOA) receipts, net of expense, of $108.0 million ($68.0 million after tax, or approximately $0.69 per diluted share), as well as favorable pricing, lower material costs and the impact of prior-year acquisitions, partially offset by lower material surcharges, lower volume, higher manufacturing costs and restructuring charges related to the announced closure of the manufacturing facility in St. Thomas. The higher manufacturing costs were the result of lower plant utilization.
Outlook:
The Company expects sales to be down approximately 5% in 2013 compared to 2012, primarily driven by lower volume in the Mobile Industries and Steel segments, as well as lower surcharges, partially offset by increased volume in the Aerospace and Defense segment. The Company's earnings are expected to be lower in 2013 compared to 2012, primarily due to lower CDSOA receipts, surcharges and volume and higher manufacturing costs, partially offset by lower material costs.
From a liquidity standpoint, the Company expects to generate cash from operations of approximately $330 million, which is a 50% decrease from 2012, as the Company anticipates lower net income and higher cash used for working capital items, partially offset by lower pension and postretirement contributions. Pension and postretirement contributions are expected to be approximately $300 million in 2013, compared to $376 million in 2012. The Company expects to increase capital expenditures to approximately $360 million in 2013, compared to $300 million in 2012.
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THE STATEMENTS OF INCOME
Sales by Segment:
2012 | 2011 | $ Change | % Change | ||||||||
(Excludes intersegment sales) | |||||||||||
Mobile Industries | $ | 1,675.0 | $ | 1,768.9 | $ | (93.9 | ) | (5.3 | )% | ||
Process Industries | 1,337.6 | 1,240.5 | 97.1 | 7.8 | % | ||||||
Aerospace and Defense | 346.9 | 324.1 | 22.8 | 7.0 | % | ||||||
Steel | 1,627.5 | 1,836.7 | (209.2 | ) | (11.4 | )% | |||||
Total Company | $ | 4,987.0 | $ | 5,170.2 | $ | (183.2 | ) | (3.5 | )% | ||
Net sales for 2012 decreased $183.2 million, or 3.5%, compared to 2011, primarily due to lower volume of approximately $325 million principally driven by the Steel segment and the Mobile Industries’ heavy truck and light vehicle market sectors. In addition, the decrease in sales reflects lower surcharges of approximately $155 million and the effect of currency rate changes of approximately $75 million, partially offset by favorable pricing of $195 million, the impact of prior-year acquisitions of $160 million and favorable sales mix of $10 million.
Gross Profit:
2012 | 2011 | $ Change | % Change | ||||||||
Gross profit | $ | 1,366.3 | $ | 1,369.7 | $ | (3.4 | ) | (0.2 | %) | ||
Gross profit % to net sales | 27.4 | % | 26.5 | % | — | — | |||||
Rationalization expenses included in cost of products sold | $ | 8.3 | $ | 6.7 | $ | 1.6 | 23.9 | % | |||
Gross profit decreased in 2012 compared to 2011, primarily due to lower surcharges of approximately $160 million, lower sales volume of approximately $150 million and higher manufacturing costs of approximately of $75 million, mostly offset by favorable pricing of approximately $190 million, lower raw material and logistics costs of approximately $155 million and the impact from prior-year acquisitions of approximately $40 million.
Selling, General and Administrative Expenses:
2012 | 2011 | $ Change | % Change | ||||||||
Selling, general and administrative expenses | $ | 643.9 | $ | 626.2 | $ | 17.7 | 2.8% | ||||
Selling, general and administrative expenses % to net sales | 12.9 | % | 12.1 | % | — | 80 | bps | ||||
The increase in selling, general and administrative expenses of $17.7 million in 2012 compared to 2011 was primarily due to the full-year impact of acquisitions of approximately $15 million and higher salaries and related benefits of approximately $15 million, partially offset by lower expense related to incentive compensation plans of approximately $15 million.
21
Impairment and Restructuring Charges:
2012 | 2011 | $ Change | |||||||
Impairment charges | $ | 6.6 | $ | 0.5 | $ | 6.1 | |||
Severance and related benefit costs | 18.4 | 0.1 | 18.3 | ||||||
Exit costs | 4.5 | 13.8 | (9.3 | ) | |||||
Total | $ | 29.5 | $ | 14.4 | $ | 15.1 | |||
Impairment and restructuring charges increased $15.1 million in 2012 compared to 2011. Impairment and restructuring charges of $29.5 million in 2012 were primarily due to the recognition of severance and related benefits, including $10.7 million of pension curtailment charges, as well as impairment charges, related to the announced closure of the manufacturing facility in St. Thomas and the recognition of environmental remediation costs at the former manufacturing facility in Sao Paulo, Brazil (Sao Paulo). Impairment and restructuring charges of $14.4 million in 2011 were primarily related to environmental remediation costs and workers compensation claims by former associates at the former manufacturing facility in Sao Paulo. Refer to Note 10 – Impairment and Restructuring in the Notes to the Consolidated Financial Statements for additional discussion.
In November 2010, the Company entered into an agreement to sell the real estate of its former manufacturing facility in Sao Paulo. The transfer of this land is expected to be completed as early as 2013 after the Company has completed the soil remediation of the site and the groundwater remediation plan has been approved. Based on the terms of the agreement, once the title transfers, the Company expects to receive approximately $30 million, including interest, subject to fluctuations in foreign currency exchange rates, over an 18-month period.
Interest Expense and Income:
2012 | 2011 | $ Change | % Change | ||||||||
Interest expense | $ | (31.1 | ) | $ | (36.8 | ) | $ | 5.7 | (15.5 | )% | |
Interest income | $ | 2.9 | $ | 5.6 | $ | (2.7 | ) | (48.2 | )% | ||
Interest expense for 2012 decreased compared to 2011 primarily due to lower average debt and higher capitalized interest. Interest income decreased for 2012 compared to 2011 primarily due to lower invested cash balances.
Other (Expense) Income:
2012 | 2011 | $ Change | % Change | |||||||
CDSOA receipts (expense), net | $ | 108.0 | $ | (1.1 | ) | $ | 109.1 | NM | ||
Other (expense), net | $ | (6.7 | ) | $ | — | $ | (6.7 | ) | NM | |
CDSOA receipts are reported net of applicable expenses. The CDSOA provides for distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic producers where the domestic producers have continued to invest in their technology, equipment and people. The Company reported CDSOA receipts, net of expense, of $108.0 million in 2012. In 2012, the Company reported expenses in excess of CDSOA receipts of $1.1 million. Refer to Note 19 - Continued Dumping and Subsidy Offset Act in the Notes to the Consolidated Financial Statements for additional information.
Other (expense), net increased in 2012 compared to 2011 primarily due to higher foreign currency exchange losses and higher losses from the disposal of fixed assets. Other (expense), net for 2012 also includes the loss on the divestiture of Advanced Green Components (AGC) of $2.0 million.
22
Income Tax Expense:
2012 | 2011 | $ Change | Change | ||||||||
Income tax expense | $ | 270.1 | $ | 240.2 | $ | 29.9 | 12.4% | ||||
Effective tax rate | 35.3 | % | 34.5 | % | — | 80 | bps | ||||
The effective tax rate on pretax income for 2012 was unfavorable relative to the U.S. federal statutory rate primarily due to losses at certain foreign subsidiaries where no tax benefit could be recorded, including restructuring charges related to the closure of the Company's manufacturing facility in St. Thomas, U.S. state and local taxes, and U.S. taxation of foreign income. These factors were partially offset by earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, U.S. foreign tax credits, the U.S. manufacturing deduction and certain discrete U.S. tax benefits.
The effective tax rate for 2011 was favorable relative to the U.S. federal statutory rate primarily due to earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, the U.S. manufacturing deduction, the U.S. research tax credit and the net effect of other U.S. tax items, partially offset by losses at certain foreign subsidiaries where no tax benefit could be recorded, U.S. state and local taxes and the net effect of other discrete items.
The change in the effective tax rate in 2012 compared to 2011 was primarily due to losses at certain foreign subsidiaries where no tax benefit could be recorded, including restructuring charges related to the closure of the Company's manufacturing facility in St. Thomas, and higher U.S. state and local taxes, partially offset by U.S. foreign tax credits, and the net effect of other discrete items.
23
BUSINESS SEGMENTS
Management measures the financial performance of each segment using earnings before interest and taxes (EBIT). As of January 1, 2012, the Company modified the way in which certain selling, general and administrative (SG&A) expenses are allocated among segments to better reflect the use of shared resources by the segment. Segment results for 2011 have been revised to be consistent with the new allocations. Refer to Note 14 - Segment Information in the Notes to the Consolidated Financial Statements for the reconciliation of EBIT by segment to consolidated income before income taxes.
The presentation of segment results below includes a reconciliation of the changes in net sales for each segment reported in accordance with U.S. GAAP to net sales adjusted to remove the effects of acquisitions made in 2011 and currency exchange rates. The effects of acquisitions and currency exchange rates on net sales are removed to allow investors and the Company to meaningfully evaluate the percentage change in net sales on a comparable basis from period to period. During the third quarter of 2011, the Company completed the acquisition of substantially all of the assets of Gears and Services. Gears and Services is part of the Process Industries segment. During the fourth quarter of 2011, the Company completed the acquisition of Drives. Results for Drives are reported in the Mobile and Process Industries segments based on customer application. The acquisition of the assets of Wazee, which was completed on December 31, 2012, had no impact on the 2012 operating results.
Mobile Industries Segment:
2012 | 2011 | $ Change | Change | ||||||||
Net sales, including intersegment sales | $ | 1,675.5 | $ | 1,769.4 | $ | (93.9 | ) | (5.3)% | |||
EBIT | $ | 208.1 | $ | 261.8 | $ | (53.7 | ) | (20.5)% | |||
EBIT margin | 12.4 | % | 14.8 | % | — | (240) bps | |||||
2012 | 2011 | $ Change | % Change | ||||||||
Net sales, including intersegment sales | $ | 1,675.5 | $ | 1,769.4 | $ | (93.9 | ) | (5.3)% | |||
Less: Acquisitions | 65.4 | — | 65.4 | NM | |||||||
Currency | (53.5 | ) | — | (53.5 | ) | NM | |||||
Net sales, excluding the impact of acquisitions and currency | $ | 1,663.6 | $ | 1,769.4 | $ | (105.8 | ) | (6.0)% | |||
The Mobile Industries segment’s net sales, excluding the effects of acquisitions and currency-rate changes, decreased 6.0% in 2012 compared to 2011, primarily due to lower volume of approximately $120 million, partially offset by favorable pricing of $15 million and higher surcharges of $5 million. The lower volume was led by a decrease in light-vehicle volume of approximately 20%, driven by exited business, and a decrease in heavy truck volume of approximately 20%, partially offset by an increase in rail volume of approximately 20%. EBIT decreased in 2012 compared to 2011, primarily due to lower volume of approximately $45 million, restructuring costs of approximately $30 million due to the closure of the St. Thomas plant and higher manufacturing and material costs of approximately $25 million, partially offset by favorable pricing of approximately $15 million, lower logistics costs of approximately $15 million and higher surcharges of approximately $5 million.
Sales for the Mobile Industries segment are expected to decrease by 5% to 10% in 2013 compared to 2012. The expected decrease is primarily due to lower volume across all markets except the automotive aftermarket, led by a decrease in light-vehicle volume of approximately 15% driven by the Company's market strategy and a decrease in heavy truck volume of approximately 10%. EBIT for the Mobile Industries segment is expected to decline in 2013 compared to 2012 as a result of lower volume and higher manufacturing costs, partially offset by lower restructuring costs.
24
Process Industries Segment:
2012 | 2011 | $ Change | Change | ||||||||
Net sales, including intersegment sales | $ | 1,343.3 | $ | 1,244.6 | $ | 98.7 | 7.9% | ||||
EBIT | $ | 274.9 | $ | 274.2 | $ | 0.7 | 0.3% | ||||
EBIT margin | 20.5 | % | 22.0 | % | — | (150 | ) bps | ||||
2012 | 2011 | $ Change | % Change | ||||||||
Net sales, including intersegment sales | $ | 1,343.3 | $ | 1,244.6 | $ | 98.7 | 7.9% | ||||
Less: Acquisitions | 94.2 | — | 94.2 | NM | |||||||
Currency | (21.4 | ) | — | (21.4 | ) | NM | |||||
Net sales, excluding the impact of acquisitions and currency | $ | 1,270.5 | $ | 1,244.6 | $ | 25.9 | 2.1% | ||||
The Process Industries segment’s net sales, excluding the effect of acquisitions and currency-rate changes, increased 2.1% for 2012 compared to 2011, primarily due to favorable pricing of approximately $25 million. EBIT in 2012 was comparable to 2011 due to favorable pricing of $25 million and the impact of prior-year acquisitions of $15 million, mostly offset by higher manufacturing costs of approximately $20 million, the negative impact of currency of approximately $10 million and the impact of unfavorable sales mix of approximately $5 million.
Sales for the Process Industries segment are expected to be relatively flat in 2013 compared to 2012 as a result of a slight increase in sales to industrial distributors, offset by lower volume across most other market sectors. EBIT for the Process Industries segment is expected to increase slightly in 2013 compared to 2012.
Aerospace and Defense Segment:
2012 | 2011 | $ Change | Change | ||||||||
Net sales, including intersegment sales | $ | 346.9 | $ | 324.1 | $ | 22.8 | 7.0% | ||||
EBIT | $ | 36.3 | $ | 5.1 | $ | 31.2 | NM | ||||
EBIT margin | 10.5 | % | 1.6 | % | — | 890 | bps | ||||
2012 | 2011 | $ Change | % Change | ||||||||
Net sales, including intersegment sales | $ | 346.9 | $ | 324.1 | $ | 22.8 | 7.0% | ||||
Less: Currency | (1.1 | ) | — | (1.1 | ) | NM | |||||
Net sales, excluding the impact of currency | $ | 348.0 | $ | 324.1 | $ | 23.9 | 7.4% | ||||
The Aerospace and Defense segment’s net sales, excluding the effect of currency-rate changes, increased 7.4% for 2012 compared to 2011. The increase was due to higher volume of approximately $20 million and favorable pricing of approximately $5 million. The increase in volume was driven by an increase in the critical motion market sector of approximately 15% and the defense market sector of approximately 10%. EBIT increased in 2012 compared to 2011, primarily due to the impact of higher volume of approximately $10 million, favorable pricing of approximately $5 million, lower manufacturing costs of approximately $5 million and lower selling, general and administrative costs of approximately $5 million. The lower manufacturing costs were due to lower product warranty charges of approximately $4 million in 2012 compared to 2011, and an inventory write-down of approximately $3 million recognized in 2011.
Sales for the Aerospace and Defense segment are expected to increase by approximately 7% to 12% in 2013 compared to 2012, due to higher volume across all market sectors led by an increase in defense volume of approximately 14%, an increase in general aviation volume of approximately 8% and an increase in critical motion volume of approximately 7%. EBIT for the Aerospace and Defense segment is expected to increase significantly in 2013 compared to 2012 as a result of higher volumes and lower selling, general and administrative expenses.
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Steel Segment:
2012 | 2011 | $ Change | Change | ||||||||
Net sales, including intersegment sales | $ | 1,728.7 | $ | 1,956.5 | $ | (227.8 | ) | (11.6)% | |||
EBIT | $ | 251.8 | $ | 267.4 | $ | (15.6 | ) | (5.8)% | |||
EBIT margin | 14.6 | % | 13.7 | % | — | 90 | bps | ||||
2012 | 2011 | $ Change | % Change | ||||||||
Net sales, including intersegment sales | $ | 1,728.7 | $ | 1,956.5 | $ | (227.8 | ) | (11.6)% | |||
Less: Currency | (1.0 | ) | — | (1.0 | ) | NM | |||||
Net sales, excluding the impact of acquisitions and currency | $ | 1,729.7 | $ | 1,956.5 | $ | (226.8 | ) | (11.6)% | |||
The Steel segment’s net sales for 2012, excluding the effects of acquisitions and currency-rate changes, decreased 11.6% compared to 2011. The decrease was primarily due to lower volume of approximately $220 million and lower surcharges of approximately $165 million, partially offset by higher pricing and favorable sales mix of approximately $155 million. The lower volume was led by a decrease in industrial demand of approximately 25%, a decrease in oil and gas demand of approximately 15% and a decrease in mobile demand of approximately 5%.
Surcharges decreased to $416 million in 2012 from $581 million in 2011. Approximately 60% of the decrease in surcharges was a result of lower volumes. The remaining portion was a result of lower market prices for certain input raw materials, especially scrap steel, nickel and molybdenum. Surcharges are a pricing mechanism that the Company uses to recover scrap steel, energy and certain alloy costs, which are derived from published monthly indices.
Amounts are shown in whole values | 2012 | 2011 | Change | % Change | |||||||
Scrap index per ton | $ | 429 | $ | 485 | $ | (56 | ) | (11.5)% | |||
Shipments (in tons) | 1,070,000 | 1,286,000 | (216,000 | ) | (16.8)% | ||||||
Average selling price per ton, including surcharges | $ | 1,615 | $ | 1,522 | $ | 93 | 6.1% | ||||
The increase in the average selling price was primarily the result of higher pricing, partially offset by lower surcharges.
The Steel segment’s EBIT decreased $15.6 million in 2012 compared to 2011, primarily due to lower surcharges of approximately $165 million, lower volume of approximately $100 million and higher manufacturing costs of approximately $55 million, partially offset by favorable pricing of approximately $140 million, lower raw material costs of approximately $140 million and lower LIFO expense of approximately $30 million. In 2012, the Steel segment recognized LIFO income of $15.6 million, compared to LIFO expense of $15.2 million in 2011. The change in LIFO was due to lower inventory levels and the mix of inventory. Raw material costs consumed in the manufacturing process, including scrap steel, alloys and energy, decreased 8% in 2012 compared to the prior year to an average cost of $510 per ton.
Sales for the Steel segment are expected to decrease 7% to 12% for 2013 compared to 2012, primarily due to lower surcharges and lower volume. The Company expects lower volume to be driven by a decrease in oil and gas demand of approximately 15% and a decrease in industrial demand of approximately 5%, partially offset by an increase in mobile demand of approximately 5%. EBIT for the Steel segment is expected to decrease in 2013 compared to 2012 driven by lower surcharges, lower volume and higher manufacturing costs, partially offset by lower raw material costs. Scrap, alloy and energy costs are expected to decrease in the near term from current levels.
Corporate:
2012 | 2011 | $ Change | Change | ||||||||
Corporate expenses | $ | 84.4 | $ | 80.8 | $ | 3.6 | 4.5 % | ||||
Corporate expenses % to net sales | 1.7 | % | 1.6 | % | — | 10 | bps | ||||
Corporate expenses increased in 2012 compared to 2011, primarily due to higher salaries and related benefits of $5 million and higher professional fees of $4 million, partially offset by lower expense related to incentive compensation plans of $4 million.
26
RESULTS OF OPERATIONS:
2011 compared to 2010
Overview:
2011 | 2010 | $ Change | % Change | ||||||||
Net sales | $ | 5,170.2 | $ | 4,055.5 | $ | 1,114.7 | 27.5 | % | |||
Income from continuing operations | 456.6 | 269.5 | 187.1 | 69.4 | % | ||||||
Income from discontinued operations | — | 7.4 | (7.4 | ) | NM | ||||||
Income attributable to noncontrolling interest | 2.3 | 2.1 | 0.2 | 9.5 | % | ||||||
Net income attributable to The Timken Company | $ | 454.3 | $ | 274.8 | $ | 179.5 | 65.3 | % | |||
Diluted earnings per share: | |||||||||||
Continuing operations | $ | 4.59 | $ | 2.73 | $ | 1.86 | 68.1 | % | |||
Discontinued operations | — | 0.08 | (0.08 | ) | NM | ||||||
Diluted earnings per share | $ | 4.59 | $ | 2.81 | $ | 1.78 | 63.3 | % | |||
Average number of shares - diluted | 98,655,513 | 97,516,202 | — | 1.4 | % | ||||||
The Company reported net sales for 2011 of $5.2 billion, compared to $4.1 billion in 2010, a 27.5% increase. Sales in 2011 were higher across all business segments except for the Aerospace and Defense segment. The increase in sales was primarily driven by strong demand from the Mobile Industries and Steel segments and the industrial distribution channel within the Process Industries segment, as well as higher surcharges, partially offset by lower sales in the Aerospace and Defense segment. For 2011, diluted earnings per share were $4.59, compared to $2.81 for 2010. Income from continuing operations per diluted share was $4.59 for 2011, compared to $2.73 for 2010.
The Company’s results for 2011 reflected the improvement of the end-market sectors served principally by the Mobile Industries and Steel segments, higher surcharges, improved manufacturing performance, lower restructuring costs and the favorable impact of prior-year restructuring initiatives, partially offset by lower demand from aerospace and defense customers, higher raw material costs and related LIFO expense and higher expense related to incentive compensation plans.
The income from discontinued operations recognized in 2010 was the result of favorable working capital adjustments from the sale of the Company’s Needle Roller Bearings (NRB) operations, completed in December 2009.
THE STATEMENTS OF INCOME
Sales by Segment:
2011 | 2010 | $ Change | % Change | ||||||||
(Excludes intersegment sales) | |||||||||||
Mobile Industries | $ | 1,768.9 | $ | 1,560.3 | $ | 208.6 | 13.4 | % | |||
Process Industries | 1,240.5 | 900.0 | 340.5 | 37.8 | % | ||||||
Aerospace and Defense | 324.1 | 338.3 | (14.2 | ) | (4.2 | )% | |||||
Steel | 1,836.7 | 1,256.9 | 579.8 | 46.1 | % | ||||||
Total Company | $ | 5,170.2 | $ | 4,055.5 | $ | 1,114.7 | 27.5 | % | |||
Net sales for 2011 increased $1.1 billion, or 27.5%, compared to 2010, primarily due to higher volume of approximately $530 million principally driven by the Mobile Industries’ off-highway and rail market sectors, increases in demand for Process Industries’ distribution channel and the Steel segment’s industrial and oil and gas market sectors. In addition, the increase in sales reflected higher surcharges of approximately $225 million, higher pricing and favorable sales mix of approximately $185 million, the impact of acquisitions of approximately $120 million and the effect of currency rate changes of approximately $55 million. The favorable impact from acquisitions for 2011 was primarily due to the acquisitions of Gears and Services, in July 2011, and Drives, in October 2011, as well as the acquisition of QM Bearings and Power Transmission, Inc. (QM Bearings), completed in September 2010.
27
Gross Profit:
2011 | 2010 | $ Change | Change | ||||||||
Gross profit | $ | 1,369.7 | $ | 1,021.7 | $ | 348.0 | 34.1 % | ||||
Gross profit % to net sales | 26.5 | % | 25.2 | % | — | 130 | bps | ||||
Rationalization expenses included in cost of products sold | $ | 6.7 | $ | 5.5 | $ | 1.2 | 21.8 % | ||||
Gross profit increased in 2011 compared to 2010, primarily due to the impact of higher sales volume of approximately $230 million, higher surcharges of approximately $225 million and the impact of pricing and sales mix of approximately $180 million, partially offset by higher raw material costs of approximately $295 million and higher logistics costs of approximately $40 million. Gross profit in 2011 also benefited by $40 million from the impact of acquisitions.
Selling, General and Administrative Expenses:
2011 | 2010 | $ Change | Change | ||||||||
Selling, general and administrative expenses | $ | 626.2 | $ | 563.8 | $ | 62.4 | 19.3 % | ||||
Selling, general and administrative expenses % to net sales | 12.1 | % | 13.9 | % | — | (180 | ) bps | ||||
The increase in selling, general and administrative expenses of $62.4 million in 2011 compared to 2010 was primarily due to higher salaries and related costs to support higher sales volume, as well as higher expense related to incentive compensation plans of approximately $15 million. Selling, general and administrative expenses for 2010 benefited from a favorable adjustment to the allowance for doubtful accounts of approximately $10 million. In addition, the acquisitions of Gears and Services and Drives added approximately $15 million of selling, general and administrative expenses for 2011. Selling, general and administrative expenses, as a percentage of sales, decreased in 2011 compared to 2010 as a result of the Company’s ability to effectively leverage these costs against higher sales.
Impairment and Restructuring Charges:
2011 | 2010 | $ Change | |||||||
Impairment charges | $ | 0.5 | $ | 4.7 | $ | (4.2 | ) | ||
Severance and related benefit costs | 0.1 | 6.4 | (6.3 | ) | |||||
Exit costs | 13.8 | 10.6 | 3.2 | ||||||
Total | $ | 14.4 | $ | 21.7 | $ | (7.3 | ) | ||
Impairment and restructuring charges decreased $7.3 million in 2011 compared to 2010. In 2011, the Company recognized $13.8 million of exit costs, which primarily related to environmental remediation costs and workers compensation claims made by former associates at its former manufacturing facility in Sao Paulo. In 2010, the impairment charges of $4.7 million primarily related to fixed asset impairment charges at the Company’s facility in Mesa, Arizona and its former manufacturing facility in Sao Paulo. The severance and related benefit costs of $6.4 million recognized in 2010 primarily related to manufacturing workforce reductions that began in 2009 to realign the Company’s organization, improve efficiency and reduce costs. The exit costs of $10.6 million recognized in 2010 primarily related to environmental remediation costs at the Company’s former manufacturing facility in Sao Paulo and a former manufacturing plant in Columbus, Ohio. Refer to Note 10 – Impairment and Restructuring in the Notes to the Consolidated Financial Statements for additional discussion.
28
Interest Expense and Income:
2011 | 2010 | $ Change | % Change | ||||||||
Interest expense | $ | (36.8 | ) | $ | (38.2 | ) | $ | 1.4 | (3.7 | )% | |
Interest income | $ | 5.6 | $ | 3.7 | $ | 1.9 | 51.4 | % | |||
Interest expense for 2011 decreased compared to 2010 primarily due to lower financing costs as a result of refinancing the Company’s $500 million Amended and Restated Credit Agreement (Senior Credit Facility), which occurred in May 2011. Interest income increased for 2011 compared to 2010 primarily due to higher interest rates on invested cash balances.
Income Tax Expense:
2011 | 2010 | $ Change | Change | ||||||||
Income tax expense | $ | 240.2 | $ | 136.0 | $ | 104.2 | 76.6 % | ||||
Effective tax rate | 34.5 | % | 33.5 | % | — | 100 | bps | ||||
The effective tax rate on the pretax income for 2011 was favorable relative to the U.S. federal statutory rate primarily due to earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, the U.S. manufacturing deduction, the U.S. research tax credit and the net effect of other U.S. tax items, partially offset by losses at certain foreign subsidiaries where no tax benefit could be recorded, U.S. state and local taxes and the net effect of other discrete items.
The effective tax rate for 2010 was favorable relative to the U.S. federal statutory rate primarily due to earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, the U.S. manufacturing deduction, the U.S. research tax credit and the net effect of other U.S. tax items, partially offset by losses at certain foreign subsidiaries where no tax benefit could be recorded, and U.S. state and local taxes. The effective tax rate for 2010 also includes the net impact of a $21.6 million charge in the first quarter to record the deferred tax impact of the Patient Protection and Affordable Care Act of 2010, as amended (PPACA), partially offset by a $19.8 million tax benefit in the fourth quarter to record the benefit of contributions made to a newly established Voluntary Employee Benefit Association (VEBA) trust to fund certain retiree health care costs.
The change in the effective tax rate in 2011 compared to 2010 was primarily due to certain discrete tax expense items recorded in 2011 and higher U.S. state and local taxes, partially offset by earnings in certain foreign jurisdictions where the effective tax rate is less than 35%.
29
BUSINESS SEGMENTS
As of January 1, 2012, the Company modified the way in which certain SG&A expenses are allocated among segments to better reflect the use of shared resources by the business. Segment results for 2011 have been revised to be consistent with the new allocations. The 2011 allocation change increased Mobile Industries segment EBIT by $18.6 million, reduced Process Industries segment EBIT by $7.4 million, reduced Aerospace and Defense segment EBIT by $2.5 million, reduced Steel segment EBIT by $3.3 million and increased Corporate expense by $5.4 million. Segment results for 2010 have not been revised as the Company determined it was impractical.
The presentation below reconciles the changes in net sales for each segment reported in accordance with U.S. GAAP to net sales adjusted to remove the effects of acquisitions made in 2011 and 2010 and currency exchange rates. The effects of acquisitions and currency exchange rates are removed to allow investors and the Company to meaningfully evaluate the percentage change in net sales on a comparable basis from period to period. During the third quarter of 2011, the Company completed the acquisition of substantially all of the assets of Gears and Services, which is part of the Process Industries segment. During the fourth quarter of 2011, the Company completed the acquisition of Drives, the results of which are reported in the Mobile Industries and Process Industries segments based on customer application. During the fourth quarter of 2010, the Company completed the acquisition of substantially all of the assets of City Scrap and Salvage Co. (City Scrap), which is part of the Steel segment. During the third quarter of 2010, the Company completed the acquisition of QM Bearings, which is part of the Process Industries segment. The year 2010 represents the base year for which the effects of currency are measured; as such, currency is assumed to be zero for 2010.
Mobile Industries Segment:
2011 | 2010 | $ Change | Change | ||||||||
Net sales, including intersegment sales | $ | 1,769.4 | $ | 1,560.6 | $ | 208.8 | 13.4 | % | |||
EBIT | $ | 261.8 | $ | 207.6 | $ | 54.2 | 26.1 | % | |||
EBIT margin | 14.8 | % | 13.3 | % | — | 150 bps | |||||
2011 | 2010 | $ Change | % Change | ||||||||
Net sales, including intersegment sales | $ | 1,769.4 | $ | 1,560.6 | $ | 208.8 | 13.4 | % | |||
Less: Acquisitions | 11.1 | — | 11.1 | NM | |||||||
Currency | 30.4 | — | 30.4 | NM | |||||||
Net sales, excluding the impact of acquisitions and currency | $ | 1,727.9 | $ | 1,560.6 | $ | 167.3 | 10.7 | % | |||
The Mobile Industries segment’s net sales, excluding the effects of acquisitions and currency-rate changes, increased 10.7% in 2011 compared to 2010, primarily due to higher volume of approximately $140 million and pricing and surcharges of approximately $30 million. The higher volume was seen across most market sectors, led by an approximately 30% increase in off-highway, an approximately 30% increase in rail and an approximately 15% increase in heavy truck, partially offset by an approximately 10% decrease in light-vehicle. EBIT was higher in 2011 compared to 2010, primarily due to the impact of higher volume of approximately $60 million and the impact of pricing and surcharges of approximately $30 million, partially offset by higher raw material and logistics costs of approximately $45 million and higher selling, general and administrative costs of approximately $10 million.
30
Process Industries Segment:
2011 | 2010 | $ Change | Change | ||||||||
Net sales, including intersegment sales | $ | 1,244.6 | $ | 903.4 | $ | 341.2 | 37.8 % | ||||
EBIT | $ | 274.2 | $ | 133.6 | $ | 140.6 | 105.2 % | ||||
EBIT margin | 22.0 | % | 14.8 | % | — | 720 | bps | ||||
2011 | 2010 | $ Change | % Change | ||||||||
Net sales, including intersegment sales | $ | 1,244.6 | $ | 903.4 | $ | 341.2 | 37.8 % | ||||
Less: Acquisitions | 103.8 | — | 103.8 | NM | |||||||
Currency | 22.2 | — | 22.2 | NM | |||||||
Net sales, excluding the impact of acquisitions and currency | $ | 1,118.6 | $ | 903.4 | $ | 215.2 | 23.8 % | ||||
The Process Industries segment’s net sales, excluding the effect of acquisitions and currency-rate changes, increased 23.8% for 2011 compared to 2010, primarily due to higher volume of approximately $190 million and pricing and sales mix of approximately $25 million. The higher sales primarily resulted from a 25% increase to industrial distributors. In addition, the higher sales resulted from a 15% increase to original equipment manufacturers, primarily driven by an approximately 30% increase in gear drives and an approximately 25% increase in global energy. EBIT was higher in 2011 compared to 2010 due to the impact of increased volume of approximately $100 million and higher pricing and favorable sales mix of approximately $40 million, partially offset by higher raw material costs of approximately $15 million. EBIT for the Process Industries segment also benefited from acquisitions in 2011.
Aerospace and Defense Segment:
2011 | 2010 | $ Change | Change | ||||||||
Net sales, including intersegment sales | $ | 324.1 | $ | 338.3 | $ | (14.2 | ) | (4.2) % | |||
EBIT | $ | 5.1 | $ | 16.7 | $ | (11.6 | ) | (69.5) % | |||
EBIT margin | 1.6 | % | 4.9 | % | — | (330 | ) bps | ||||
2011 | 2010 | $ Change | % Change | ||||||||
Net sales, including intersegment sales | $ | 324.1 | $ | 338.3 | $ | (14.2 | ) | (4.2) % | |||
Less: Currency | 2.2 | — | 2.2 | NM | |||||||
Net sales, excluding the impact of currency | $ | 321.9 | $ | 338.3 | $ | (16.4 | ) | (4.8) % | |||
The Aerospace and Defense segment’s net sales, excluding the effect of currency-rate changes, decreased 4.8% for 2011 compared to 2010. The decline was due to a decrease in volume of approximately $20 million, partially offset by favorable pricing. The decrease in volume was driven by reduced volume of defense-related products, partially offset by increased volume from commercial aerospace customers. EBIT decreased in 2011 compared to 2010, primarily due to the impact of lower volume of approximately $8 million, a product warranty charge of approximately $5 million and an inventory write-down of approximately $3 million, partially offset by favorable pricing and reduced selling, general and administrative costs totaling approximately $7 million.
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Steel Segment:
2011 | 2010 | $ Change | Change | ||||||||
Net sales, including intersegment sales | $ | 1,956.5 | $ | 1,359.5 | $ | 597.0 | 43.9 % | ||||
EBIT | $ | 267.4 | $ | 146.2 | $ | 121.2 | 82.9 % | ||||
EBIT margin | 13.7 | % | 10.8 | % | — | 290 | bps | ||||
2011 | 2010 | $ Change | % Change | ||||||||
Net sales, including intersegment sales | $ | 1,956.5 | $ | 1,359.5 | $ | 597.0 | 43.9 % | ||||
Less: Acquisitions | 7.6 | — | 7.6 | NM | |||||||
Currency | 0.7 | — | 0.7 | NM | |||||||
Net sales, excluding the impact of acquisitions and currency | $ | 1,948.2 | $ | 1,359.5 | $ | 588.7 | 43.3 % | ||||
The Steel segment’s net sales for 2011, excluding the effects of acquisitions and currency-rate changes, increased 43.3% compared to 2010, due to higher volume of approximately $240 million, higher surcharges of approximately $210 million, higher pricing of approximately $80 million and favorable sales mix of approximately $60 million. The higher volume was experienced across all market sectors, primarily driven by an 80% increase in oil and gas and a 26% increase in industrial.
Surcharges increased to $572.8 million in 2011, from $362.7 million in 2010. Approximately 40% of the increase in surcharges was a result of higher volumes. Surcharges are a pricing mechanism that the Company uses to recover scrap steel, energy and certain alloy costs, which are derived from published monthly indices.
Amounts are shown in whole values | 2011 | 2010 | Change | % Change | ||||||
Scrap index per ton | $ | 485 | $ | 426 | $ | 59 | 13.8% | |||
Shipments (in tons) | 1,286,000 | 1,026,000 | 260,000 | 25.3% | ||||||
Average selling price per ton, including surcharges | $ | 1,522 | $ | 1,325 | $ | 197 | 14.9% | |||
The increase in the average selling prices was primarily the result of higher surcharges and base prices. The higher surcharges were the result of higher prices for certain input raw materials, especially scrap steel and nickel.
The Steel segment’s EBIT increased in 2011 compared to 2010, primarily due to higher surcharges of approximately $210 million, pricing and sales mix of approximately $130 million and the impact of higher sales volume of approximately $85 million, partially offset by higher raw material costs of approximately $250 million, higher logistics costs of approximately $25 million and higher LIFO expense. In 2011, the Steel segment recognized LIFO expense of $15.2 million, compared to LIFO expense of $2.8 million in 2010. Raw material costs consumed in the manufacturing process, including scrap steel, alloys and energy, increased 22% in 2011 compared to the prior year, to an average cost of $555 per ton.
Corporate:
2011 | 2010 | $ Change | Change | ||||||||
Corporate expenses | $ | 80.8 | $ | 67.4 | $ | 13.4 | 19.9% | ||||
Corporate expenses % to net sales | 1.6 | % | 1.6 | % | — | — | |||||
Corporate expenses increased in 2011 compared to 2010, primarily due to higher performance-based compensation of approximately $8 million.
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THE BALANCE SHEETS
The following discussion is a comparison of the Consolidated Balance Sheets at December 31, 2012 and December 31, 2011.
Current Assets:
December 31, | |||||||||||
2012 | 2011 | $ Change | % Change | ||||||||
Cash and cash equivalents | $ | 586.4 | $ | 464.8 | 121.6 | 26.2 | % | ||||
Restricted cash | — | 3.6 | (3.6 | ) | NM | ||||||
Accounts receivable, net | 546.7 | 645.5 | (98.8 | ) | (15.3 | )% | |||||
Inventories, net | 862.1 | 964.4 | (102.3 | ) | (10.6 | )% | |||||
Deferred income taxes | 98.6 | 113.7 | (15.1 | ) | (13.3 | )% | |||||
Deferred charges and prepaid expenses | 12.6 | 12.8 | (0.2 | ) | (1.6 | )% | |||||
Other current assets | 67.7 | 88.1 | (20.4 | ) | (23.2 | )% | |||||
Total current assets | $ | 2,174.1 | $ | 2,292.9 | $ | (118.8 | ) | (5.2 | )% | ||
Refer to the Consolidated Statements of Cash Flows for a discussion of the increase in cash and cash equivalents. Accounts receivable, net decreased as a result of lower sales in the fourth quarter of 2012 compared to the same period in 2011, partially offset by a lower allowance for doubtful accounts of $7 million. Inventories decreased primarily due to a concerted effort to reduce inventories across all businesses to match current demand. Deferred income taxes decreased as a result of lower accruals for incentive-based compensation and a reduction in the allowance for doubtful accounts. Other current assets decreased as a result of a $15 million decrease in short-term marketable securities. These short-term marketable securities matured during the first quarter of 2012 and were converted to cash and cash equivalents.
Property, Plant and Equipment, Net:
December 31, | |||||||||||
2012 | 2011 | $ Change | % Change | ||||||||
Property, plant and equipment | $ | 3,792.1 | $ | 3,589.4 | $ | 202.7 | 5.6 | % | |||
Less: allowances for depreciation | (2,386.8 | ) | (2,280.5 | ) | (106.3 | ) | (4.7 | )% | |||
Property, plant and equipment, net | $ | 1,405.3 | $ | 1,308.9 | $ | 96.4 | 7.4 | % | |||
The increase in property, plant and equipment, net in 2012 was primarily due to capital expenditures in 2012 exceeding depreciation expense.
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Other Assets:
December 31, | |||||||||||
2012 | 2011 | $ Change | % Change | ||||||||
Goodwill | $ | 338.9 | $ | 332.7 | $ | 6.2 | 1.9 | % | |||
Other intangible assets | 224.7 | 235.7 | (11.0 | ) | (4.7 | )% | |||||
Deferred income taxes | 62.5 | 117.2 | (54.7 | ) | (46.7 | )% | |||||
Other non-current assets | 39.2 | 40.0 | (0.8 | ) | (2.0 | )% | |||||
Total other assets | $ | 665.3 | $ | 725.6 | $ | (60.3 | ) | (8.3 | )% | ||
The decrease in other intangible assets was primarily due to current-year amortization expense exceeding intangibles acquired in 2012. The decrease in deferred income taxes was primarily due to the contributions to the Company's defined benefit pension plans and its VEBA trust and CDSOA receipts during 2012.
Current Liabilities:
December 31, | |||||||||||
2012 | 2011 | $ Change | % Change | ||||||||
Short-term debt | $ | 14.3 | $ | 22.0 | $ | (7.7 | ) | (35.0 | )% | ||
Accounts payable | 216.2 | 287.3 | (71.1 | ) | (24.7 | )% | |||||
Salaries, wages and benefits | 213.9 | 259.3 | (45.4 | ) | (17.5 | )% | |||||
Income taxes payable | 33.5 | 45.5 | (12.0 | ) | (26.4 | )% | |||||
Deferred income taxes | 2.9 | 3.1 | (0.2 | ) | (6.5 | )% | |||||
Other current liabilities | 177.5 | 188.4 | (10.9 | ) | (5.8 | )% | |||||
Current portion of long-term debt | 9.6 | 14.3 | (4.7 | ) | (32.9 | )% | |||||
Total current liabilities | $ | 667.9 | $ | 819.9 | $ | (152.0 | ) | (18.5 | )% | ||
The decrease in short-term debt was primarily due to a reduction in the utilization of the Company's foreign lines of credit in Asia. The decrease in accounts payable was primarily due to lower volume. Salaries, wages and benefits decreased primarily due to the reduction in accruals for incentive based compensation plans. The decrease in income taxes payable was primarily due to the income tax payments made during 2012, partially offset by the current-year provision for income taxes in 2012. The decrease in other current liabilities was primarily due to lower accrued product warranty reserves and lower restructuring accruals.
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Non-Current Liabilities:
December 31, | |||||||||||
2012 | 2011 | $ Change | % Change | ||||||||
Long-term debt | $ | 455.1 | $ | 478.8 | $ | (23.7 | ) | (4.9 | )% | ||
Accrued pension cost | 391.4 | 491.0 | (99.6 | ) | (20.3 | )% | |||||
Accrued postretirement benefits cost | 371.8 | 395.9 | (24.1 | ) | (6.1 | )% | |||||
Deferred income taxes | 4.9 | 7.5 | (2.6 | ) | (34.7 | )% | |||||
Other non-current liabilities | 107.0 | 91.8 | 15.2 | 16.6 | % | ||||||
Total non-current liabilities | $ | 1,330.2 | $ | 1,465.0 | $ | (134.8 | ) | (9.2 | )% | ||
The decrease in accrued pension cost was primarily due to the Company's contributions of $325.8 million to its global defined benefit pension plans, as well as favorable returns on pension assets, partially offset by a decrease in the discount rate used to measure the projected benefit obligation. The decrease in accrued postretirement benefits cost was primarily due to a contribution of $50 million to the VEBA trust to fund health care benefits, partially offset by a decrease in the discount rate used to measure the accumulated benefit obligation. The increase in other non-current liabilities was primarily due to an increase in the Company's accrual for uncertain tax positions related to CDSOA receipts in 2012.
Shareholders’ Equity:
December 31, | |||||||||||
2012 | 2011 | $ Change | % Change | ||||||||
Common stock | $ | 944.5 | $ | 942.3 | $ | 2.2 | 0.2 | % | |||
Earnings invested in the business | 2,411.2 | 2,004.7 | 406.5 | 20.3 | % | ||||||
Accumulated other comprehensive loss | (1,013.2 | ) | (889.5 | ) | (123.7 | ) | 13.9 | % | |||
Treasury shares | (110.3 | ) | (29.2 | ) | (81.1 | ) | (277.7 | )% | |||
Noncontrolling interest | 14.4 | 14.2 | 0.2 | 1.4 | % | ||||||
Total equity | $ | 2,246.6 | $ | 2,042.5 | $ | 204.1 | 10.0 | % | |||
Earnings invested in the business increased in 2012 by net income attributable to the Company of $495.5 million, partially offset by dividends of $89.0 million. The increase in the accumulated other comprehensive loss was primarily due to a $133.2 million after tax pension and postretirement liability adjustment, partially offset by a $10.5 million increase from foreign currency translation. The pension and postretirement liability adjustment was primarily due to the realization of actuarial losses in 2012 due to a decrease in the discount rate used to measure the pension and postretirement plan obligations, partially offset by higher than expected returns from plan assets and the amortization of prior-year service costs and actuarial losses for these plans. The increase in the foreign currency translation adjustment was due to the U.S. dollar weakening relative to other currencies, such as the British pound, the Euro, the Canadian dollar and the Polish zloty. The increase in treasury shares was primarily due to the Company's purchase of 2.5 million of its common shares for an aggregate of $112.3 million, partially offset by shares issued pursuant to stock compensation plans.
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CASH FLOWS
2012 | 2011 | $ Change | |||||||
Net cash provided by operating activities | $ | 625.9 | $ | 211.7 | $ | 414.2 | |||
Net cash used by investing activities | (297.7 | ) | (508.0 | ) | 210.3 | ||||
Net cash used by financing activities | (210.4 | ) | (106.6 | ) | (103.8 | ) | |||
Effect of exchange rate changes on cash | 3.8 | (9.4 | ) | 13.2 | |||||
Increase (decrease) in cash and cash equivalents | $ | 121.6 | $ | (412.3 | ) | $ | 533.9 | ||
Operating activities provided net cash of $625.9 million in 2012, compared to $211.7 million in 2011. The change in cash from operating activities was primarily due to higher cash provided from working capital items, particularly accounts receivable and inventory, lower pension and other postretirement benefit contributions and payments, and pretax CDSOA receipts. Pension and other postretirement benefit contributions and payments were $412.7 million in 2012, compared to $456.0 million in 2011. Net income attributable to The Timken Company increased by $41.2 million in 2012 compared to 2011.
The following chart displays the impact of working capital items on cash during 2012 and 2011:
2012 | 2011 | |||||
Cash Provided (Used): | ||||||
Accounts receivable | $ | 103.0 | $ | (111.6 | ) | |
Inventories | 102.5 | (125.6 | ) | |||
Trade accounts payable | (73.2 | ) | 14.9 | |||
Other accrued expenses | (54.0 | ) | 29.1 | |||
Investing activities used cash of $297.7 million in 2012 compared to $508.0 million in 2011. The decrease was primarily due to a $271.4 million decrease in cash used for acquisitions and a $37.0 million decrease in short-term marketable securities, partially offset by an increase in cash used for capital expenditures of $91.9 million. Short-term marketable securities provided cash of $14.3 million in 2012 after using cash of $22.7 million in 2011.
Net cash used by financing activities was $210.4 million and $106.6 million in 2012 and 2011, respectively. The increase in cash used for financing activities was primarily due to a $68.5 million increase in the Company's repurchase of its common shares. Other factors increasing cash used by financing activities were a reduction in net borrowings, net of restricted cash, of $29.0 million and a $13.0 million increase in cash dividends paid to shareholders in 2012 compared to 2011. The Company purchased 2.5 million of its common shares for an aggregate of $112.3 million in 2012 after purchasing 1.0 million of its common shares for an aggregate of $43.8 million in 2011.
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LIQUIDITY AND CAPITAL RESOURCES
Total debt was $479.0 million and $515.1 million at December 31, 2012 and December 31, 2011, respectively. Cash and cash equivalents exceeded debt by $107.4 million at December 31, 2012. At December 31, 2011, debt exceeded cash and cash equivalents by $46.7 million. The ratio of net cash to capital was 5.0% at December 31, 2012. The ratio of net debt to capital was 2.2% at December 31, 2011.
Reconciliation of total debt to net (cash) debt and the ratio of net (cash) debt to capital:
Net Debt:
December 31, | ||||||
2012 | 2011 | |||||
Short-term debt | $ | 14.3 | $ | 22.0 | ||
Current portion of long-term debt | 9.6 | 14.3 | ||||
Long-term debt | 455.1 | 478.8 | ||||
Total debt | $ | 479.0 | $ | 515.1 | ||
Less: Cash and cash equivalents | 586.4 | 464.8 | ||||
Restricted cash | — | 3.6 | ||||
Net (cash) debt | $ | (107.4 | ) | $ | 46.7 | |
Ratio of Net Debt to Capital:
December 31, | ||||||
2012 | 2011 | |||||
Net (cash) debt | $ | (107.4 | ) | $ | 46.7 | |
Total equity | 2,246.6 | 2,042.5 | ||||
Net debt (cash) + total equity (capital) | $ | 2,139.2 | $ | 2,089.2 | ||
Ratio of net (cash) debt to capital | (5.0 | )% | 2.2 | % | ||
The Company presents net (cash) debt because it believes net (cash) debt is more representative of the Company’s financial position than total debt due to the amount of cash and cash equivalents.
On November 30, 2012, the Company entered into a three-year Amended and Restated Accounts Receivable Securitization Financing Agreement (Asset Securitization Agreement), which provides for borrowings up to $200 million, subject to certain borrowing base limitations, and is secured by certain domestic trade receivables of the Company. At December 31, 2012, the Company had no outstanding borrowings under the Asset Securitization Agreement; however, certain borrowing base limitations reduced the availability under the Asset Securitization Agreement to $154.2 million.
The Company has a $500 million Senior Credit Facility that matures on May 11, 2016. At December 31, 2012, the Company had no outstanding borrowings under the Senior Credit Facility but had letters of credit outstanding totaling $8.6 million, which reduced the availability under the Senior Credit Facility to $491.4 million. Under the Senior Credit Facility, the Company has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. At December 31, 2012, the Company was in full compliance with the covenants under the Senior Credit Facility. The maximum consolidated leverage ratio permitted under the Senior Credit Facility is 3.25 to 1.0. As of December 31, 2012, the Company’s consolidated leverage ratio was 0.52 to 1.0. The minimum consolidated interest coverage ratio permitted under the Senior Credit Facility is 4.0 to 1.0. As of December 31, 2012, the Company’s consolidated interest coverage ratio was 27.51 to 1.0.
37
The interest rate under the Senior Credit Facility is based on the Company’s consolidated leverage ratio. In addition, the Company pays a facility fee based on the consolidated leverage ratio multiplied by the aggregate commitments of all of the lenders under the Senior Credit Facility.
Other sources of liquidity include short-term and long-term lines of credit for certain of the Company’s foreign subsidiaries, which provide for borrowings up to $235.2 million in the aggregate. The majority of these lines are uncommitted. At December 31, 2012, the Company had borrowings outstanding of $23.9 million, which reduced the availability under these facilities to $211.3 million.
The Company expects that any cash requirements in excess of cash on hand will be met by the committed funds available under its Asset Securitization Agreement and the Senior Credit Facility. Management believes it has sufficient liquidity to meet its obligations through at least the term of the Senior Credit Facility.
At December 31, 2012, approximately $244.2 million, or 41.6%, of the Company’s cash and cash equivalents resided in jurisdictions outside the United States. Repatriation of these funds to the United States could be subject to domestic and foreign taxes and an immaterial amount could be subject to governmental restrictions. Part of the Company’s strategy is to grow in attractive market sectors, many of which are outside the United States. This strategy may include making investments in facilities and equipment and potential new acquisitions. The Company plans to fund these investments, as well as meet working capital requirements, with cash and cash equivalents and unused lines of credit within the geographic location of these investments when possible.
The Company expects to remain in compliance with its debt covenants. However, the Company may need to limit its borrowings under the Senior Credit Facility or other facilities in order to remain in compliance. As of December 31, 2012, the Company could have borrowed the full amounts available under the Senior Credit Facility and Asset Securitization Agreement, and would have still been in compliance with its debt covenants.
The Company expects cash from operations in 2013 to decrease to approximately $330 million from $625.9 million in 2012 as the Company anticipates lower net income and an increase in working capital partially offset by lower pension and postretirement contributions. The Company expects to make approximately $300 million in pension and postretirement contributions in 2013, compared to $375.8 million in 2012. The Company also expects to increase capital expenditures to approximately $360 million in 2013 compared to $300 million in 2012.
CONTRACTUAL OBLIGATIONS
The Company’s contractual debt obligations and contractual commitments outstanding as of December 31, 2012 were as follows:
Payments due by Period:
Contractual Obligations | Total | Less than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | ||||||||||
Interest payments | $ | 193.4 | $ | 27.8 | $ | 32.2 | $ | 22.8 | $ | 110.6 | |||||
Long-term debt, including current portion | 464.7 | 9.6 | 249.9 | 20.0 | 185.2 | ||||||||||
Short-term debt | 14.3 | 14.3 | — | — | — | ||||||||||
Operating leases | 122.2 | 35.4 | 50.9 | 24.5 | 11.4 | ||||||||||
Purchase commitments | 112.1 | 82.7 | 26.4 | 3.0 | — | ||||||||||
Retirement benefits | 2,809.1 | 299.9 | 581.6 | 564.8 | 1,362.8 | ||||||||||
Total | $ | 3,715.8 | $ | 469.7 | $ | 941.0 | $ | 635.1 | $ | 1,670.0 | |||||
The interest payments beyond five years primarily relate to medium-term notes that mature over the next 16 years.
Purchase commitments are defined as an agreement to purchase goods or services that are enforceable and legally binding on the Company. Included in purchase commitments above are certain obligations related to take or pay contracts, capital commitments, service agreements and utilities. Many of these commitments relate to take or pay contracts, in which the Company guarantees payment to ensure availability of products or services. These purchase commitments do not represent the entire anticipated purchases in the future, but represent only those items for which the Company is contractually obligated. The majority of the Company's products and services are purchased as needed, with no commitment.
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Retirement benefits represent pension and health care payments expected to be paid to retirees or their beneficiaries over the next ten years. These payments are largely covered by pension and postretirement benefit plan assets.
As of December 31, 2012, the Company had approximately $112.6 million of total gross unrecognized tax benefits. The Company anticipates a decrease in its unrecognized tax positions of $40 million to $45 million during the next 12 months. The anticipated decrease is primarily due to settlements with tax authorities. Future tax positions are not known at this time and therefore not included in the above summary of the Company’s fixed contractual obligations. Refer to Note 15 – Income Taxes in the Notes to the Consolidated Financial Statements for additional discussion.
During 2012, the Company made cash contributions of approximately $325.8 million to its global defined benefit pension plans, of which $314.1 million was discretionary. The Company also contributed $50 million to a VEBA trust to fund retiree health care costs. The Company currently expects to make contributions to its global defined benefit pension plans totaling approximately $250 million in 2013, of which $230 million is discretionary. The Company also currently expects to make contributions to a VEBA trust to fund retiree health care costs totaling $50 million in 2013. The Company may consider making additional discretionary contributions to either its global defined benefit pension plans or its postretirement benefit plans during 2013. Returns for the Company’s global defined benefit pension plan assets in 2012 were 13.8%, above the expected rate of return of 8.25% due to broad increases in global equity markets. The higher returns positively impacted the funded status of the plans at the end of 2012 and are expected to result in lower pension expense in future years. However, pension expense will increase due to the reduction in the discount rate in 2013 compared to 2012. Refer to Note 12 - Retirement Benefit Plans and Note 13 - Postretirement Benefit Plans in the Notes to the Consolidated Financial Statements for additional discussion.
During 2012, the Company purchased 2.5 million of its common shares for approximately $112.3 million in the aggregate under the Company's 2012 common stock purchase plan. This plan authorizes the Company to buy, in the open market or in privately negotiated transactions, up to 10 million shares of common stock, which are to be held as treasury shares and used for specified purposes. The authorization expires on December 31, 2015.
As disclosed in Note 9 – Contingencies and Note 15 – Income Taxes in the Notes to the Consolidated Financial Statements, the Company has exposure for certain legal and tax matters.
The Company does not have any off-balance sheet arrangements with unconsolidated entities or other persons.
RECENTLY ADOPTED ACCOUNTING PRONOUNCMENTS
Information required for this item is incorporated by reference to Note 1 – Significant Accounting Policies in the Notes to the Consolidated Financial Statements.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The following paragraphs include a discussion of some critical areas that require a higher degree of judgment, estimates and complexity.
Revenue recognition:
The Company recognizes revenue when title passes to the customer. This occurs at the shipping point except for goods sold by certain foreign entities and certain exported goods, where title passes when the goods reach their destination. Selling prices are fixed based on purchase orders or contractual arrangements. Shipping and handling costs billed to customers are included in net sales and the related costs are included in cost of products sold in the Consolidated Statements of Income.
In July 2011, the Company acquired the assets of Gears and Services. Gears and Services recognizes a portion of its revenues on the percentage of completion method. In 2012, the Company recognized approximately $60 million in net sales under the percentage of completion method.
Inventory:
Inventories are valued at the lower of cost or market, with approximately 55% valued by the LIFO method and the remaining 45% valued by the first-in, first-out (FIFO) method. The majority of the Company’s domestic inventories are valued by the LIFO method, and all of the Company’s international inventories are valued by the FIFO method. An actual valuation of the inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs. Because these are subject to many factors beyond management’s control, annual results may differ from interim results as they are subject to the final year-end LIFO inventory valuation. The Company recognized a decrease in its LIFO reserve of $7.1 million for 2012, compared to an increase in its LIFO reserve of $23.1 million for 2011.
Goodwill:
The Company tests goodwill and indefinite-lived intangible assets for impairment at least annually. The Company performs its annual impairment test on October first after the annual forecasting process is completed. Furthermore, goodwill is reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Each interim period, management of the Company assesses whether or not an indicator of impairment is present that would necessitate that a goodwill impairment analysis be performed in an interim period other than during the fourth quarter.
The goodwill impairment analysis is a two-step process. Step one compares the carrying amount of the reporting unit to its estimated fair value. To the extent that the carrying value of the reporting unit exceeds its estimated fair value, step two is performed, where the reporting unit’s carrying value of goodwill is compared to the implied fair value of goodwill. To the extent that the carrying value of goodwill exceeds the implied fair value of goodwill, impairment exists and must be recognized.
The Company reviews goodwill for impairment at the reporting unit level. Prior to 2012, the Company’s reporting units were the same as its reportable segments: Mobile Industries, Process Industries, Aerospace and Defense and Steel. During 2012, management began reviewing goodwill for impairment at a level below the segment level for the Process Industries and Aerospace and Defense segments. This change was necessitated by a change in management structure, as well as the level of review of financial information by management within the Aerospace and Defense segment, and the acquisition of the assets of Gears and Services. Gears and Services is part of the Process Industries segment and provides aftermarket gear box repair services and gear-drive systems for the industrial, energy and military marine market sectors. The Company still reviews goodwill for impairment at the segment level for the Mobile Industries and Steel segments.
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During 2011, the Company adopted the provisions of Accounting Standards Update (ASU) No. 2011-8, “Intangibles–Goodwill and Other (Topic 350): Testing Goodwill for Impairment,” which allows companies to assess qualitative factors to determine if goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test. Based on a review of various qualitative factors, management concluded that the goodwill for the Mobile Industries, Process Industries and Steel segments, as well as the Gears and Services reporting unit, was not impaired and that the two-step approach was not required to be performed for these reporting units. Based on a review of various qualitative factors, management concluded that the goodwill for the reporting units within the Aerospace and Defense segment would be tested under the two-step approach. The Company prepares its goodwill impairment analysis by comparing the estimated fair value of each reporting unit, using an income approach (a discounted cash flow model), as well as a market approach, with its carrying value.
The income approach requires several assumptions including future sales growth, EBIT (earnings before interest and taxes) margins and capital expenditures. The Company’s reporting units each provide their forecast of results for the next three years. These forecasts are the basis for the information used in the discounted cash flow model. The discounted cash flow model also requires the use of a discount rate and a terminal revenue growth rate (the revenue growth rate for the period beyond the three years forecasted by the reporting units), as well as projections of future operating margins (for the period beyond the forecasted three years). During the fourth quarter of 2012, the Company used a discount rate for its Aerospace and Defense reporting units of 10% to 13.5% and a terminal revenue growth rate of 3%.
The market approach requires several assumptions including EBITDA (earnings before interest, taxes, depreciation and amortization) multiples for comparable companies that operate in the same markets as the Company’s reporting units. During the fourth quarter of 2012, the Company used EBITDA multiples of 5.0 to 9.5 for its Aerospace and Defense reporting units.
As of December 31, 2012, the Company had $338.9 million of goodwill on its Consolidated Balance Sheet, of which $162.2 million was attributable to the Aerospace and Defense segment. See Note 7 – Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements for the carrying amount of goodwill by segment. The fair value of the Aerospace and Defense segment's three reporting units was $178.3 million, $140.1 million and $222.8 million, respectively, compared to their carrying value of $145.7 million, $102.7 million and $172.4 million, respectively. As a result, the Company did not recognize any goodwill impairment charges for the year ended December 31, 2012. A 240 basis point increase in the discount rate would have resulted in one of the Aerospace and Defense segment's reporting units failing step one of the goodwill impairment analysis, which would have required the completion of step two of the goodwill impairment analysis to arrive at a potential goodwill impairment loss. The projected cash flows could decline by as much as 20% and the reporting units' fair value would still exceed their carrying value.
In 2012, the income approach for the reporting units within the Aerospace and Defense segment was weighted by 70% and the market approach was weighted by 30% in arriving at fair value. The 70/30 weighting was selected to give consideration for the fact that the metrics for the last twelve months for the reporting units within the Aerospace and Defense segment were not reflective of expected performance and the discounted-cash flow model provided a more normalized view of future operating conditions for the Aerospace and Defense segment. Had the Company used a 50/50 weighting, the Company would still have passed step one of the goodwill impairment test for each of the reporting units within the Aerospace and Defense segment for the year ended December 31, 2012.
During 2012, the Company adopted the provisions of Accounting Standards Update (ASU) No. 2012-02, “Intangibles–Goodwill and Other (Topic 350): Testing indefinite-lived intangibles for Impairment,” which allows companies to assess qualitative factors to determine if indefinite-lived intangibles might be impaired and whether it is necessary to perform the two-step impairment test. Based on a review of various qualitative factors, management concluded that the Company's indefinite-lived intangible assets were not impaired and that the two-step approach was not required to be performed for these reporting units.
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Restructuring costs:
The Company’s policy is to recognize restructuring costs in accordance with Accounting Standards Codification (ASC) 420, “Exit or Disposal Cost Obligations,” and ASC 712, “Compensation and Non-retirement Post-Employment Benefits.” Detailed contemporaneous documentation is maintained and updated to ensure that accruals are properly supported. If management determines that there is a change in estimate, the accruals are adjusted to reflect this change.