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1.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10Q
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
or
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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 44706-2798
(Address of principal executive offices) (Zip Code)
(330) 438-3000
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
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
___ ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES X NO
___ ___
Common shares outstanding at July 31, 2003, 85,566,821.
PART I. FINANCIAL INFORMATION 2.
THE TIMKEN COMPANY AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
June 30 Dec 31
2003 2002
ASSETS ---------- ----------
Current Assets (Thousands of dollars)
Cash and cash equivalents........................... $52,445 $82,050
Accounts receivable, less allowances,
(2003-$19,217; 2002-$14,386)........................ 610,690 361,316
Deferred income taxes............................... 34,510 36,003
Inventories (Note 4) ............................... 744,352 488,923
---------- ----------
Total Current Assets...................... 1,441,997 968,292
Property, plant and equipment....................... 3,440,993 2,945,076
Less allowances for depreciation................... 1,790,866 1,718,832
---------- ----------
1,650,127 1,226,244
Goodwill............................................ 192,800 129,943
Intangible pension asset............................ 128,386 129,042
Intangible assets (Note 10)......................... 107,537 5,217
Deferred income taxes............................... 169,122 169,051
Other assets........................................ 311,534 120,567
---------- ----------
Total Assets.................................. $4,001,503 $2,748,356
========== ==========
LIABILITIES
Current Liabilities
Accounts payable and other liabilities.............. $512,012 $296,543
Short-term debt and commercial paper................ 272,884 111,134
Accrued expenses.................................... 281,372 226,393
---------- ----------
Total Current Liabilities................. 1,066,268 634,070
Noncurrent Liabilities
Long-term debt (Note 5) ............................ 744,523 350,085
Accrued pension cost................................ 699,430 723,188
Accrued postretirement benefits cost................ 494,083 411,304
Other noncurrent liabilities........................ 26,273 20,623
---------- ----------
Total Noncurrent Liabilities.............. 1,964,309 1,505,200
Shareholders' Equity (Note 7)
Common stock........................................ 632,607 310,317
Earnings invested in the business................... 760,330 764,446
Accumulated other comprehensive loss................ (422,011) (465,677)
---------- ----------
Total Shareholders' Equity................ 970,926 609,086
Total Liabilities and Shareholders' Equity.... $4,001,503 $2,748,356
========== ==========
PART I. FINANCIAL INFORMATION Continued 3.
THE TIMKEN COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Six Months Ended Three Months Ended
June 30 June 30 June 30 June 30
2003 2002 2003 2002
---------- ---------- ---------- ----------
(Thousands of dollars, except per share data)
Net sales................................................... $1,828,260 $1,276,586 $990,253 $660,829
Cost of products sold....................................... 1,539,925 1,033,643 832,184 536,528
---------- ---------- ---------- ----------
Gross Profit............................................. 288,335 242,943 158,069 124,301
Selling, administrative and general expenses................ 240,468 178,997 135,197 93,005
Impairment and restructuring charges (Note 8)............... 853 17,283 853 14,226
---------- ---------- ---------- ----------
Operating Income......................................... 47,014 46,663 22,019 17,070
Interest expense............................................ (23,275) (15,924) (13,114) (7,889)
Interest income............................................. 418 697 208 317
Other income (expense)...................................... 1,276 (9,075) (2,578) (1,607)
---------- ---------- ---------- ----------
Income Before Income Taxes and Cumulative
Effect of Change in Accounting Principle......... 25,433 22,361 6,535 7,891
Provision for income taxes (Note 6)................ 10,173 9,213 2,614 3,931
---------- ---------- ---------- ----------
Income Before Cumulative Effect of Change in Accounting
Principle.............................................. $ 15,260 $ 13,148 $ 3,921 $ 3,960
Cumulative effect of change in accounting principle (net of
income tax benefit of $7,786)............................. - 12,702 - -
---------- ---------- ---------- ----------
Net Income ................................................. $ 15,260 $ 446 $ 3,921 $ 3,960
========== ========== ========== ==========
Earnings Per Share:
Income before cumulative effect of change in
accounting principle............................ $ 0.19 $ 0.22 $ 0.05 $ 0.07
Cumulative effect of change in accounting principle $ - $(0.21) $ - $ -
Earnings Per Share*............................... $ 0.19 $ 0.01 $ 0.05 $ 0.07
Earnings Per Share - assuming dilution:
Income before cumulative effect of change in
accounting principle............................ $ 0.19 $ 0.22 $ 0.05 $ 0.07
Cumulative effect of change in accounting principle $ - $(0.21) $ - $ -
Earnings Per Share - assuming dilution**.......... $ 0.19 $ 0.01 $ 0.05 $ 0.07
Dividends Per Share............................... $ 0.26 $ 0.26 $ 0.13 $ 0.13
========== ========== ========== ==========
* Average shares outstanding............................... 79,198,167 60,092,322 85,520,667 60,239,065
** Average shares outstanding - assuming dilution........... 79,402,600 60,732,056 85,760,495 61,038,029
PART I. FINANCIAL INFORMATION Continued 4.
THE TIMKEN COMPANY AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
Cash Provided (Used) June 30 June 30
2003 2002
-------- --------
OPERATING ACTIVITIES (Thousands of dollars)
Net income ............................................... $ 15,260 $ 446
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of accounting change................... - 12,702
Depreciation and amortization............................ 88,952 73,855
Gain on disposals of property, plant and equipment....... (1,954) (3,939)
Provision for deferred income taxes...................... 3,892 24,033
Stock issued in lieu of cash to employee benefit plans... 2,280 5,416
Non-cash impact of changes in impairment and
restructuring charges - net............................. - (9,071)
Changes in operating assets and liabilities:
Accounts receivable..................................... (39,164) (69,329)
Inventories............................................. (18,749) (23,465)
Other assets............................................ (4,163) (17,304)
Accounts payable and accrued expenses................... 1,414 27,243
Foreign currency translation............................ (9,723) 3,732
-------- -------
Net Cash Provided by Operating Activities.............. 38,045 24,319
INVESTING ACTIVITIES
Capital expenditures..................................... (51,707) (34,897)
Proceeds from disposals of property, plant and equipment. 12,078 5,726
Other ................................................... (1,054) 12,483
Acquisitions............................................. (718,952)* (6,751)
-------- -------
Net Cash Used by Investing Activities.................. (759,635) (23,439)
FINANCING ACTIVITIES
Cash dividends paid to shareholders...................... (19,376) (15,640)
Issuance of common stock for acquisition................. 180,010* -
Accounts receivable securitization financing............. 125,000 -
Payments on long-term debt............................... (49,222) (1,727)
Proceeds from issuance of long-term debt................. 424,957 304
Short-term debt activity - net........................... 28,540 13,106
-------- --------
Net Cash Provided (Used) by Financing Activities....... 689,909 (3,957)
Effect of exchange rate changes on cash................... 2,076 779
Decrease in Cash and Cash Equivalents..................... (29,605) (2,298)
Cash and Cash Equivalents at Beginning of Period.......... 82,050 33,392
-------- --------
Cash and Cash Equivalents at End of Period................ $ 52,445 $ 31,094
======== ========
* Excluding $140 million of common stock (9,395,973 shares) issued to
Ingersoll-Rand Company, in conjunction with the acquisition.
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 5.
Note 1 -- Basis of Presentation
The accompanying consolidated condensed financial statements (unaudited) for
The Timken Company (the "company") have been prepared in accordance with the
instructions to Form 10-Q and do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) and disclosures considered necessary
for a fair presentation have been included. For further information, refer to
the consolidated financial statements and footnotes included in the company's
annual report on Form 10-K for the year ended December 31, 2002.
Note 2 -- Stock-Based Compensation
On December 31, 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends
SFAS No. 123, "Accounting for Stock-Based Compensation," by providing alterna-
tive methods of transition to SFAS No. 123's fair value method of accounting
for stock-based compensation. SFAS No. 148 also amends the disclosure require-
ments of SFAS No. 123. The company has elected to follow Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations in accounting for its stock options to key associates
and directors. Under APB Opinion No. 25, whenever the market price of the com-
pany's stock options equals the market price of the underlying common stock on
the date of grant, no compensation expense is required.
The effect on net income (loss) and earnings per share as if the company had
applied the fair value recognition provisions of SFAS No. 123 is as follows:
Six months ended Three months ended
June 30 June 30
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands of dollars)
Net income, as reported $ 15,260 $ 446 $ 3,921 $ 3,960
Add: Stock-based employee
compensation expense, net
of related taxes 864 244 413 190
Deduct: Total stock-based
employee compensation
expense determined under
fair value based methods
for all awards, net of
related tax effects (2,798) (2,561) (1,581) (1,634)
-------- -------- -------- --------
Pro forma net income (loss) $ 13,326 $ (1,871) $ 2,753 $ 2,516
======== ======== ======== ========
Earnings per share:
Basic and diluted -
as reported $0.19 $(0.01) $0.05 $0.07
Basic and diluted -
pro forma $0.17 $(0.03) $0.03 $0.04
Note 3 -- Acquisition
On February 18, 2003, the company acquired Ingersoll-Rand Company Limited's
(IR's) Engineered Solutions business, a leading worldwide producer of needle
roller, heavy-duty roller and ball bearings, and motion control components and
assemblies. IR's Engineered Solutions business is comprised of certain
operating assets and subsidiaries, including The Torrington Company. IR's
Engineered Solutions business, hereafter referred to as Torrington, had sales
of $1.2 billion in 2002.
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 6.
Continued
Note 3 -- Acquisition (continued)
The company paid IR $700 million in cash, subject to post-closing purchase price
adjustments, and issued $140 million of its common stock (9,395,973 shares) to
Ingersoll-Rand Company, a subsidiary of IR. To finance the cash portion of the
transaction the company utilized, in addition to cash on hand: $180.0 million,
net of underwriting discounts and commissions, from a public offering of
12.65 million shares of common stock at $14.90 per common share; $246.9 million,
net of underwriting discounts and commissions, from a public offering of
$250.0 million of 5.75% senior unsecured notes due 2010; $125.0 million from
its Asset Securitization facility; and approximately $86 million from its new
senior credit facility. Costs related to the acquisition were $18.2 million
and are included in the purchase price.
The purchase price has been allocated to assets acquired and liabilities
assumed based on estimated fair market values at the date of acquisition. The
purchase price allocation is preliminary and further adjustments will be made
upon completion of the final valuation studies and integration initiatives
implemented by the company. The company continues to evaluate possible plant
rationalizations for sites that it acquired in the Torrington acquisition.
In March 2003, the company announced the planned closing of its plant in
Darlington, England within eight to twelve months. In July 2003, the company
announced that it will close its plant in Rockford, Illinois within three to
five months. In August 2003, the company announced it is exploring strategic
alternatives for its Standard Plant in Torrington, Connecticut.
The table below reflects unaudited pro forma results of the company and
Torrington as if the acquisition had taken place at the beginning of the periods
presented, after giving effect to certain adjustments, including the amorti-
zation of intangible assets, interest expense on acquisition debt, depreciation
of fixed assets, employee benefits and income tax effects. Unaudited pro forma
earnings for each quarter presented include higher than normal cost of products
sold resulting from the one-time write-up of acquired inventories required by
the purchase accounting rules. This charge decreased earnings per share by
approximately $0.05 for the six months ended June 30, 2003 and 2002,
respectively, based on the preliminary asset valuation. No effect has been
given to operating synergies in this presentation. These pro forma amounts do
not purport to be indicative of the results that would have been obtained if the
acquisition had occurred as of the beginning of the periods presented or that may
be obtained in the future:
Six months ended
June 30
2003 2002
---------- ----------
(Amounts in thousands, except per share data)
Net sales $1,979,503 $1,886,791
Income before cumulative
effect of change in
accounting principle 8,408 28,797
Net income $ 8,408 $ 16,095
Earnings per share:
Basic and diluted:
Income before cumulative
effect of change in
accounting principle $ 0.11 $ 0.35
Cumulative effect of
change in accounting
principle - (0.15)
---------- ----------
Earnings per share -
basic and diluted $ 0.11 $ 0.20
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 7.
Continued
Note 4 -- Inventories June 30 Dec 31
2003 2002
-------- ---------
(Thousands of dollars)
Finished products $349,649 $210,945
Work-in-process and raw materials 351,340 243,485
Manufacturing supplies 43,363 34,493
-------- --------
$744,352 $488,923
======== ========
An actual valuation of 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 must necessarily be based on manage-
ment's estimates of expected year-end inventory levels and costs. Because
these are subject to many forces beyond management's control, interim results
are subject to the final year-end LIFO inventory valuation.
June 30 Dec 31
2003 2002
Note 5 -- Long-term Debt -------- --------
(Thousands of dollars)
State of Ohio Pollution Control Revenue Refunding Bonds,
maturing on June 1, 2033. The variable interest
rate is tied to the bank's tax exempt weekly interest
rate. The rate at June 30, 2003 is 1.00%. $ 17,000 $ -
State of Ohio Pollution Control Revenue Refunding Bonds,
maturing on July 1, 2003. The variable interest rate
is tied to the bank's tax exempt weekly interest rate. - 17,000
State of Ohio Water Development Revenue Refunding
Bond, maturing on May 1, 2007. The variable interest
rate is tied to the bank's tax exempt weekly interest
rate. The rate at June 30, 2003 is 1.00%. 8,000 8,000
State of Ohio Air Quality Bond, maturing on November 1,
2025. The variable interest rate is tied to the
bank's tax exempt weekly interest rate. The rate at
June 30, 2003 is 1.00%. 9,500 9,500
State of Ohio Water Development Revenue Refunding Bonds,
maturing on November 1, 2025. The variable interest
rate is tied to the bank's tax exempt weekly interest
rate. The rate at June 30, 2003 is 1.00%. 12,200 12,200
State of Ohio Water Development Authority Solid Waste
Revenue Bonds, maturing on July 1, 2032. The
variable interest rate is tied to the bank's tax
exempt weekly interest rate. The rate at
June 30, 2003 is 1.05%. 24,000 24,000
Fixed Rate Medium-Term Notes, Series A, due at various
dates through May, 2028, with interest rates ranging
from 6.20% to 7.76%. 292,000 292,000
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 8.
Continued
Note 5 -- Long-term Debt and Other Financing Arrangements (continued)
June 30 Dec 31
2003 2002
-------- ---------
(Thousands of dollars)
Senior credit facility, maturing on December 31,
2007. The variable interest rate is LIBOR plus
1.5%. The rate at June 30, 2003 is 2.84%. 125,000 -
Unsecured notes, maturing on February 15, 2010,
with a fixed interest rate of 5.75%. 250,000 -
Fixed rate credit facility with Citic Industrial
Bank, due at various dates through July 2004,
with interest rates ranging from 4.54% to 5.84%. 8,298 5,455
Other 9,629 5,711
-------- --------
755,627 373,866
Less: Current Maturities 11,104 23,781
-------- --------
$744,523 $350,085
======== ========
On December 19, 2002, the company entered into an Accounts Receivable
Securitization financing agreement (Asset Securitization), which provides for
borrowings up to $125 million, limited to certain borrowing base calculations,
and is secured by certain trade receivables. Under the terms of the Asset
Securitization, the company sells, on an ongoing basis, certain domestic trade
receivables to Timken Receivables Corporation, a wholly owned consolidated
subsidiary, that in turn uses the trade receivables to secure the borrowings,
which are funded through a vehicle that issues commercial paper in the short-
term market. As of June 30, 2003, there was $125 million outstanding on this
facility, and no payments have been made. This balance is reflected on the
company's consolidated condensed balance sheet as of June 30, 2003 in short-
term debt and commercial paper. The yield on the commercial paper, which is
the commercial paper rate plus program fees, is considered a financing cost,
and is included in interest expense on the consolidated statements of
operations. This rate was 1.74% at June 30, 2003.
Under the $500 million senior credit facility, the company has three financial
covenants: consolidated net worth; leverage ratio; and fixed charge coverage
ratio. At June 30, 2003, the company was in compliance with the covenants
under its senior credit facility and its other debt agreements.
Prior to June 30, 2003, the company delivered the necessary funds to the bond
trustee to pay principle and interest on the outstanding $17 million of State of
Ohio Pollution Control Revenue Refunding Bonds (series 1999), which matured on
July 1, 2003. Therefore, as of the end of the second quarter of 2003, these
bonds were legally defeased or nullified. On June 27, 2003, the company closed
on a bond issuance of $17 million in State of Ohio Pollution Control Revenue
Refunding Bonds (series 2003), which matures on June 1, 2033. The series 2003
bonds are included in long-term debt in the company's balance sheet as of
June 30, 2003.
Note 6 -- Income Tax Provision Six Months Ended Three Months Ended
June 30 June 30 June 30 June 30
2003 2002 2003 2002
-------- -------- -------- --------
U.S. (Thousands of dollars)
Federal $ 73 $ 5,876 $(3,931) $ 1,657
State & Local 328 1,137 (299) 408
Foreign 9,772 2,200 6,844 1,866
------- ------- ------- -------
$10,173 $ 9,213 $ 2,614 $ 3,931
======= ======= ======= =======
Taxes provided exceeded the U.S. statutory rate primarily due to losses at
certain foreign operations in which the realization of the tax benefit of
these losses is more than likely not to occur and taxes paid to state and
local jurisdictions.
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited)
Continued 9.
June 30 Dec 31
Note 7 -- Shareholders' Equity 2003 2002
-------- --------
Class I and Class II serial preferred stock (Thousands of dollars)
without par value:
Authorized -- 10,000,000 shares each class
Issued - none $ - $ -
Common Stock without par value:
Authorized -- 200,000,000 shares
Issued (including shares in treasury)
2003 - 85,569,989 shares
2002 - 63,451,916 shares
Stated Capital 53,064 53,064
Other paid-in capital 579,607 257,992
Less cost of Common Stock in treasury
2003 - 3,575 shares
2002 - 40,074 shares (64) (739)
-------- --------
$632,607 $310,317
======== ========
An analysis of the change in capital and earnings invested in the business is as follows:
Common Stock Earnings Accumulated
Other Invested Other
Stated Paid-In in the Comprehensive Treasury
Capital Capital Business Loss Stock Total
------- -------- -------- ---------- -------- ----------
(Thousands of dollars)
Balance December 31, 2002 $53,064 $257,992 $764,446 ($465,677) ($739) $609,086
Net Income 15,260 15,260
Foreign currency translation adjustment 42,113 42,113
Change in fair value of derivative financial
instruments, net of reclassifications
(net of income tax of $299) 1,553 1,553
----------
Total comprehensive income 58,926
Dividends - $0.26 per share (19,376) (19,376)
Issuance of 36,499 shares from treasury
and 72,100 shares from authorized related
to stock option and employee benefit plans 1,605 675 2,280
Issuance of 22,045,973 shares from authorized
to finance the Torrington acquisition 320,010 320,010
------- -------- -------- ---------- -------- ----------
Balance June 30, 2003 $53,064 $579,607 $760,330 ($422,011) ($64) $970,926
======= ======== ======== ========== ======== ==========
The total comprehensive income (loss) for the three months ended June 30, 2003 and 2002 was $39,353,000 and
$9,387,000 respectively. Total comprehensive loss for the six months ended June 30, 2002 was $17,713,000.
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 10.
Continued
Note 8 -- Integration, Impairment and Restructuring Charges
In April 2001, the company announced a strategic global refocusing of its
manufacturing operations (MSI) to establish a foundation for accelerating the
company's growth initiatives. This second phase of the company's transformation
included creating focused factories for each product line or component,
replacing specific manufacturing processes with state-of-the-art processes
through the company's global supply chain, rationalizing production
to the lowest total cost plants in the company's global manufacturing system
and implementing lean manufacturing process redesign. The company closed its
bearing plants in Columbus, Ohio and Duston, England, sold its tooling plant in
Ashland, Ohio, and reduced employment by 1,824 associates by the end of 2002.
To implement the MSI initiatives during 2001 and 2002, the company incurred
$107.4 million in cumulative impairment, restructuring and reorganization charges
related to MSI and salaried workforce reduction programs.
Impairment and restructuring charges for both the three and six months ended
June 30, 2003 totaled $0.9 million and represented severance for eight former
Timken associates in the Industrial Group and corporate information technology.
As of June 30, 2003, the majority of the remaining accrual balance was paid.
The company continues to evaluate its cost structure and it may take further
rationalization actions in the future.
In the second quarter of 2003, the company incurred total pretax integration and
reorganization charges of $14.8 million, of which $11.4 million relates to the
acquisition of Torrington and $3.4 million is the result of the Duston, England
plant closure. Of this amount, $6.6 million was reported in the company's cost
of products sold and $8.2 million was reported in selling, administrative and
general expenses. Reorganizaiton charges for the quarter ended June 30, 2002
totaled $4.8 million classified as cost of products sold ($2.8 million) and
selling, administrative and general expenses ($2.0 million).
For the six months ended June 30, 2003, the company incurred total pretax
integration and reorganization charges of $23.8 million, of which $20.4 million
relates to the acquisition of Torrington and $3.4 million is the result of the
Duston, England plant closure. Of this amount, $10.3 was reported in the
company's cost of products sold and $13.5 was reported in selling, admini-
strative and general expenses. Reorganization charges for the six months ended
June 30, 2002 totaled $9.9 million, classified as cost of products sold
($5.1 million) and selling, administrative and general expense ($4.8 million).
During the second quarter of 2003, the company reached agreement with a former
joint venture partner in China, whereby a restructuring severance accrual was
reversed as payments were not required to be made. Accordingly, the company
reversed the remaining accrual of $0.9 million to income in the second quarter
of 2003.
For the three months ended June 30, 2002, the company incurred impairment and
restructuring charges of $14.2 million. Impaired asset charges for the Duston
plant closure in the Automotive Group totaled $12.0 million. SFAS No. 88 and
106 curtailments related to certain Ashland plant associates totaled
$1.7 million. The majority of the $0.9 million of restructuring charges for the
Automotive Group related to the Duston plant closure. The majority of the
$0.6 million of restructuring charges for the Industrial Group related to the
Columbus plant closure. The reversal of separation costs totaled ($1.0) million
and related to associates who were previously included in the severance accrual
but for whom severance was not paid as these associates subsequently retired or
found other employment.
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 11.
Continued
Note 8 -- Integration, Impairment and Restructuring Charges (continued)
For the six months ended June 30, 2002, the company incurred impairment and
restructuring charges of $17.3 million. Impaired asset charges for the Duston
plant closure in the Automotive Group totaled $13.0 million. SFAS No. 88 and
106 curtailments related to certain Ashland plant associates totaled
$1.7 million. The majority of the $1.8 million of restructuring charges for the
Automotive Group related to the Duston plant closure. The majority of the
$1.1 million of restructuring charges for the Industrial Group related to the
Columbus plant closure. The reversal of separation costs totaled ($1.0) million
and related to associates who were previously included in the severance accrual
but for whom severance was not paid as these associates subsequently retired or
found other employment. Impaired asset charges for the Duston plant closure in
the Industrial Group totaled $0.5 million. The Steel Group restructuring charges
totaled $0.2 million.
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 12.
Continued
Note 9 -- Segment Information
With the acquisition of Torrington, the company reorganized two of its
reportable segments - the Automotive and Industrial Groups. Timken's automotive
aftermarket business is now part of the Industrial Group, which is managing the
combined distribution operations. The company's sales to emerging markets,
principally in central and eastern Europe and Asia, previously were reported as
part of the Industrial Group. In the first quarter of 2003, emerging market
sales to automotive original equipment manufacturers are now included in the
Automotive Group. The primary measurement used by management to measure the
financial performance of each Group is adjusted EBIT (earnings before interest
and taxes excluding special items such as restructuring, reorganization and
integration costs, one-time gains or losses on sales of assets and allocated
payments received under the Continued Dumping and Subsidy Offset Act (CDSOA)).
The segment results that follow for both 2003 and 2002 reflect the reporting
reorganization described above.
(Thousands of Dollars) Six Months Ended Three Months Ended
June 30 June 30 June 30 June 30
2003 2002 2003 2002
Automotive Group -------- -------- -------- --------
Net sales to external customers $674,654 $379,451 $376,525 $196,053
Depreciation and amortization 30,104 17,193 17,403 8,619
EBIT, as adjusted 15,857 7,494 6,989 35
Industrial Group
Net sales to external customers $694,543 $484,420 $389,580 $251,182
Intersegment sales 346 - 154 -
Depreciation and amortization 26,067 22,782 13,927 11,521
EBIT, as adjusted 48,388 31,070 30,578 19,990
Steel Group
Net sales to external customers $459,063 $412,715 $224,148 $213,594
Intersegment sales 73,556 81,032 32,692 41,759
Depreciation and amortization 32,781 33,880 16,357 16,953
EBIT, as adjusted 3,783 26,687 (2,747) 14,568
Profit Before Taxes
Total EBIT, as adjusted, for reportable
segments 68,028 65,251 34,820 34,593
Impairment and restructuring charges (853) (17,283) (853) (14,226)
Integration/Reorganization expenses (23,831) (9,866) (14,768) (4,822)
Gain (loss) on sale of assets 3,107 - (2,340) -
CDSOA repayment (2,808) - (2,808) -
Acquisition-related unrealized
currency exchange gains 1,930 - 1,930 -
Prior restructuring accrual reversal 942 - 942 -
Interest expense (23,275) (15,924) (13,114) (7,889)
Interest income 418 697 208 317
Intersegment adjustments 1,775 (514) 2,518 (82)
-------- -------- -------- --------
Income before income taxes and
cumulative effect of change in
accounting principle $ 25,433 $ 22,361 $ 6,535 $ 7,891
======== ======== ======== ========
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 13.
Continued
Note 10 - Intangible Assets
The changes in the carrying amount of goodwill and indefinite lived intangible
assets for the six months ended June 30, 2003 are as follows:
(Thousands of Dollars) Balance Balance
12/31/02 Acquisition Other 6/30/03
--------- ----------- ------- ---------
Goodwill:
Automotive $ 1,633 $ 55,954 $ 3,204 $ 60,791
Industrial 119,440 1,710 1,439 122,589
Steel 8,870 - 550 9,420
--------- ---------- -------- ---------
$ 129,943 $ 57,664 $ 5,193 $ 192,800
========= ========== ======== =========
The following table displays intangible assets as of June 30, 2003 and
December 31, 2002:
(Thousands of Dollars) As of June 30, 2003
----------------------------------
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
-------- ------------ --------
Amortized intangible assets:
Automotive customer relationships $ 29,503 $ (1,877) $ 27,626
Automotive unpatented technology 11,616 (387) 11,229
Automotive technology use 10,652 (363) 10,289
Automotive patents 8,784 (307) 8,477
Automotive engineering drawings 2,400 (188) 2,212
Automotive trademarks 321 (137) 184
Industrial customer relationships $ 16,992 $ (283) $ 16,709
Industrial unpatented technology 7,744 (258) 7,486
Industrial patents 5,856 (204) 5,652
Industrial land use rights 3,685 (192) 3,493
Industrial engineering drawings 1,600 (125) 1,475
Industrial trademarks 258 (114) 144
Industrial know-how transfer 417 (355) 62
Steel trademarks $ 428 $ (93) $ 335
-------- ----------- --------
$100,256 $ (4,883) $ 95,373
======== =========== ========
Unamortized intangible assets:
Goodwill $192,800 $ - $192,800
Automotive trade names $ 7,047 $ - $ 7,047
Automotive land use rights 110 - 110
Automotive technology use 580 - 580
Automotive patents 70 70
Industrial trade names $ 3,402 $ - $ 3,402
Industrial license agreements 955 - 955
-------- ----------- --------
$204,964 $ - $204,964
======== =========== ========
Total Intangible Assets $305,220 $ (4,883) $300,337
======== =========== ========
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 14.
Continued
Note 10 - Intangible Assets (continued)
As of December 31, 2002
----------------------------------
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
-------- ------------ --------
Amortized intangible assets:
Industrial trademarks $ 712 $ (213) $ 499
Industrial land use rights 4,484 (905) 3,579
Industrial know-how transfer 417 (341) 76
-------- ----------- --------
$ 5,613 $ (1,459) $ 4,154
======== =========== ========
Unamortized intangible assets:
Goodwill $129,943 $ - $129,943
Automotive land use rights 112 - 112
Industrial license agreements 951 - 951
-------- ----------- --------
$131,006 $ - $131,006
======== =========== ========
Total Intangible Assets $136,619 $ (1,459) $135,160
======== =========== ========
Amortization expense for intangible assets was approximately $2,716,000 for the
three months ended June 30, 2003, and is estimated to be approximately
$8,365,000 annually for the next five fiscal years.
Preliminary goodwill for Torrington is approximately $58.7 million at June 30,
2003. The June 30, 2003 balances for the other intangible assets include a
write-up of approximately $89.1 million based on the preliminary valuation of
the identified intangible assets acquired in the Torrington acquisition.
Note 11 - Equity Investments
The company, prior to the Torrington acquisition, owned equity interests in
certain joint ventures. As part of the Torrington acquisition, several
additional equity interests were acquired. The balances related to investments
accounted for under the equity method are reflected in other assets in the
consolidated condensed balance sheets, which were approximately $150.9 million
and $25.1 million at June 30, 2003 and December 31, 2002, respectively.
In July 2003, the company sold to NSK its interest in a needle bearing
manufacturing venture in Japan that had been operated by NSK and Torrington for
$146 million, which approximated the carrying value at June 30, 2003.
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 15.
Continued
Note 11 - Equity Investments (continued)
The company is a guarantor of $27.5 million in debt for PEL Technologies, LLC
("PEL"). A $23.5 million letter of credit was guaranteed by the company to
secure payment on Ohio Water Development Authority revenue bonds held by PEL,
as well as a guarantee for a $4 million bank loan. In case of default by PEL
on either obligation, the company has agreed to pay existing balances due as of
the date of default. The letter of credit expires on July 22, 2006. The bank
loan obligation expires on the earlier of March 27, 2012 or on the date that PEL
maintains a certain debt coverage ratio for a specified period.
Equity investments are reviewed for impairment when circumstances (such as lower
than expected financial performance or change in strategic direction) indicate
that the net book value of the investment may not be recoverable. If an
impairment does exist, the equity investment is written down to its fair value
with a corresponding charge to the statement of operations.
Note 12 - Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51" (the Interpretation). The Interpretation requires the consolidation of
variable interest entities in which an enterprise absorbs a majority of the
entity's expected losses, receives a majority of the entity's expected residual
returns, or both, as a result of ownership, contractual or other financial
interest in the entity. Currently, entities are generally consolidated by an
enterprise that has a controlling financial interest through ownership of a
majority voting interest in the entity.
During 2000, the company formed a joint venture, PEL Technologies, LLC, ("PEL")
that has developed a proprietary technology that converts iron units into
engineered iron oxides for use in pigments, coatings and abrasives.
The company is a guarantor of $27.5 million in debt for Pel. A $23.5 million
letter of credit was guaranteed by the company to secure payment on Ohio Water
Development Authority revenue bonds held by PEL, as well as a guarantee for a
$4 million bank loan. In case of default by PEL on either obligation, the
company has agreed to pay existing balances due as of the date of default.
The letter of credit expires on July 22, 2006. The bank loan obligation
expires on the earlier of March 27, 2012 or on the date that PEL maintains
a certain debt coverage ratio for a specified period. The company's investment
in PEL totals $17.8 million at June 30, 2003 and is reported in other assets on
the consolidated condensed balance sheet.
PART I. NOTES TO FINANCIAL STATEMENTS (Unaudited) 16.
Continued
Note 12 - Recent Accounting Pronouncements (continued)
Through June 30, 2003, the company recorded its proportional share (20.5%) of
PEL's operating results using the equity method since the company does not own
a majority voting interest in PEL. The company is currently evaluating the
effects of the Interpretation on the accounting for its ownership interest in
PEL. Based on its preliminary analysis, the company has concluded that PEL is
a variable interest entity, but has not yet determined if Timken is the primary
beneficiary, but it is likely that Timken may be the primary beneficiary. As of
June 30, 2003. PEL's assets and long-term debt obligations totaled $58.8 million
and $79.1 million, respectively. As of June 30, 2003, the company estimates
that its maximum exposure to loss as a result of its involvement with PEL ranges
between $15 million and $25 million, net of income taxes.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," which amends and clarifies
financial accounting and reporting for derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities under SFAS No. 133. SFAS No. 149 is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003 except for the provisions that were cleared by
the FASB in prior pronouncements. The company is currently evaluating the
impact of this statement on the financial statements of the company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150 is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. SFAS No. 150 establishes standards for how an
issuer classifies and measures in its statement of financial position certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its
scope as a liability because that financial instrument embodies an obligation
of the issuer. The company does not expect the adoption of this statement to
have a material effect on its financial position or results of operations.
17.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Results of Operations
- ---------------------
The results for both the second quarter of 2003 and the six months ended
June 30, 2003 were significantly impacted by the acquisition of Torrington,
which was acquired on February 18, 2003.
Timken reported net sales of $990.3 million for the second quarter of 2003, an
increase of 49.9% from $660.8 million in the second quarter of 2002. Net sales
for the six months ended June 30, 2003 were $1.83 billion, an increase of 43.2%
from the same period in the prior year. The company reported income before
cumulative effect of change in accounting principle of $3.9 million or $0.05 per
diluted share for the second quarter of 2003, compared to $4.0 million or $0.07
per diluted share in the same quarter a year ago. Income before cumulative
effect of change in accounting principle for the six months ended June 30, 2003
was $15.3 million or $0.19 per diluted share, compared to $13.1 million or $0.22
per diluted share for the same period in the prior year. Results for the
three months ended June 30, 2003 were negatively impacted by high energy and
and raw material costs, and higher pension and benefits costs. Results for the
six months ended June 20, 2002 were negatively impacted by the $12.7 million or
$0.21 per diluted share aftertax cumulative effect of change in accounting
principle related to the adoption of SFAS No. 142, "Goodwill and Other
Intangible Assets."
The Automotive Group benefited from continued strength in light truck production and
new platform launches; however, it was negatively affected by weakening
passenger car production and higher costs associated with the implementation of
the manufacturing strategy and rationalization programs. The Industrial Group's
results were favorably impacted by growth in its automotive distribution
business and improved pricing, partially offset by persistent weakness in the
industrial sector and high levels of distributor inventories for Torrington
industrial products. The Steel Group's results were negatively impacted by
high raw material and energy costs, increased costs for pensions and benefits,
and a decline in margins due to a change in product mix.
In the second quarter of 2003, the company incurred total pretax integration and
reorganization charges of $14.8 million, of which $11.4 million relates to the
acquisition of Torrington and $3.4 million is the result of the Duston, England
plant closure. Of the $14.8 million, $6.6 million was reflected in the
company's cost of products sold and $8.2 million was reflected in selling,
administrative and general expenses for the quarter. Additionally, results for
both the three months and six months ended June 30, 2003 included $0.9 million in
impairment and restructuring charges. Operating income for the second quarter
of 2002 included $14.2 million for impairment and restructuring charges and
$4.8 million for reorganization charges. For the six months ended June 30, 2003,
the company incurred total pretax integration and reorganization charges of
$23.8 million, of which $20.4 million relates to the acquisition of Torrington
and $3.4 million is the result of the Duston, England plant closure. For the six
months ended June 30, 2002, operating income included $17.3 million for impairment
and restructuring charges and $9.9 million for reorganization charges.
18.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
Gross profit was $158.1 million (16.0% of net sales) in the second quarter of
2003, compared to $124.3 million (18.8% of net sales) in the second quarter of
2002. Gross profit in the second quarter of 2003 was negatively impacted by
high energy and raw material costs, higher costs associated with the
implementation of the manufacturing strategy and rationalization programs in the
company's Automotive Group, lower volume in the Industrial Group due to high
levels of distributor inventories for Torrington products, and higher pension
and benefits costs. Second quarter 2003 gross profit was also negatively
impacted by an additional expense of $2.8 million in cost of products sold
resulting from the one-time write-up of inventories acquired in the Torrington
acquisition required by purchase accounting rules, and $3.4 million in costs
related to the Duston, England plant closure. Reorganization charges included
in gross profit for the second quarter of 2002 were $2.8 million. Gross profit
was $288.3 million (15.8% of net sales) for the six months ended June 30, 2003,
compared to $242.9 million (19.0% of net sales) for the same period in the prior
year. For the six months ended June 30, 2003, gross profit included integration
charges of $6.9 million related to the Torrington acquisition, of which
$6.3 million related to the one-time write-up of Torrington inventory, and
$3.4 million related to reorganization costs for the Duston, England site
closure. Reorganization charges included in gross profit for the six months
ended June 30, 2002 were $5.1 million.
Selling, administrative and general expenses were $135.2 million (13.7% of net
sales) in the second quarter of 2003 compared to $93.0 million (14.1% of net
sales) in the same period a year ago. Although the amount of selling,
administrative and general expenses increased in the second quarter of 2003
compared to the same period a year ago, the expenses as a percentage of net
sales decreased due to higher sales volume. The increase in the total dollar
amount of selling, administrative and general expenses resulted from the
addition of Torrington's financial results, costs incurred in connection with
the acquisition and integration of Torrington, and the impact of currency
exchange rates. This increase was partially offset by a decrease in selling,
administrative and general expenses related to Timken's business cost reductions
achieved through manufacturing strategy initiative ("MSI") and salaried
workforce reduction initiatives. Selling, administrative and general expenses
in the second quarter of 2003 included $8.2 million of integration expenses
related to the Torrington acquisition. The second quarter 2002 selling
administrative and general expenses included reorganization charges of
$2.0 million. Selling, administrative and general expenses were $240.5 million
(13.2% of net sales) for the six months ended June 30, 2003, compared to
$179.0 million (14.0% of net sales) recorded in the same period a year ago.
Selling, administrative and general expenses for the six months ended June 30,
2003 included $13.5 million of integration expenses related to the Torrington
acquisition. The six months ended June 30, 2002 selling, administrative and
general expenses included reorganization charges of $4.8 million.
19.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
Impairment and restructuring charges for both the three months and six months
ended June 30, 2003 totaled $0.9 million, representing severance payments to
former employees in the Industrial Group and corporate information technology.
Second quarter of 2002 impairment and restructuring charges of $14.2 million
were comprised of ($0.1) million for separation costs, $0.6 million for exit
costs, $12.0 million for asset impairment charges for the Duston, England plant
closure, as well as $1.7 million for SFAS No. 88 and 106 curtailments resulting
from the sale of the Ashland, Ohio plant. For the six months ended June 30,
2002, impairment and restructuring charges of $17.3 million were comprised of
$1.0 million for separation costs, $1.1 million for exit costs, $13.0 million
for asset impairment charges for the Duston, England plant closure, $0.5 million
for asset impairment charges for the Columbus, Ohio plant closure, and
$1.7 million for SFAS No. 88 and 106 curtailments resulting from the sale of the
Ashland, Ohio plant.
Second quarter 2003 interest expense of $13.1 million increased by $5.2 million
from the second quarter of 2002. For the six months ended June 30, 2003,
interest expense of $23.3 million increased by $7.4 million from the same period
of the prior year. The increases for both time periods are primarily due to the
additional debt incurred as a result of the Torrington acquisition.
Second quarter 2003 other income (expense) of ($2.6) million increased by
($1.0) million from ($1.6) million in the second quarter of 2002. Second
quarter 2003 other income (expense) includes a one-time repayment of a portion
of 2002 antidumping receipts received under the U.S. Continued Dumping and
Subsidy Offset Act (CDSOA), losses from equity investments, and loss on the sale
of assets at the Duston England plant, partially offset by acquisition-related
currency exchange gains. The second quarter 2002 other income (expense)
included loss on the sale of assets and losses from equity investments,
partially offset by currency exchange gains. For the six months ended June 30,
2003, other income (expense) was $1.3 million and included a one-time gain of
$5.4 million related to the sale of property in the United Kingdom in addition
to the second quarter 2003 items. For the six months ended June 30, 2002,
other income (expense) was ($9.1) million and included loss on sale of assets,
loss on equity investments and currency exchange losses.
The effective tax rates were 40.0% and 41.2% for the six months ended June 30,
2003 and 2002, respectively. The effective tax rates for both the three months
and six months ended June 30, 2003 and 2002, respectively, exceeded the U.S.
statutory tax rate primarily due to losses at certain foreign operations in
which the realization of the tax benefit of these losses is not likely to occur,
as well as taxes paid to state and local jurisdictions.
With the acquisition of Torrington, the company reorganized two of its
reportable segments - Automotive and Industrial Groups. Timken's automotive
aftermarket business is now part of the Industrial Group, which is managing the
combined distribution operations. The company's sales to emerging markets,
principally in central and eastern Europe and Asia, previously were reported as
part of the Industrial Group. Beginning in the first quarter of 2003, emerging
market sales to automotive original equipment manufacturers are now included in
the Automotive Group. The primary measurement used by management to measure the
financial performance of each Group is adjusted EBIT (earnings before interest
and taxes excluding special items such as impairment and restructuring,
reorganization and integration costs, one-time gains or losses on sales of
assets, allocated payments received under CDSOA, and other items similar in
20.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
nature). The segment results that follow for both 2003 and 2002 reflect the
reporting reorganization described above.
Automotive Group
The Automotive Group includes sales of bearings and other products and services
(not including steel) to automotive original equipment manufacturers. The
Automotive Group net sales for the second quarter of 2003 increased 92.1% to
$376.5 million from $196.1 million in the second quarter of 2002. The majority
of the increase between periods resulted from the acquisition of Torrington.
The Automotive Group also benefited from continued strength in light truck
production and new platform launches; however, it was negatively affected by
weakening passenger car production. Net sales for the six months ended June 30,
2003 increased 77.8% to $674.7 million from $379.5 million from the same period
in the prior year. For the remainder of 2003, the company expects some
softening in the North American production of automotive light vehicles,
particularly passenger cars, compared to the second half of 2002.
The Automotive Group had adjusted EBIT of $7.0 million in the second quarter of
2003, compared to a breakeven in the second quarter of 2002. The Automotive
Group's second quarter 2003 adjusted EBIT was favorably impacted by the
Torrington acquisition and new platform launches. However, the Automotive
Group's adjusted EBIT was negatively affected by inefficiencies related to the
implementation of MSI, weakening passenger car production, and increases in
pension and benefit expenses. Problems in implementing the Timken manufacturing
strategy and suspension by Torrington of a rationalization program during the
acquisition process, prior to the February 2003 acquisition of Torrington by
Timken, delayed the benefits expected from these initiatives. For the six
months ended June 30, 2003, adjusted EBIT was $15.9 million compared to
$7.5 million in the same period of the prior year.
In the second quarter of 2003, the Automotive Group's selling, administrative
and general expenses were $18.7 million higher compared to the same period a
year ago, although as a percentage of net sales, the selling, administrative and
general expenses decreased by 1.2%, compared to the second quarter of 2002. This
was primarily the result of the additional selling, administrative and general
expenses incurred as a result of the acquisition of Torrington, the impact of
currency exchange rates and higher expenses associated with new product develop-
ment. For the six months ended June 30, 2003, the Automotive Group's selling,
administrative and general expenses were $23.6 million higher compared to the
same period a year ago, although as a percentage of net sales, the selling,
administrative and general expenses decreased by 1.0%, compared to the first half
of 2002.
Industrial Group
The Industrial Group has global sales of bearings and other products and
services (not including steel) to a diverse customer base. These include:
industrial equipment, off-highway, rail and aerospace and defense customers.
The Industrial Group also includes the financial results for Timken's
distribution operations for products other than steel. The Industrial Group's
net sales, including intersegment sales, for the second quarter of 2003 were
$389.7 million, an increase of 55.2% over the second quarter 2002 net sales of
$251.2 million. The majority of the increase between periods resulted from the
acquisition of Torrington. The Industrial Group results were also favorably
impacted by growth in its automotive distribution business and improved pricing,
partially offset by persistent weakness in the industrial sector and high levels
21.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
of distributor inventories for Torrington industrial products. Net sales,
including intersegment sales, for the six months ended June 30, 2003 increased
43.5% to $694.9 million from $484.4 million from the same period in the prior
year. Intersegment sales represent sales of bearings and services to the Steel
Group. For the remainder of 2003, the company expects that general industrial
demand will remain flat.
For the second quarter of 2003, Industrial Group adjusted EBIT was $30.6 million,
up from $20.0 million in the second quarter of 2002. The increase in adjusted
EBIT is the result of growth in the automotive distribution businesses,
improved pricing and the exiting of low-margin business, partially offset by
persistent weakness in the industrial sector, increased costs for pensions and
benefits, and high levels of distributor inventories for Torrington industrial
products. For the six months ended June 30, 2003, adjusted EBIT was
$48.4 million compared to $31.1 million in the same period of the prior year.
In the second quarter of 2003, the Industrial Group's selling, administrative
and general expenses were $20.8 million higher compared to the same period a
year ago, although as a percentage of net sales, the selling, administrative and
general expenses decreased by 0.8%, compared to the second quarter of 2002. This
was primarily the result of additional selling, administrative and general expenses
incurred as a result of the acquisition of Torrington and the impact of currency
exchange rates. For the six months ended June 30, 2003, the Industrial Group's
selling, administrative and general expenses were $33.2 million higher compared to
the same period a year ago, although as a percentage of net sales, the selling,
administrative and general expenses decreased by 0.4% compared to the first half
of 2002.
Steel Group
The Steel Group's net sales, including intersegment sales, for the second
quarter of 2003 increased 0.6% to $256.8 million from $255.4 million in the
second quarter of 2002. Sales to general industrial customers increased in the
second quarter of 2003 compared to the same period a year ago as the Steel
Group gained market share from its competition as the industry continued to
restructure. These gains were mostly offset, however, as sales to automotive
customers decreased during the second quarter of 2003 from the same period in
the prior year and sales to the bearing industry continue to be weak. Second
quarter 2003 oil country sales more than doubled from the same period a year
ago, although these sales represent a small percentage of Steel Group sales.
Shipments to steel service centers and tool steel customers in the second
quarter of 2003 increased from the second quarter of 2002, but continue to be
weak as a result of the low overall industrial production. Steel Group results
reflect the effects of continued weakness in the aerospace sector as a majority
of the Steel Group demand relates to commercial airline applications. Net
sales, including intersegment sales, for the six months ended June 30, 2003
increased 7.9% to $532.6 million from $493.7 million from the same period in
the prior year.
Adjusted EBIT (loss) for the Steel Group was ($2.7) million in the second
quarter of 2003, compared to $14.6 million in the second quarter of 2002. The
Steel Group's results were negatively impacted by high raw material and energy
costs, increased costs for pensions and benefits, and a decline in margins due
to a change in product mix. Plant operations were intermittently curtailed to
avoid extremely high energy costs and to reduce inventories to improve working
capital. Steps were also taken to recover a portion of high raw material and
energy costs through surcharges and price increases. The company does not
expect these actions to fully offset these higher costs for the remainder of the
year as market prices for steel continue to be under pressure. For the six
22.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
months ended June 30, 2003, adjusted EBIT was $3.8 million compared to
$26.7 million in the same period of the prior year. For the remainder of 2003,
the company expects raw material and energy costs to be high relative to both
the first half of 2003 and the second half of 2002.
Selling, administrative and general expenses for the Steel Group in the second
quarter of 2003 were $3.4 million lower than the first quarter of 2002,
primarily due to the Steel Group's continued focus on cost reductions. For the
six months ended June 30, 2003, the Steel Group's selling, administrative and
general expenses were $4.1 million lower compared to the same period in the prior year.
Financial Condition and Cash Flows
- ----------------------------------
Total assets as shown on the Consolidated Condensed Balance Sheets increased by
approximately $1.3 billion from December 31, 2002. The majority of this
increase related to the acquisition of Torrington, which was purchased for
$840 million, before expenses and certain post-closing adjustments. Inventory
balances at the end of the second quarter of 2003 increased approximately 52%
compared to year-end 2002 levels. Although the Steel Group inventory balance
decreased as a result of managing production in accordance with demand and the
change in the sales mix between bars and tubing, this was more than offset by
the increase in the Automotive and Industrial Groups' inventory balances as of
June 30, 2003. The increase in these inventories was primarily due to the
Torrington acquisition and the impact of currency exchange rate changes. In
addition, Automotive Group inventory levels increased as a result of the
anticipated changes in customer demand and capacity constraints arising from
the manufacturing rationalization. Accounts receivable have increased by
$249.4 million since December 31, 2002. The increase is due primarily to the
acquisition of Torrington and the impact of currency exchange rate changes.
Property, plant and equipment increased $423.9 million to $1.65 billion at
June 30, 2003 due primarily to the Torrington acquisition. The June 30, 2003
balance includes a write-up of $110.7 million based on a preliminary valuation
of the fixed assets acquired in the Torrington acquisition. Goodwill increased
$62.9 million to $192.8 million at June 30, 2003, primarily as a result of the
preliminary purchase price allocation for the Torrington acquisition.
Preliminary estimates of goodwill for the Torrington acquisition was
$58.7 million at June 30, 2003. Intangible assets, excluding goodwill and
intangible pension asset, increased $102.3 million to $107.5 million at June 30,
2003 primarily as a result of intangible assets acquired in the Torrington
acquisition. Intangible assets at June 30, 2003 include a write-up of
$89.1 million based on the preliminary valuation of the identified intangible
assets acquired in the Torrington acquisition.
23.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
Other assets increased by $190.9 million to $311.5 million as of June 30, 2003
due principally to other assets acquired in the acquisition of Torrington.
These amounts are based on the preliminary purchase price allocation that will
be finalized during 2003, as asset valuations are completed. Prior to the
Torrington acquisition, Timken owned equity interests in certain joint ventures.
As part of the Torrington acquisition, several additional equity interests were
acquired. The balances related to investments accounted for under the equity
method are reflected in other assets in the consolidated condensed balance
sheets, and were approximately $150.9 million and $25.1 million at June 30,
2003 and December 31, 2002, respectively. In July 2003, the company, for
$146 million, sold to NSK its interest in a needle bearing manufacturing venture
in Japan that had been operated by NSK and Torrington. The sale price
approximated the carrying value of this investment, net of taxes. In addition,
the company and NSK reached an agreement to jointly serve certain Japan-based
auto manufacturers and their principal suppliers with engineering solutions based
on needle bearings and related services. Equity investments are reviewed for
impairment when circumstances (such as lower than expected financial performance
or change in strategic direction) indicate that the net book value of the
investment may not be recoverable. If an impairment does exist, the equity
investment is written down to its fair value with a corresponding charge to the
statement of operations.
Accounts payable and other liabilities increased $215.5 million to
$512.0 million at June 30, 2003 as a result of payables assumed in the acquisition
of Torrington, as well as timing of payments to suppliers. Accrued expenses
increased $55.0 million to $281.4 million at June 30, 2003, primarily as a
result of amounts assumed in the acquisition of Torrington.
Long-term accrued pension cost decreased by $23.8 million to $699.4 million at
June 30, 2003. The impact of the additional pension liability resulting from
the Torrington acquisition was more than offset by pension contributions
totaling $68.0 million. Postretirement benefits costs increased by
$82.8 million to $494.1 million at June 30, 2003 primarily due to the additional
liability incurred for plans related to active employees as a result of the
Torrington acquisition.
As shown on the Consolidated Condensed Statement of Cash Flows, the increase in
inventories used $18.7 million of cash during the first six months of 2003.
The increase in accounts receivable used $39.2 million of cash during the first
six months of 2003. Also, foreign currency translation used $9.7 million of
cash during the first six months of 2003. Accounts payable and accrued expenses
generated $1.4 million of cash during the first six months of 2003, primarily
as a result of increased payables resulting from Torrington since the date of
acquisition and the timing of payments to suppliers. In addition, accrued
expenses were affected by the timing of pension contributions made in the
first six months of 2003, compared to the first six months of 2002. Capital
expenditures used $51.7 million of cash in the first six months of 2003,
compared to $34.9 million in the first six months of 2002. The company expects
capital expenditures to continue to be higher in 2003 as a result of the
Torrington acquisition and new product development, although the company will
continue to focus on further efficiency and productivity.
24.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
The 51.2% debt-to-capital ratio at June 30, 2003 was higher than the
43.1% at year-end 2002. Total debt increased by $556.2 million during the
first six months to $1.02 billion at June 30, 2003. The increase was primarily
due to the $520 million of debt incurred as a result of the Torrington
acquisition. The components of the debt resulting from the acquisition were:
$250 million of seven-year unsecured notes; $145 million drawn from the new
$500 million five-year senior credit facility; and a $125 million asset
securitization facility put in place at the end of 2002 and drawn down in full
in connection with the Torrington acquisition, which is included in short-term
debt on the condensed consolidated balance sheet. Proceeds from the
acquisition financing were also used to repay outstanding commercial paper at
the date of the acquisition. The remaining increase in debt was used to fund
working capital and capital expenditures. The company expects that any cash
requirements in excess of cash generated from operating activities will be met
by the remaining availability under the senior credit facility. In July 2003,
the company's cash position was favorably affected by the sale of its interest
in NTC, a joint venture with Japan-based NSK Ltd (NSK). The company received
approximately $146 million in cash, pre-tax, which it has used to pay down debt
under the senior credit facility.
Under the $500 million senior credit facility, the company has three financial
covenants: consolidated net worth; leverage ratio; and fixed charge coverage
ratio. These financial covenants became effective for the second quarter
ending on June 30, 2003. At June 30, 2003, the company was in compliance with
the covenants under its senior credit facility and its other debt agreements.
The company's contractual debt obligations and contractual commitments
outstanding as of June 30, 2003 are as follows (in millions):
Payments Due by Period
Total Less than 1 1-3 years 4-5 After 5
Year Years Years
------- ----------- ---------- ------- --------
Long-term Debt $619.5 - $10.3 $121.1 $488.1
Senior Credit Facility $125.0 - - $125.0 -
Asset Securitization $125.0 $125.0 - - -
Other Lines of Credit $147.9 $147.9 - - -
Operating Leases $44.1 $10.3 $12.6 $6.2 $15.0
Supply Agreement $17.4 $7.1 $10.3 - -
The company's capital lease obligations are immaterial. At June 30, 2003, the
company had available $310.9 million through a $500 million five-year senior
credit facility with a syndicate of financial institutions. The company's
previous senior credit facility of $300 million, which would have expired in
June of 2003, was terminated in February of 2003 in connection with the
Torrington acquisition. The company is the guarantor of $27.5 million in debt
for PEL Technologies, LLC, an equity investment of the company, and an operating
lease of a subsidiary's warehouse facility, which had future rental commitments
of $16.3 million at June 30, 2003. In connection with the sale of the company's
Ashland tooling plant in 2002, the company entered into a $25.9 million
four-year supply agreement, which expires on June 30, 2006 pursuant to which
the company purchases tooling from Ashland.
25.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
Total shareholders' equity increased by approximately $361.8 million since
December 31, 2002, primarily as a result of the issuance of 22 million shares
valued at approximately $320 million to finance the Torrington acquisition.
Other significant factors affecting shareholders' equity were net income of
$15.3 million, a favorable non-cash foreign currency translation adjustment of
$42.1 million, partially offset by payment of dividends of $19.4 million.
For the six months ended June 30, 2003, shareholders' equity was positively
impacted by the effect of currency exchange rates, primarily due to the
strength of the Euro.
During the first six months of 2003, the company did not purchase any shares
of its common stock to be held in treasury as authorized under the company's
2000 common stock purchase plan. This plan authorizes the company to buy in
the open market or in privately negotiated transactions up to four million
shares of common stock, which are to be held as treasury shares and used for
specified purposes. The company may exercise this authorization until
December 31, 2006. The company does not expect to be active in repurchasing
shares under this plan in the near-term.
Other Information
- -----------------
Assets and liabilities of subsidiaries (other than Timken Romania, which is
considered to operate in a highly inflationary economy) are translated at the
rate of exchange in effect on the balance sheet date; income and expenses are
translated at the average rates of exchange prevailing during the quarter.
Related translation adjustments are reflected as a separate component of
accumulated other comprehensive loss. Foreign currency gains and losses
resulting from transactions and the translation of financial statements are
included in the consolidated results of operations.
Foreign currency exchange gains (losses) included in the company's operating
results for the first six months of 2003 totaled $3.0 million, of which
$1.9 million relates to acquisition-related unrealized exchange gains, compared
to ($0.6) million during the first six months of 2002. Also, for the first six
months of 2003, the company recorded a positive non-cash foreign currency
translation adjustment of $42.1 million that increased shareholders' equity,
compared to a positive non-cash foreign currency translation adjustment of
$5.6 million that increased shareholders' equity in the first six months of
2002. The first six months of 2003 was positively impacted by the effect of
currency exchange rates, primarily the strength of the Euro.
On August 6, 2003, the board of directors declared a quarterly cash dividend
of $0.13 per share, payable on September 3, 2003 to shareholders of record as
of August 18, 2003. This will be the 325th consecutive dividend paid on the
common stock of the company.
The company reviews its critical accounting policies throughout the year.
The company has concluded that there have been no changes to its critical
accounting policies during the six months ended June 30, 2003.
26.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
Recent Accounting Pronouncements
- --------------------------------
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51" (the Interpretation). The Interpretation requires the consolidation of
variable interest entities in which an enterprise absorbs a majority of the
entity's expected losses, receives a majority of the entity's expected residual
returns, or both, as a result of ownership, contractual or other financial
interest in the entity. Currently, entities are generally consolidated by an
enterprise that has a controlling financial interest through ownership of a
majority voting interest in the entity.
During 2000, the company formed a joint venture, PEL Technologies, LLC, ("PEL")
that has developed a proprietary technology that converts iron units into
engineered iron oxides for use in pigments, coatings and abrasives.
The company is a guarantor of $27.5 million in debt for PEL. A $23.5 million
letter of credit was guaranteed by the company to secure payment on Ohio Water
Development Authority revenue bonds held by PEL, as well as a guarantee for a
$4 million bank loan. In case of default by PEL on either obligation, the
company has agreed to pay existing balances due as of the date of default.
The letter of credit expires on July 22, 2006. The bank loan obligation
expires on the earlier of March 27, 2012 or on the date that PEL maintains a
certain debt coverage ratio for a specified period. The company's investment
in PEL totals $17.8 million at June 30, 2003 and is reported in other assets on
the consolidated condensed balance sheet.
Through June 30, 2003, the company recorded its proportional share (20.5%) of
PEL's operating results using the equity method since the company does not own
a majority voting interest in PEL. The company is currently evaluating the
effects of the Interpretation on the accounting for its ownership interest in
PEL. Based on its preliminary analysis, the company has concluded that PEL is
a variable interest entity, but has not yet determined if Timken is the primary
beneficiary, but it is likely that Timken may be the primary beneficiary. As of
June 30, 2003. PEL's assets and long-term debt obligations totaled $58.8 million
and $79.1 million, respectively. As of June 30, 2003, the company estimates
that its maximum exposure to loss as a result of its involvement with PEL ranges
between $15 million and $25 million, net of income taxes.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," which amends and clarifies
financial accounting and reporting for derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered
into or modified after June 30, 2003 and for hedging relationships designated
after June 30, 2003, except for the provisions that were cleared by the FASB in
prior pronouncements. The company is currently evaluating the impact of this
statement on the financial statements of the company.
27.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. SFAS No. 150 establishes standards for how an
issuer classifies and measures in its statement of financial position certain
financial instruments with characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that is within its
scope as a liability because that financial instrument embodies an obligation
of the issuer. The company does not expect the adoption of this statement to
have a material effect on its financial position or results of operations.
Certain statements set forth in this document (including the company's
forecasts, beliefs and expectations) that are not historical in nature are
"forward-looking" statements within the meaning of the Private Securities
Litigation Reform Act of 1995. The company cautions readers that actual results
may differ materially from those projected or implied in forward-looking
statements made by or on behalf of the company due to a variety of important
factors, such as:
a) risks associated with the acquisition of Torrington, including the
uncertainties in both timing and amount of actual benefits, if any, that
may be realized as a result of the integration of the Torrington business
with the company's operations and the timing and amount of the resources
required to achieve those benefits; risks associated with diversion of
management's attention from routine operations during the integration
process; and risks associated with the higher level of debt associated
with the acquisition.
b) changes in world economic conditions, including additional adverse effects
from terrorism or hostilities. This includes, but is not limited to,
political risks associated with the potential instability of governments
and legal systems in countries in which the company or its customers conduct
business and significant changes in currency valuations.
c) the effects of changes in customer demand on sales, product mix and prices
in the industries in which the company operates. This includes the effects
of customer strikes, the impact of changes in industrial business cycles and
whether conditions of fair trade continue in the U.S. market.
d) competitive factors, including changes in market penetration, increasing
price competition by existing or new foreign and domestic competitors, the
introduction of new products by existing and new competitors and new
technology that may impact the way the company's products are sold or
distributed.
e) changes in operating costs. This includes the effect of changes in the
company's manufacturing processes; changes in costs associated with varying
levels of operations; changes resulting from inventory management and cost
reduction initiatives and different levels of customer demands; the effects
of unplanned work stoppages; changes in the cost of labor and benefits; and
the cost and availability of raw materials and energy.
28.
Management's Discussion and Analysis of Financial Condition and Results of
Operations (continued)
f) the success of the company's operating plans, including its ability to
achieve the benefits from its global restructuring, manufacturing
transformation, and administrative cost reduction initiatives as well as
its ongoing continuous improvement and rationalization programs; the
ability of acquired companies to achieve satisfactory operating results;
and its ability to maintain appropriate relations with unions that
represent company associates in certain locations in order to avoid
disruptions of business.
g) unanticipated litigation, claims or assessments. This includes, but is not
limited to, claims or problems related to intellectual property, product
liability or warranty and environmental issues.
h) changes in worldwide financial markets, including interest rates to the
extent they affect the company's ability to raise capital or increase
the company's cost of funds, have an impact on the overall performance of
the company's pension fund investments and/or cause changes in the economy
which affect customer demand.
i) additional factors described in greater detail on pages S-20 to S-28 in:
the company's Registration Statement and included Prospectus Supplement
dated February 12, 2003 relating to the offering of the company's 5.75%
notes due 2010; the company's Annual Report on Form 10-K for the year
ended December 31, 2002; the company's Annual Report; or the company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003.
Additional risks relating to the company's business, the industries in which
the company operates or the company's common stock may be described from time
to time in the company's filings with the SEC. All of these risk factors are
difficult to predict, are subject to material uncertainties that may affect
actual results and may be beyond the company's control.
Except as required by the federal securities laws, the company undertakes no
obligation to publicly update or revise any forward-looking statement, whether
as a result of new information, future events or otherwise.
29.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Refer to information appearing under the caption "Management's
Discussion and Analysis of Financial Condition and Results of
Operations" on pages 17-28 of this Form 10-Q. Furthermore, a
discussion of market risk exposures is included in Part II,
Item 7A, "Quantitative and Qualitative Disclosure about Market
Risk," of the Company's 2002 Annual Report on Form 10-K. There
have been no material changes in reported market risk since the
inclusion of this discussion in the Company's 2002 Annual Report
on Form 10-K referenced above.
Item 4. Controls and Procedures
As of the end of the period covered by this report, the Company
carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's
principal executive officer and principal financial officer, of the
effectiveness of the design and operation of the Company's disclosure
controls and procedures pursuant to Exchange Act rule 13a-14. Based
upon that evaluation, the principal executive officer and principal
financial officer concluded that the Company's disclosure controls
and procedures were effective as of June 30, 2003. There have been
no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent
to June 30, 2003.
30.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
The company is normally involved in various claims and legal actions
arising in the ordinary course of its 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 2. Changes in Securities
(a) Between April 1, 2003 and May 16, 2003, the date of filing the
registration statement on Form S-8 for the Timken Share Incentive
Plan (the "Plan"), established and administered in accordance
with the laws of England and Wales, the trustee of the Plan
purchased 171 shares of the company's common stock in the open
market on behalf of persons not resident in the United States who
are employed by subsidiaries of the company. The purchases were
made in reliance on the off-shore nature of the offering for an
aggregate consideration of approximately $3,000.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a). Exhibits
11 Computation of Per Share Earnings
12 Computation of Ratio of Earnings to Fixed Charges
31.1 Certification of James W. Griffith, President and Chief
Executive Officer of The Timken Company, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Glenn A. Eisenberg, Executive Vice
President-Finance and Administration (principal financial
officer) of The Timken Company, pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32 Certifications of James W. Griffith, President and Chief
Executive Officer, and Glenn A. Eisenberg, Executive Vice
President-Finance and Administration (principal financial
officer) of The Timken Company pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
On July 24, 2003, the company filed a Form 8-K regarding Results
of Operations and Financial Condition, which contained a press
release announcing the company's second quarter of 2003 results.
31.
(b) Reports on Form 8-K (continued):
On July 3, 2003, the company filed a Form 8-K regarding Other
Events and Regulation FD Disclosure, which contained a press
release announcing that the company reached an agreement to
sell its interest in a needle bearing manufacturing venture in
Japan to NSK.
On April 30, 2003, the company filed a Form 8-K regarding
Results of Operations and Financial Condition, which contained
information regarding the company's reorganization of its
Automotive and Industrial Groups.
On April 28, 2003, the company filed a Form 8-K regarding
Results of Operations and Financial Condition, which contained
a press release announcing the company's first quarter results.
32.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
The Timken Company
_______________________________
Date August 14, 2003 BY /s/ James W. Griffith
________________________ _______________________________
James W. Griffith
President and Chief Executive Officer,
and Director
Date August 14, 2003 BY /s/ Glenn A. Eisenberg
________________________ _______________________________
Glenn A. Eisenberg
Executive Vice President - Finance and
Administration