Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Dollars in millions, except per share data)
OVERVIEW
Introduction:
The Timken Company designs and manufactures a growing portfolio of engineered bearings and power transmission products. With more than a century of knowledge and innovation, the Company continuously improves the reliability and efficiency of global machinery and equipment to move the world forward. Timken posted $4.1 billion in sales in 2021 and employs more than 18,000 people globally, operating in 42 countries. The Company operates under two reportable segments: (1) Mobile Industries and (2) Process Industries. The following further describes these business segments:
• Mobile Industries serves OEM customers that manufacture off-highway equipment for the agricultural, mining and construction markets; on-highway vehicles including passenger cars, light trucks, and medium- and heavy-duty trucks; rail cars and locomotives; outdoor power equipment; rotorcraft and fixed-wing aircraft; and other mobile equipment. Beyond service parts sold to OEMs, aftermarket sales and services to individual end users, equipment owners, operators and maintenance shops are handled directly or through the Company's extensive network of authorized automotive and heavy-truck distributors.
• Process Industries serves OEM and end-user customers in industries that place heavy demands on the fixed operating equipment they make or use in heavy and other general industrial sectors. This includes metals, cement and aggregate production; power generation and renewable energy sources; oil and gas extraction and refining; pulp and paper and food processing; automation and robotics; and health and critical motion control equipment. Other applications include marine equipment, gear drives, cranes, hoists and conveyors. This segment also supports aftermarket sales and service needs through its global network of authorized industrial distributors and through the provision of services directly to end users.
Timken creates value by understanding customer needs and applying its know-how to serve a broad range of customers in attractive markets and industries across the globe. The Company’s business strengths include its product technology, end-market diversity, geographic reach and aftermarket mix. Timken collaborates with OEMs to improve equipment efficiency with its engineered products and captures subsequent equipment replacement cycles by selling largely through independent channels in the aftermarket. Timken focuses its international efforts and footprint in regions of the world where strong macroeconomic factors such as urbanization, infrastructure development and sustainability create demand for its products and services.
The Company's strategy has three primary elements:
Profitable Growth. The Company intends to expand into new and existing markets by leveraging its collective knowledge of metallurgy, friction management and power transmission to create value for Timken customers. Using a highly collaborative technical selling approach, the Company places particular emphasis on creating unique solutions for challenging and/or demanding applications. The Company intends to grow in attractive market sectors around the world, emphasizing those spaces that are highly fragmented, demand high service and value the reliability and efficiency offered by Timken products. The Company also targets applications that offer significant aftermarket demand, thereby providing product and services revenue throughout the equipment’s lifetime.
Operational Excellence. Timken operates with a relentless drive for exceptional results and a passion for superior execution. The Company embraces a continuous improvement culture that is charged with increasing efficiency, lowering costs, eliminating waste, encouraging organizational agility and building greater brand equity to fuel growth. This requires the Company’s ongoing commitment to attract, retain and develop the best talent across the world.
Capital Deployment to Drive Shareholder Value. The Company is intently focused on providing the highest returns for shareholders through its capital allocation framework, which includes: (1) investing in the core business through capital expenditures, research and development and initiatives to drive profitable organic growth; (2) pursuing strategic acquisitions to broaden its portfolio and capabilities across diverse markets, with a focus on bearings, adjacent power transmission products and related services; (3) returning capital to shareholders through dividends and share repurchases; and (4) maintaining a strong balance sheet and sufficient liquidity. As part of this framework, the Company may also restructure, reposition or divest underperforming product lines or assets.
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RESULTS OF OPERATIONS
2021 vs. 2020
Overview:
2021 2020 $ Change % Change
Net sales $ 4,132.9 $ 3,513.2 $ 619.7 17.6 %
Net income 381.5 292.4 89.1 30.5 %
Net income attributable to noncontrolling interest 12.4 7.9 4.5 57.0 %
Net income attributable to The Timken Company $ 369.1 $ 284.5 $ 84.6 29.7 %
Diluted earnings per share $ 4.79 $ 3.72 $ 1.07 28.8 %
Average number of diluted shares 77,006,589 76,401,366 — 0.8 %
The increase in net sales was primarily driven by higher organic volume revenue across most market sectors, including positive pricing, the favorable impact of foreign currency exchange rate changes and the benefit of acquisitions. The increase in net income was primarily due to the favorable impact of higher volume and related manufacturing utilization, lower restructuring charges and a lower tax rate, partially offset by higher material, logistics and other operating costs. In addition, the impact of foreign currency exchange rate changes was favorable versus the same period a year-ago.
Outlook:
The world continues to be impacted by the COVID-19 pandemic. Timken has implemented plans across the enterprise to operate in a safe manner, while protecting employees and adhering to mandates and other guidance from local governments and health authorities. The Company's main priority continues to be the health of its employees and others in the communities where it does business.
With pandemic conditions generally improving across the globe, industrial markets have strengthened in most parts of the world, and the Company has experienced supply chain disruptions, inflation and staffing issues related to serving the increased customer demand. During 2021, Timken was able to serve customers and meet demand levels across most markets, although at higher costs than anticipated. Timken's outlook assumes that COVID-19 conditions will continue to improve, but that supply chain disruptions and inflationary pressures will largely persist throughout 2022.
The Company expects 2022 full-year revenue to be up approximately 10% compared to 2021, primarily due to higher demand across most end markets, positive pricing and the execution of outgrowth initiatives. The Company's earnings are expected to be up in 2022 compared with 2021, primarily due to the favorable impact of higher volume and price/mix, partially offset by higher material, logistics and other operating costs.
The Company expects to generate cash from operating activities in 2022 above 2021 levels driven by higher earnings and lower pension and other postretirement contributions and payments. The Company expects capital expenditures to be approximately 4% of sales in 2022, compared with 3.6% of sales ($148 million) in 2021.
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THE STATEMENTS OF INCOME
Sales:
2021 2020 $ Change Change
Net sales $ 4,132.9 $ 3,513.2 $ 619.7 17.6 %
Net sales increased in 2021 compared with 2020, primarily due to higher organic revenue of $513 million, the favorable impact of foreign currency exchange rate changes of $78 million, and the benefit of acquisitions of $29 million. The higher organic revenue was driven by higher demand across most market sectors in the Mobile Industries and Process Industries segments, plus the benefit of outgrowth initiatives and positive pricing.
Gross Profit:
2021 2020 $ Change Change
Gross profit $ 1,102.5 $ 1,009.9 $ 92.6 9.2 %
Gross profit % to net sales 26.7 % 28.7 % — (200) bps
Gross profit increased in 2021 compared with 2020, primarily due to the impact of higher volume of $196 million, the favorable impact of foreign currency exchange rate changes of $23 million, favorable net manufacturing performance of $20 million, favorable price/mix of $15 million, and the favorable impact of acquisitions of $8 million. These increases were partially offset by higher material and logistics costs of $171 million.
Selling, General and Administrative ("SG&A") Expenses:
2021 2020 $ Change Change
Selling, general and administrative expenses $ 580.5 $ 533.8 $ 46.7 8.7%
Selling, general and administrative expenses % to net
sales
14.0 % 15.2 % — (120) bps
The increase in SG&A expenses in 2021 compared with 2020 was primarily due to higher spending to support the higher sales levels, the favorable impact of temporary cost reduction actions implemented in 2020 in response to the COVID-19 pandemic that did not repeat in 2021, and the addition of SG&A from recent acquisitions.
Impairment and Restructuring Charges:
2021 2020 $ Change
Impairment charges $ 4.5 $ 0.4 $ 4.1
Severance and related benefit costs 2.6 19.6 (17.0)
Exit costs 1.8 1.2 0.6
Total $ 8.9 $ 21.2 $ (12.3)
Impairment and restructuring charges of $8.9 million in 2021 were comprised primarily of severance and related benefits associated with the planned closures of the Company's Villa Carcina, Italy bearing plant and Indianapolis, Indiana chain plant. These initiatives are expected to reduce headcount and right-size the Company's manufacturing footprint. In addition, impairment and restructuring during 2021 included impairment charges related to certain engineering-related assets used in the business. Management concluded no further investment would be made in the engineering-related assets and, as a result, reduced the value to zero.
Impairment and restructuring charges of $21.2 million in 2020 were comprised primarily of severance and related benefits associated with initiatives to reduce headcount and right-size the Company's manufacturing footprint, including the planned closure of the Company's Indianapolis, Indiana chain plant and the reorganization of the Company's Canton, Ohio and Gaffney, South Carolina bearing facilities. In addition, the Company recognized severance and related benefits as it began to accelerate and expand cost reduction initiatives.
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Interest Expense and Income:
2021 2020 $ Change % Change
Interest expense $ (58.8) $ (67.6) $ 8.8 (13.0 %)
Interest income 2.3 3.7 (1.4) (37.8 %)
Interest expense decreased in 2021 compared to 2020 primarily due to lower average outstanding debt during the year.
Other Income (Expense):
2021 2020 $ Change % Change
Non-service pension and other postretirement
income (expense) $ 18.3 $ (4.7) $ 23.0 (489.4 %)
Other income, net 0.8 10.0 (9.2) (92.0 %)
The Company recognized non-service pension and other postretirement income in 2021 primarily due to the recognition of lower net actuarial losses ("Mark-to-Market Charges") in 2021 compared to 2020. In 2020, the Company recognized Mark-to-Market Charges totaling $18.5 million. In 2021, the Company recognized Mark-to-Market Charges of $0.3 million. R efer to Note 16 - Retirement Benefit Plans and Note 17 - Other Postretirement Benefit Plans in the Notes to the Consolidated Financial Statements for more information .
The change in other income in 2021, compared to 2020, was primarily due to the acquisition-related gain in 2020. The acquisition-related gain represents a bargain purchase price gain on the acquisition of the assets of Aurora Bearing Company ("Aurora") acquired on November 30, 2020. Refer to Note 3 - Acquisitions for more information.
Income Tax Expense:
2021 2020 $ Change Change
Income tax expense $ 95.1 $ 103.9 $ (8.8) (8.5 %)
Effective tax rate 20.0 % 26.2 % — (620) bps
The effective tax rate for 2021 was 20.0%, which was favorable compared to the U.S. federal statutory rate of 21%, primarily due to the release of accruals for uncertain tax positions, favorable U.S. permanent differences and the release of a valuation allowance on certain non-U.S. deferred tax assets. These amounts were partially offset by the unfavorable effect of earnings in foreign jurisdictions where the effective tax rate was higher than 21%.
The effective tax rate for 2020 was 26.2%, which was unfavorable compared to the U.S. federal statutory rate of 21%, primarily due to earnings in certain foreign jurisdictions where the effective tax rate was higher than 21%, unfavorable U.S. permanent differences and U.S. state and local income taxes.
The change in the effective rate for 2021 compared with 2020 was a decrease of 6.2%. The decrease was primarily due to the release of accruals for uncertain tax positions, favorable U.S. permanent differences, including the tax impact from stock-based compensation awards and the new elective GILTI high tax exemption rules, and the release of a valuation allowance on certain non-U.S. deferred tax assets.
Refer to Note 5 - Income Taxes in the Notes to the Consolidated Financial Statements for more information on the computation of the income tax expense in interim periods.
For a discussion of changes in our results from 2020 to 2019, refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2020.
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BUSINESS SEGMENTS
The Company ' s reportable segments are business units that serve different industry sectors. While the segments often operate using shared infrastructure, each reportable segment is managed to address specific customer needs in these diverse market sectors. The primary measurement used by management to measure the financial performance of each segment is earnings before interest, taxes, depreciation and amortization ("EBITDA"). Refer to Note 4 - Segment Information in the Notes to the Consolidated Financial Statements for the reconciliation of EBITDA 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 completed in 2021 and 2020 and foreign currency exchange rate changes. The effects of acquisitions and foreign currency exchange rate changes 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.
The following items highlight the Company ' s acquisitions completed in 2021 and 2020 by segment based on the customers and underlying markets served:
• The Company acquired Intelligent Machine Solutions (“iMS”) during the third quarter of 2021. The majority of the results for iMS are reported in the Process Industries segment.
• The Company acquired Aurora during the fourth quarter of 2020. Results for Aurora are reported in the Mobile Industries and Process Industries segments based on customers and underlying market sectors served.
Mobile Industries Segment:
2021 2020 $ Change Change
Net sales $ 1,965.7 $ 1,671.6 $ 294.1 17.6 %
EBITDA $ 240.1 $ 232.5 $ 7.6 3.3 %
EBITDA margin 12.2 % 13.9 % — (170) bps
2021 2020 $ Change % Change
Net sales $ 1,965.7 $ 1,671.6 $ 294.1 17.6 %
Less: Acquisitions 15.0 — 15.0 NM
Currency 23.3 — 23.3 NM
Net sales, excluding the impact of acquisitions and currency $ 1,927.4 $ 1,671.6 $ 255.8 15.3 %
The Mobile Industries segment's net sales, excluding the effects of acquisitions and foreign currency exchange rate changes, increased $255.8 million or 15.3% in 2021 compared with 2020, reflecting organic growth in the off-highway, automotive and heavy truck sectors. These increases were partially offset by lower revenue in the aerospace sector. EBITDA increased in 2021 by $7.6 million or 3.3% compared with 2020, primarily due to the impact of higher volume and related manufacturing utilization, and positive price/mix, partially offset by higher material, logistics and other operating costs.
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Process Industries Segment:
2021 2020 $ Change Change
Net sales $ 2,167.2 $ 1,841.6 $ 325.6 17.7 %
EBITDA $ 506.3 $ 442.9 $ 63.4 14.3 %
EBITDA margin 23.4 % 24.0 % — (60) bps
2021 2020 $ Change % Change
Net sales $ 2,167.2 $ 1,841.6 $ 325.6 17.7 %
Less: Acquisitions 13.9 — 13.9 NM
Currency 54.1 — 54.1 NM
Net sales, excluding the impact of acquisitions and currency
$ 2,099.2 $ 1,841.6 $ 257.6 14.0 %
The Process Industries segment's net sales, excluding the effects of acquisitions and foreign currency exchange rate changes, increased $257.6 million or 14.0% in 2021 compared with 2020. The increase was primarily driven by organic growth in the distribution, renewable energy and general industrial sectors. EBITDA increased $63.4 million or 14.3% in 2021 compared with 2020 primarily due to the impact of higher volume and related manufacturing utilization, the impact of favorable foreign currency exchange rate changes, and positive price/mix, partially offset by higher material, logistics and other operating costs.
Unallocated Corporate:
2021 2020 $ Change Change
Unallocated corporate expense $ (46.1) $ (40.7) $ (5.4) 13.3 %
Unallocated corporate expense % to net sales (1.1 %) (1.2 %) — 10 bps
Unallocated corporate expense increased in 2021 compared with 2020 primarily due to the favorable impact of COVID-19 related temporary cost reduction initiatives in 2020, which did not repeat in 2021.
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CASH FLOWS
2021 2020 $ Change
Net cash provided by operating activities $ 387.3 $ 577.6 $ (190.3)
Net cash used in investing activities (173.8) (153.5) (20.3)
Net cash used in financing activities (269.3) (331.1) 61.8
Effect of exchange rate changes on cash (7.4) 11.9 (19.3)
(Decrease) increase in cash and cash equivalents $ (63.2) $ 104.9 $ (168.1)
Operating Activities:
The decrease in net cash provided by operating activities in 2021 compared with 2020 was primarily due to an increase in cash used for working capital items of $236.4 million, an increase in pension and other postretirement benefit contributions and payments of $3.9 million and an increase in other items. The decrease was partially offset by higher net income of $89.1 million and the favorable impact of income taxes of $8.1 million. Refer to the table below for additional detail of the impact of each line on net cash provided by operating activities.
The following chart displays the impact of working capital items on cash during 2021 and 2020, respectively:
2021 2020 $ Change
Cash (used in) provided by:
Accounts receivable $ (55.8) $ (20.7) $ (35.1)
Unbilled receivables 6.2 18.5 (12.3)
Inventories (215.8) 27.4 (243.2)
Trade accounts payable 76.7 22.6 54.1
Other accrued expenses 55.2 55.1 0.1
Cash (used in) provided by working capital items $ (133.5) $ 102.9 $ (236.4)
The large cash outflow for inventories in 2021 was driven by higher demand levels and longer supply chain lead times, which resulted in increased levels of inventory.
The following table displays the impact of income taxes on cash during 2021 and 2020, respectively:
2021 2020 $ Change
Accrued income tax expense $ 95.1 $ 103.9 $ (8.8)
Income tax payments (100.7) (119.3) 18.6
Other miscellaneous (1.0) 0.7 (1.7)
Change in income taxes $ (6.6) $ (14.7) $ 8.1
Investing Activities:
The increase in net cash used in i nvesting activities in 2021 compared with 2020 was primarily due to an increase of capital expenditures of $26.7 million.
Financing Activities:
The change in net cash used by financing activities in 2021 compared with 2020 was primarily due to a decrease in net payments of $111.8 million on outstanding debt, partially offset by an increase in the purchase of treasury shares of $43.7 million.
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LIQUIDITY AND CAPITAL RESOURCES
Reconciliation of total debt to net debt and the ratio of net debt to capital:
Net Debt:
December 31,
2021 2020
Short-term debt, including current portion of long-term debt $ 53.8 $ 130.7
Long-term debt 1,411.1 1,433.9
Total debt $ 1,464.9 $ 1,564.6
Less: Cash and cash equivalents 257.1 320.3
Net debt $ 1,207.8 $ 1,244.3
Ratio of Net Debt to Capital:
December 31,
2021 2020
Net debt $ 1,207.8 $ 1,244.3
Total equity 2,377.7 2,225.2
Capital (net debt + total equity) $ 3,585.5 $ 3,469.5
Ratio of net debt to capital 33.7 % 35.9 %
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 held by the Company and the ability to utilize such cash and cash equivalents to reduce debt if needed.
At December 31, 2021, the Company had strong liquidity with $257.1 million of cash and cash equivalents on the Consolidated Balance Sheet, as well as $733 million of available resources of committed credit lines. Of the $257.1 million of cash and cash equivalents, $240.5 million resided in jurisdictions outside the U.S. Repatriation of non-U.S. cash could be subject to taxes and some portion may be subject to governmental restrictions. Part of the Company's strategy is to grow in attractive market sectors, many of which are outside the U.S. This strategy includes making investments in facilities, 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 where feasible.
On June 25, 2019, the Company entered into the Fourth Amended and Restated Credit Agreement ("Senior Credit Facility"), which is a $650.0 million unsecured revolving credit facility that matures on June 25, 2024. At December 31, 2021, the Senior Credit Facility had outstanding borrowings of $9.0 million, which reduced the availability to $641.0 million. The Senior Credit Facility h as two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. The maximum consolidated leverage ratio permitted under the Senior Credit Facility is 3.5 to 1.0. As of December 31, 2021, the Company's consolidated leverage ratio was 2.05 to 1.0 (based on total debt discussed further below). The minimum consolidated interest coverage ratio permitted under the Senior Credit Facility is 3.0 to 1.0. As of December 31, 2021, the Company's consolidated interest coverage ratio was 12.10 to 1.0.
On May 27, 2020, both the Senior Credit Facility and the $350 million variable-rate term loan that matures on September 11, 2023 (the "2023 Term Loan") were amended to, among other things, effectively increase the limit with respect to the consolidated leverage ratio. As amended, the consolidated leverage ratio under both the Senior Credit Facility and the 2023 Term Loan was calculated using a net debt construct, netting unrestricted cash in excess of $25 million, instead of total debt. This change to the consolidated leverage ratio calculation was effective through June 30, 2021. In the third quarter of 2021, the calculation of the consolidated leverage ratio under the Senior Credit Facility and the 2023 Term Loan reverted back to a total debt construct.
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The interest rate under the Senior Credit Facility is variable with a spread based on the Company's debt rating. The average rate on outstanding U.S. dollar borrowings was 1.09% and the average rate on outstanding Euro borrowings was 1.00% as of December 31, 2021. In addition, the Company pays a facility fee based on the applicable rate, which is variable with a spread based on the Company's debt rating, multiplied by the aggregate commitments of all of the lenders under the Senior Credit Facility. As of December 31, 2021, the Company carried investment-grade credit ratings with Moody's (Baa2), S&P Global (BBB-) and Fitch (BBB-).
The Company renewed the Amended and Restated Asset Securitization Agreement (the "Accounts Receivable Facility") on November 30, 2021. The $100.0 million facility matures on November 30, 2024. The Accounts Receivable Facility is subject to certain borrowing base limitations and is secured by certain domestic trade accounts receivable of the Company. These limitations reduced the availability of the Accounts Receivable Facility to $92.0 million at December 31, 2021. As of December 31, 2021, there were no outstanding borrowings under the Accounts Receivable Facility.
Other sources of liquidity include uncommitted short-term lines of credit for certain of the Company's foreign subsidiaries, which provide for borrowings of up to approximately $295.3 million. At December 31, 2021, the Company had borrowings outstanding of $42.6 million and bank guarantees of $0.4 million, which reduced the aggregate availability under these facilities to approximately $252.3 million.
At December 31, 2021, the Company was in full compliance with all applicable covenants on its outstanding debt, and expects to remain in full compliance with its debt covenants.
The Company expects to generate cash from operating activities in 2022 above 2021 levels driven by higher earnings and lower pension and other postretirement contributions and payments. The Company expects capital expenditures to be approximately 4% of sales in 2022, compared with 3.6% of sales ($148 million) in 2021.
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FUTURE CONTRACTUAL PAYMENTS
The Company’s contractual debt obligations and contractual commitments outstanding as of December 31, 2021 were as follows:
Payments due by period:
Future Contractual Payments Total Less than
1 Year 1-5 Years More than
5 Years
Interest payments $ 294.9 $ 50.2 $ 169.8 $ 74.9
Long-term debt 1,411.1 — 675.4 735.7
Short-term debt, including current portion of long-term debt 53.8 53.8 — —
Purchase commitments 79.3 65.0 14.3 —
Operating leases 116.6 29.2 61.9 25.5
Retirement benefit plans 134.7 14.8 57.2 62.7
Total $ 2,090.4 $ 213.0 $ 978.6 $ 898.8
The interest payments beyond five years primarily relate to long-term fixed-rate notes. Refer to Note 12 - Financing Arrangements in the Notes to the Consolidated Financial Statements for additional information.
In order to maintain minimum funding requirements, the Company is required to make contributions to the trusts established for its defined benefit pension plans and other postretirement benefit plans. The table above shows the expected future minimum cash contributions to the trusts for the funded plans as well as estimated future benefit payments to participants for the unfunded plans. Those minimum funding requirements and estimated benefit payments can vary significantly. The amounts in the table above are based on actuarial estimates using current assumptions for, among other things, discount rates, expected return on assets and health care cost trend rates. During 2021, the Company made cash contributions and payments of approximat ely $20.4 million to its global defined benefit pension plans and $4.1 million to its other postretirement benefit plans. Refer to Note 16 - Retirement Benefit Plans and Note 17 - Other Postretirement Benefit Plans in the Notes to the Consolidated Financial Statements for additional information.
Refer to Note 5 - Income Taxes and Note 13 - Contingencies in the Notes to the Consolidated Financial Statements for additional information regarding the Company's exposure for certain tax and legal matters.
In the ordinary course of business, the Company utilizes standby letters of credit issued by financial institutions to guarantee certain obligations, most of which relate to insurance contracts. At December 31, 2021, outstanding letters of credit totaled $42.8 million, primarily having expiration dates within 12 months.
NEW ACCOUNTING GUIDANCE ISSUED AND NOT YET ADOPTED
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.
Inventory:
Inventories are valued at the lower of cost or market, with approximately 59% valued by the first-in, first-out ("FIFO") method and the remaining 41% valued by the last-in, first-out ("LIFO") method. The majority of the Company’s domestic inventories are valued by the LIFO method, while 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 an increase in its LIFO reserve of $27.3 million during 2021 compared to a decrease in its LIFO reserve of $3.2 million during 2020.
Goodwill and Indefinite-lived Intangible Assets:
The Company tests goodwill and indefinite-lived intangible assets for impairment at least annually, performing its annual impairment test as of October 1st. Furthermore, goodwill and indefinite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Each interim period, the Company assesses whether or not an indicator of impairment is present that would necessitate a goodwill and indefinite-lived intangible assets impairment analysis be performed in an interim period other than during the fourth quarter.
As of December 31, 2021, the Company had $1,022.7 million of goodwill on its Consolidated Balance Sheet, of which $371.7 million was attributable to the Mobile Industries segment and $651.0 million was attributable to the Process Industries segment. See Note 9 - Goodwill and Other Intangible Assets in the Notes to the Consolidated Financial Statements for movements in the carrying amount of goodwill by segment.
The Company reviews goodwill for impairment at the reporting unit level. The Mobile Industries segment has four reporting units and the Process Industries segment has two reporting units. The reporting units within the Mobile Industries segment are Mobile Industries, Lubrication Systems, Aerospace Drive Systems and Aerospace Bearing Inspection. The reporting units within the Process Industries segment are Process Industries and Industrial Services.
Accounting guidance permits an entity to first assess qualitative factors to determine whether additional indefinite-lived intangible asset impairment testing, including goodwill, is required. The Company chose to utilize this qualitative assessment in the annual goodwill impairment testing (excluding the indefinite-lived intangible asset impairment testing) for the Mobile Industries, Aerospace Bearing Inspection, Process Industries and Industrial Services reporting units. Based on the qualitative assessment, the Company concluded that it was more likely than not that the fair value of these reporting units exceeded their respective carrying values.
The Company chose to perform a quantitative goodwill impairment analysis in the annual goodwill impairment testing of the Lubrication systems reporting unit. The quantitative goodwill impairment analysis compares the carrying value 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, a goodwill impairment loss would be recorded.
The Company prepares its quantitative 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 and market approach are weighted in arriving at fair value based on the relative merits of the methods used and the quantity and quality of collected data to arrive at the indicated fair value.
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The income approach requires several assumptions including future sales growth, EBITDA margins and capital expenditures. The Company’s reporting units provided their forecast of results for the next five years. These forecasts form 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 five years forecast by the reporting units), as well as projections of future operating margins (for the period beyond the forecast five years). During the fourth quarter of 2021, the Company used a discount rate of 9.5% for the Lubrication reporting unit and a terminal revenue growth rate of 2.5%.
The market approach requires several assumptions including sales and EBITDA multiples for comparable companies that operate in the same markets as the Company’s reporting units. During the fourth quarter of 2021, the Company used a sales multiple of 1.6 and a EBITDA multiple of 9.25 for the Lubrication reporting unit.
Based on the October 1, 2021 quantitative assessment for the Lubrication Systems reporting unit, the fair value of this reporting unit exceeds the current carrying value by more than 10%.
As of December 31, 2021, the Company had $131.4 million of indefinite-lived intangible assets on its Consolidated Balance Sheet. The Company’s indefinite-lived intangible assets primarily consist of acquired trade names. The Company chose to perform a quantitative impairment analysis in the annual impairment testing of indefinite-lived intangible assets. The Company prepares its quantitative indefinite-lived intangible analysis by comparing the estimated fair value of each indefinite-lived intangible asset, using a relief from royalty method, with its carrying value. The relief from royalty method requires several assumptions including future sales growth, terminal revenue growth rate, royalty rate and discount rate. During the fourth quarter of 2021, the Company used discount rates for its indefinite-lived intangible assets in the range of 10.5% to 13.4%, royalty rates in the range of 1.0% to 6.0% and terminal growth rates in the range of 1.0% to 3.5%.
Based on the October 1, 2021 quantitative assessment of indefinite-lived intangible assets, t here were three indefinite-lived intangibles with carrying values totaling $67.1 million in which the fair value exceeded the carrying value of the assets by 10% or less.
Management believes the future sales growth and EBITDA margins in the long-range plan and the discount rate used in the valuations requires significant use of judgment. If any of the Company's reporting units or indefinite-lived intangible assets do not meet their long-range plan estimates or discount rates increase significantly, the Company could be required to perform an interim goodwill or indefinite-lived intangible asset impairment analysis and record impairment charges in future periods. The assumptions used for the indefinite-lived intangibles with fair values exceeding carrying values of 10% or less are more sensitive to future performance and will be monitored accordingly.
Income taxes:
Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities, valuation allowances against deferred tax assets, and accruals for uncertain tax positions.
The Company, which is subject to income taxes in the U.S. and numerous non-U.S. jurisdictions, accounts for income taxes in accordance with Accounting Standards Codification ("ASC") Topic 740, “Income Taxes.” Deferred tax assets and liabilities are recorded for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as net operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. Deferred tax assets relate primarily to tax loss carryforwards in foreign jurisdictions, as well as pension and postretirement benefit obligations in the U.S., which the Company believes are more likely than not to result in future tax benefits. In determining the need for a valuation allowance, the historical and projected financial performance of the entity recording the net deferred tax asset is considered along with any other pertinent information. The Company recorded $7.8 million in 2021 and $0.7 million in 2020 of tax benefits related to the reversal of valuation allowances. Refer to Note 5 - Income Taxes in the Notes to the Consolidated Financial Statements for further discussion on the valuation allowance reversals.
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In the ordinary course of the Company’s business, there are many transactions and calculations where the ultimate income tax determination is uncertain. The Company is regularly under audit by tax authorities. Accruals for uncertain tax positions are provided for in accordance with the requirements of ASC Topic 740. The Company records interest and penalties related to uncertain tax positions as a component of income tax expense. In 2021, the Company recorded $8.3 million of net tax benefit for uncertain tax positions, which consisted primarily of $14.8 million related to the net reversal of accruals for prior year uncertain tax positions and settlements with tax authorities. This benefit was partially offset by $6.5 million of interest and increases to current and prior year uncertain tax positions. The Company also recorded $1.3 million of uncertain tax positions related to foreign currency translation adjustments and deferred tax liabilities.
Purchase accounting and business combinations:
Assets acquired and liabilities assumed as part of a business combination are recognized at their acquisition date fair values. In determining these fair values, the Company utilized various forms of the income, cost and market approaches depending on the asset or liability being valued. The Company used a discounted cash flow model to measure the trade names, customer relationship, and technology and know-how-related intangible assets. The estimation of fair value required significant judgment related to future net cash flows based on assumptions related to revenue and EBITDA growth rates, discount rates, and royalty rates. Inputs were generally determined by taking into account competitive trends, market comparisons, independent appraisals, and historical data, among other factors, and were supplemented by current and anticipated market conditions.
Refer to Note 1 - Significant Accounting Policies for further discussion regarding the fair value process.
Revenue recognition:
A contract exists when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.
Revenue is generally recognized as performance obligations under the terms of a contract with a customer of the Company are satisfied. Refer to Note 1 - Significant Accounting Policies in the Notes to the Consolidated Financial Statements for further discussion around the Company's revenue policy.
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Benefit Plans:
The Company sponsors a number of defined benefit pension plans that cover eligible employees. The Company also sponsors several funded and unfunded postretirement plans that provide health care and life insurance benefits for eligible retirees and their dependents. These plans are accounted for in accordance with ASC Topic 715-30, "Defined Benefit Plans – Pension," and ASC Topic 715-60, "Defined Benefit Plans – Other Postretirement."
The measurement of liabilities related to these plans is based on management's assumptions related to future events, including discount rates and health care cost trend rates. Management regularly evaluates these assumptions and adjusts them as required and appropriate. Other plan assumptions also are reviewed on a regular basis to reflect recent experience and the Company's future expectations. Actual experience that differs from these assumptions may affect future liquidity, expense and the overall financial position of the Company. While the Company believes that current assumptions are appropriate, significant differences in actual experience or significant changes in these assumptions may affect materially the Company's pension and other postretirement employee benefit obligations and its future expense and cash flow.
The discount rate is used to calculate the present value of expected future pension and postretirement cash flows as of the measurement date. The Company establishes the discount rate by constructing a notional portfolio of high-quality corporate bonds and matching the coupon payments and bond maturities to projected benefit payments under the Company's pension and postretirement welfare plans. The bonds included in the portfolio generally are non-callable. A lower discount rate will result in a higher benefit obligation; conversely, a higher discount rate will result in a lower benefit obligation. The discount rate also is used to calculate the annual interest cost, which is a component of net periodic benefit cost.
The expected rate of return on plan assets is determined by analyzing the historical long-term performance of the Company's pension plan assets, as well as the mix of plan assets between equities, fixed-income securities and other investments, the expected long-term rate of return expected for those asset classes and long-term inflation rates. Short-term asset performance can differ significantly from the expected rate of return, especially in volatile markets. A lower-than-expected rate of return on pension plan assets will increase pension expense and future contributions.
The Company recognizes actuarial gains and losses immediately through net periodic benefit cost upon the annual remeasurement in the fourth quarter, or on an interim basis if specific events trigger a remeasurement.
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Defined Benefit Pension Plans:
The Company recognized net periodic benefit cost of $5.9 million during 2021 for defined benefit pension plans, compared to net periodic benefit cost of $23.9 million during 2020 The Company recognized mark-to-market charges of $4.4 million during 2021 compared to $16.2 million during 2020. Mark-to-market charges during 2021 were primarily a result of the impact of lower than expected returns on plan assets of $28.4 million, the impact of experience losses of $9.3 million, the impact of inflation of $8.5 million and other changes in actuarial assumptions of $3.2 million, partially offset by the net increase in the discount rate used to measure its defined benefit pension obligations of $45.0 million. The impact of the increase in the discount rate used to measure the Company's defined benefit pension obligations was primarily driven by a 55 basis point increase in the discount rate used to measure its U.K. plan obligations, which increased from 1.25% in 2020 to 1.80% in 2021, and a 23 basis point increase in the weighted-average discount rate used to measure its U.S. plan obligations, which increased from 2.84% in 2020 to 3.07% in 2021.
In 2022, the Company expects net periodic benefit cost to be approximately $2 million for defined benefit pension plans, compared with net periodic benefit cost of $5.9 million in 2021. Net periodic benefit cost for 2022 does not include mark-to-market charges that will be recognized immediately through earnings in the fourth quarter of 2022, or on an interim basis if specific events trigger a remeasurement. Excluding the mark-to-market charges of $4.4 million recognized in 2021, net periodic benefit cost was $1.5 million in 2021.
The Company expects to contribute to its defined benefit pension plans or pay directly to participants of defined benefit plans approximately $10 million in 2022 compared with $20.4 million of contributions and payments in 2021. The 2021 contributions and payments included a $10 million payout of deferred compensation to a former executive officer of the Company.
For expense purposes in 2021, the Company applied a weighted-average discount rate of 2.84% to its U.S. defined benefit pension plans. For expense purposes in 2022, the Company will apply a weighted-average discount rate of 3.07% to its U.S. defined benefit pension plans.
For expense purposes in 2021, the Company applied an expected weighted-average rate of return of 4.69% for the Company’s U.S. pension plan assets. For expense purposes in 2022, the Company will apply an expected weighted-average rate of return on plan assets of 4.78%.
The following table presents the sensitivity of the Company's U.S. projected pension benefit obligation ("PBO") to the indicated increase/decrease in key assumptions:
+ / - Change at December 31, 2021
Change PBO
Assumption:
Discount rate .25% $ 17.6
In the table above, a 25 basis point decrease in the discount rate will increase the PBO by $17.6 million and decrease income before income taxes through the recognition of actuarial losses of $17.6 million. A 25 basis point increase in the discount rate will decrease the PBO by $17.6 million and increase income before income taxes through the recognition of actuarial gains of $17.6 million. Defined benefit pension plans in the U.S. represent 62% of the Company's benefit obligation.
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Other Postretirement Benefit Plans:
The Company recognized net periodic benefit credit of $12.5 million during 2021 for other postretirement benefit plans, compared to net periodic benefit credit of $6.5 million during 2020. The Company recognized mark-to-market gains of $4.1 million during 2021 compared to mark-to-market charges of $1.4 million during 2020 . Mark-to-market gains in 2021 were primarily due to the impact of a 37 basis point increase in the discount rate used to measure the Company's defined benefit postretirement obligations, which increased from 2.62% in 2020 to 2.99% in 2021 . The increase in the discount rate resulted in a $1.6 million gain. In addition to the gain from the discount rate increases, the Company recognized actuarial gains of $1.1 million due to lower than expected benefit payments, $1.0 million due to the impact of a reduction in the rate for Medicare Advantage plans and $0.4 million due to changes in other actuarial assumptions .
In 2022, the Company expects net periodic benefit credit of approximately $8 million for other postretirement benefit plans, compared to net periodic benefit credit of $12.5 million in 2021. Net periodic benefit credit f or 2022 does not include mark-to-market charges that will be recognized immediately through earnings in the fourth quarter of 2022, or on an interim basis if specific events trigger a remeasurement. Excluding the mark-to-market gains of $4.1 million recognized in 2021, the net periodic benefit credit was $8.4 million in 2021, which is relatively consistent with the outlook for 2022.
In January 2020, the Company established a second Voluntary Employee Beneficiary Association ("VEBA") trust for certain active employees’ medical benefits. The Company transferred $50 million from the existing VEBA trust to fund the second VEBA trust. The $50 million that was transferred was primarily classified as other current assets based on the portfolio of the assets in the trust. In January 2021, the Company transferred the remaining $11.1 million in the existing VEBA trust to the second VEBA trust. The Company utilized all of the assets of the second VEBA trust in 2021 and 2020 for the payment of certain active employees’ medical benefits. As a result of the transfer, the Company expects to fund 2022 payments for other postretirement benefit plans, which are expected to be approximately $5 million, from the general funds of the Company.
For expense purposes in 2021, the Company applied a discount rate of 2.62% to its other postretirement benefit plans. For expense purposes in 2022, the Company will apply a discount rate of 2.99% to its other postretirement benefit plans.
The following table presents the sensitivity of the Company's accumulated other postretirement benefit obligation ("APBO") to the indicated increase/decrease in key assumptions:
+ / - Change at December 31, 2021
Change APBO
Assumption:
Discount rate .25% $ 1.1
In the table above, a 25 basis point decrease in the discount rate will increase the APBO by $1.1 million and decrease income before income taxes through the recognition of actuarial losses of $1.1 million. A 25 basis point increase in the discount rate will decrease the APBO by $1.1 million and increase income before income taxes through the recognition of actuarial gains of $1.1 million.
For measurement purposes, the Company assumed a weighted-average annual rate of increase in the per capita cost (health care cost trend rate) for medical benefits of 6.5% for 2022, declining gradually to 5.0% in 2028 and thereafter for medical and prescription drug benefits. For Medicare Advantage benefits, actual contract rates have been set for 2022, and are assumed to increase by 7.25% for 2022, declining gradually to 5.0% in 2031 and thereafter. The assumed health care cost trend rate may have a significant effect on the amounts reported. A one percentage point increase in the assumed health care cost trend rate would have increased the 2021 total service and interest cost components by $0.1 million and would have increased the postretirement benefit obligation by $1.5 million. A one percentage point decrease would provide corresponding reductions of $0.1 million and $1.3 million, respectively.
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Other loss reserves:
The Company has a number of loss exposures that are incurred in the ordinary course of business such as environmental clean-up, product liability, product warranty, litigation and accounts receivable reserves. Establishing loss reserves for these matters requires management’s judgment with regards to estimating risk exposure and ultimate liability or realization. These loss reserves are reviewed periodically and adjustments are made to reflect the most recent facts and circumstances.
NON-GAAP MEASURES
Supplemental Non-GAAP Measures:
In addition to results reported in accordance with U.S. GAAP, the Company provides information on non-GAAP financial measures. These non-GAAP financial measures include adjusted net income, adjusted earnings per share, adjusted EBITDA and adjusted EBITDA margins, segment adjusted EBITDA and segment adjusted EBITDA margins, ratio of net debt to adjusted EBITDA (for the trailing 12 months), net debt, ratio of net debt to capital, free cash flow and return on invested capital. This information is intended to supplement GAAP financial measures and is not intended to replace GAAP financial measures. Net debt and the ratio of net debt to capital is disclosed in the "Liquidity and Capital Resources" section of Management's Discussion and Analysis of Financial Condition and Results of Operations.
Adjusted Net Income and Adjusted EBITDA:
Adjusted net income and adjusted earnings per share represent net income attributable to The Timken Company and diluted earnings per share, respectively, adjusted for impairment, restructuring and reorganization charges, acquisition costs, including transaction costs and the amortization of the inventory step-up, property losses and recoveries, actuarial gains and losses associated with the remeasurement of the Company's defined benefit pension and other postretirement benefit plans, gains and losses on the sale of real estate, gains and losses on divestitures, the income tax impact of these adjustments, as well as other income tax discrete items, and other items from time to time that are not part of the Company's core operations. Management believes adjusted net income and adjusted earnings per share are useful to investors as they are representative of the Company's core operations and are used in the management of the business.
Adjusted EBITDA represents earnings before interest, taxes, depreciation and amortization, adjusted for items that are not part of the Company's core operations. These items include impairment, restructuring and reorganization charges, acquisition costs, including transaction costs and the amortization of the inventory step-up, property losses and recoveries, actuarial gains and losses associated with the remeasurement of the Company's defined benefit pension and other postretirement benefit plans, gains and losses on the sale of real estate, gains and losses on divestitures, and other items from time to time that are not part of the Company's core operations. Management believes adjusted EBITDA is useful to investors as it is representative of the Company's core operations and is used in the management of the business, including decisions concerning the allocation of resources and assessment of performance.
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Reconciliation of net income attributable to The Timken Company to adjusted net income, adjusted EBITDA and adjusted EBITDA Margin:
Twelve Months Ended December 31,
2021 2020 2019 2018 2017
Net Sales $ 4,132.9 $ 3,513.2 $ 3,789.9 $ 3,580.8 $ 3,003.8
Net Income Attributable to The Timken Company 369.1 284.5 362.1 302.8 203.4
Impairment, restructuring and
reorganization charges (1)
15.1 29.0 9.8 7.1 13.1
Corporate pension and other
postretirement benefit related expense
(income) (2)
0.3 18.5 (4.1) 12.8 18.1
Acquisition-related charges (3)
3.2 3.7 15.5 20.6 9.0
Acquisition-related gain (4)
(0.9) (11.1) — — —
Property recoveries and related expenses (5)
— (5.5) 7.6 — —
Gain (loss) on sale of real estate — (0.4) (4.5) 0.8 (3.6)
Brazil legal matter — — 1.8 — —
Tax indemnification and related items 0.2 0.5 0.7 1.5 (1.0)
Health care plan modification costs — — — — (0.7)
Noncontrolling interest of above adjustments — (0.1) (0.5) (1.3) —
Provision for income taxes (6)
(23.6) (6.0) (34.6) (16.8) (30.8)
Adjusted Net Income $ 363.4 $ 313.1 $ 353.8 $ 327.5 $ 207.5
Net income attributable to noncontrolling
interest 12.4 7.9 12.6 2.7 (1.1)
Provision for income taxes (as reported) 95.1 103.9 97.7 102.6 57.6
Interest expense 58.8 67.6 72.1 51.7 37.1
Interest income (2.3) (3.7) (4.9) (2.1) (2.9)
Depreciation and amortization expense (7)
167.0 164.0 159.9 146.0 135.8
Less: Noncontrolling interest — (0.1) (0.5) (1.3) —
Less: Provision for income taxes (6)
(23.6) (6.0) (34.6) (16.8) (30.8)
Adjusted EBITDA $ 718.0 $ 658.9 $ 726.3 $ 646.5 $ 464.8
Adjusted EBITDA Margin (% of net sales) 17.4 % 18.8 % 19.2 % 18.1 % 15.5 %
Diluted earnings and adjusted earnings per share in the table below are based on net income attributable to The Timken Company and adjusted net income, respectively, in the table above.
Twelve Months Ended December 31,
2021 2020 2019 2018 2017
Diluted earnings per share (EPS) $ 4.79 $ 3.72 $ 4.71 $ 3.86 $ 2.58
Adjusted EPS $ 4.72 $ 4.10 $ 4.60 $ 4.18 $ 2.63
Diluted Shares 77,006,589 76,401,366 76,896,565 78,337,481 78,911,149
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Reconciliation of segment EBITDA to segment adjusted EBITDA and segment adjusted EBITDA margin:
Twelve Months Ended December 31, 2021
Mobile Process Unallocated Corporate Total
Net Sales $ 1,965.7 $ 2,167.2 $ — $ 4,132.9
EBITDA 240.1 506.3 (45.5) 700.9
Impairment, restructuring and reorganization
charges (1)
7.3 7.0 — 14.3
Corporate pension and other postretirement
benefit related expense (2)
— — 0.3 0.3
Acquisition-related charges (3)
0.7 0.6 1.9 3.2
Acquisition-related gain (4)
— — (0.9) (0.9)
Tax indemnification and related items 0.2 — — 0.2
Adjusted EBITDA $ 248.3 $ 513.9 $ (44.2) $ 718.0
Adjusted EBITDA Margin (% of net sales) 12.6 % 23.7 % NM 17.4 %
Twelve Months Ended December 31, 2020
Mobile Process Unallocated Corporate Total
Net Sales $ 1,671.6 $ 1,841.6 $ — $ 3,513.2
EBITDA 232.5 442.9 (48.1) 627.3
Impairment, restructuring and reorganization
charges (1)
11.3 14.0 0.6 25.9
Corporate pension and other postretirement
benefit related expense (2)
— — 18.5 18.5
Acquisition-related charges (3)
2.1 1.0 0.6 3.7
Acquisition-related gain (4)
— — (11.1) (11.1)
Property losses (recoveries) and related expenses (5)
(5.5) — — (5.5)
Gain on sale of real estate (0.4) — — (0.4)
Tax indemnification and related items 0.3 — 0.2 0.5
Adjusted EBITDA $ 240.3 $ 457.9 $ (39.3) $ 658.9
Adjusted EBITDA Margin (% of net sales) 14.4 % 24.9 % NM 18.8 %
(1) Impairment, restructuring and reorganization charges (including items recorded in cost of products sold) relate to: (i) plant closures; (ii) the rationalization of certain plants; and (iii) severance related to cost reduction initiatives. The Company re-assesses its operating footprint and cost structure periodically, and makes adjustments as needed that result in restructuring charges. However, management believes these actions are not representative of the Company’s core operations.
(2) Corporate pension and other postretirement benefit related expense represents actuarial losses and (gains) that resulted from the remeasurement of plan assets and obligations as a result of changes in assumptions or experience. The Company recognizes actuarial losses and (gains) in connection with the annual remeasurement in the fourth quarter, or if specific events trigger a remeasurement. Refer to Note 16 - Retirement Benefit Plans and Note 17 - Other Postretirement Benefit Plans for additional discussion.
(3) Acquisition-related charges represent deal-related expenses associated with completed and certain unsuccessful transactions, as well as any resulting inventory step-up impact.
(4) The acquisition-related gain represents a bargain purchase gain on the acquisition of the assets of Aurora that closed on November 30, 2020.
(5) Represents property loss and related expenses during the periods presented (net of insurance recoveries received in 2020) resulting from property loss that occurred during the first quarter of 2019 at one of the Company's warehouses in Knoxville, Tennessee and during the third quarter of 2019 at one of the Company's warehouses in Yantai, China.
(6) Provision for income taxes includes the net tax impact on pre-tax adjustments (listed above), the impact of discrete tax items recorded during the respective periods as well as other adjustments to reflect the use of one overall effective tax rate on adjusted pre-tax income.
(7) Depreciation and amortization shown excludes depreciation recognized in reorganization charges, if any.
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Free Cash Flow:
Free cash flow represents net cash provided by operating activities less capital expenditures. Management believes free cash flow is useful to investors because it is a meaningful indicator of cash generated from operating activities available for the execution of its business strategy.
Reconciliation of net cash provided by operating activities to free cash flow:
Twelve Months Ended December 31,
2021 2020 2019 2018 2017
Net cash provided by operating activities $ 387.3 $ 577.6 $ 550.1 $ 332.5 $ 236.8
Capital expenditures (148.3) (121.6) (140.6) (112.6) (104.7)
Free cash flow $ 239.0 $ 456.0 $ 409.5 $ 219.9 $ 132.1
Ratio of Net Debt to Adjusted EBITDA:
The ratio of net debt to adjusted EBITDA for the trailing twelve months represents total debt less cash and cash equivalents divided by adjusted EBITDA for the trailing twelve months. T he Company presents net debt to adjusted EBITDA because it believes it is more representative of the Company's financial position as it is reflective of the Company's ability to cover its net debt obligations with results from its core operations. Net income for the trailing twelve months ended December 31, 2021 and December 31, 2020 was $381.5 million and $292.4 million, respectively. Net debt to adjusted EBITDA for the trailing twelve months was 1.7 at December 31, 2021 , compared with 1.9 at December 31, 2020 .
Reconciliation of Net income to Adjusted EBITDA for the twelve months:
Twelve Months Ended December 31,
2021 2020
Net income $ 381.5 $ 292.4
Provision for income taxes 95.1 103.9
Interest expense 58.8 67.6
Interest income (2.3) (3.7)
Depreciation and amortization 167.8 167.1
Consolidated EBITDA 700.9 627.3
Adjustments:
Impairment, restructuring and reorganization charges (1)
$ 14.3 $ 25.9
Corporate pension and other postretirement benefit related (expense) income (2)
0.3 18.5
Acquisition-related charges (3)
3.2 3.7
Acquisition-related gain (4)
(0.9) (11.1)
Property recoveries and related expenses (5)
— (5.5)
Gain (loss) on sale of real estate — (0.4)
Tax indemnification and related items 0.2 0.5
Total Adjustments 17.1 31.6
Adjusted EBITDA $ 718.0 $ 658.9
Net Debt $ 1,207.8 $ 1,244.3
Ratio of Net Debt to Adjusted EBITDA 1.7 1.9
(1) Impairment, restructuring and reorganization charges (including items recorded in cost of products sold) relate to: (i) plant closures; (ii) the rationalization of certain plants and (iii) severance related to cost reduction initiatives. The Company re-assesses its operating footprint and cost structure periodically, and makes adjustments as needed that result in restructuring charges. However, management believes these actions are not representative of the Company’s core operations.
(2) Corporate pension and other postretirement benefit related expense (income) represents actuarial losses and (gains) that resulted from the remeasurement of plan assets and obligations as a result of changes in assumptions or experience. The Company recognizes actuarial losses and (gains) in connection with the annual remeasurement in the fourth quarter, or if specific events trigger a remeasurement.
(3) Acquisition-related charges represent deal-related expenses associated with completed and certain unsuccessful transactions, as well as any resulting inventory step-up impact.
(4) The acquisition-related gain represents a bargain purchase gain on the acquisition of the assets of Aurora that closed on November 30, 2020.
(5) Represents property loss and related expenses during the periods presented (net of insurance recoveries received in 2020) resulting from property loss that occurred during the first quarter of 2019 at one of the Company's warehouses in Knoxville, Tennessee and during the third quarter of 2019 at one of the Company's warehouses in Yantai, China.
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Return on Invested Capital:
Return on Invested Capital is defined as adjusted net operating profit after taxes divided by average invested capital. The Company uses Average Invested Capital as a type of non-GAAP ratio that indicates return on invested capital, which management believes is useful to investors as a measure of return on their investment.
Reconciliation of adjusted net operating profit after taxes, adjusted invested capital and return on adjusted inv ested capital:
Adjusted Net Operating Profit after Taxes (ANOPAT):
Twelve Months Ended December 31,
2021 2020 2019 2018 2017
Adjusted EBITDA (1)
$ 718.0 $ 658.9 $ 726.3 $ 646.5 $ 464.8
Less: depreciation and amortization expense (2)
167.0 164.0 159.9 146.0 135.8
Adjusted EBIT 551.0 494.9 566.4 500.5 329.0
Adjusted tax rate 24.0 % 25.5 % 26.5 % 26.5 % 30.0 %
Calculated income taxes 132.2 126.2 150.1 132.6 98.7
ANOPAT $ 418.8 $ 368.7 $ 416.3 $ 367.9 $ 230.3
Adjusted Invested Capital:
Twelve Months Ended December 31,
2021 2020 2019 2018 2017 2016
Total debt $ 1,464.9 $ 1,564.6 $ 1,730.1 $ 1,681.6 $ 962.3 $ 659.2
Total equity 2,377.7 2,225.2 1,954.8 1,642.7 1,474.9 1,310.9
Invested capital (total debt + total
equity) 3,842.6 3,789.8 3,684.9 3,324.3 2,437.2 1,970.1
Invested capital (two-point average) $ 3,816.2 $ 3,737.4 $ 3,504.6 $ 2,880.8 $ 2,203.7
Return on Invested Capital:
Twelve Months Ended December 31,
2021 2020 2019 2018 2017
ANOPAT $ 418.8 $ 368.7 $ 416.3 $ 367.9 $ 230.3
Invested capital (two-point average) 3,816.2 3,737.4 3,504.6 2,880.8 2,203.7
Return on invested capital 11.0 % 9.9 % 11.9 % 12.8 % 10.5 %
(1) Refer to page 40 for reconciliations to the most directly comparable GAAP financial measures.
(2) Depreciation and amortization shown excludes depreciation recognized in reorganization charges, if any.
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OTHER DISCLOSURES:
Foreign Currency:
Assets and liabilities of subsidiaries 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 reporting period. Related translation adjustments are reflected as a separate component of accumulated other comprehensive loss. Foreign currency gains and losses resulting from transactions are included in the Consolidated Statements of Income.
Net of related derivative activity, the Company recognized foreign currency exchange losses resulting from transactions of $9.4 million and $10.0 million for the years ended December 31, 2021 and 2020, respectively, and recognized a gain of $6.1 million for the year ended December 31, 2019. For the year ended December 31, 2021, the Company recorded a negative non-cash foreign currency translation adjustment of $62.3 million that decreased shareholders’ equity, compared with a positive non-cash foreign currency translation adjustment of $97.3 million that increased shareholders’ equity for the year ended December 31, 2020. The foreign currency translation adjustments for the year ended December 31, 2021 were favorably impacted by the weakening of t he U.S. dollar relative to other currencies as of December 31, 2021 compared to December 31, 2020.
Trade Law Enforcement:
The U.S. government has an antidumping duty order in effect covering tapered roller bearings from China. The Company is a producer of these bearings, as well as ball bearings and other bearing types, in the U.S.
Quarterly Dividend:
On February 11, 2022, the Company’s Board of Directors declared a quarterly cash dividend of $0.30 per common share. The quarterly dividend will be paid on March 4, 2022 to shareholders of record as of February 22, 2022. This will be the 399 th consecutive quarterly dividend paid on the common shares of the Company.
Forward-Looking Statements
Certain statements set forth in this Annual Report on Form 10-K and in the Company’s 2021 Annual Report to Shareholders that are not historical in nature (including the Company’s forecasts, beliefs and expectations) are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, Management’s Discussion and Analysis contains numerous forward-looking statements. Forward-looking statements generally will be accompanied by words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “outlook,” “intend,” “may,” “possible,” “potential,” “predict,” “project” or other similar words, phrases or expressions. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. The Company cautions readers that actual results may differ materially from those expressed or implied in forward-looking statements made by or on behalf of the Company due to a variety of factors, such as:
(a) deterioration in world economic conditions, or in economic conditions in any of the geographic regions in which the Company or its customers or suppliers conduct business, including adverse effects from a global economic slowdown, terrorism, or hostilities. This includes: political risks associated with the potential instability of governments and legal systems in countries in which the Company or its customers or suppliers conduct business, changes in currency valuations and recent world events that have increased the risks posed by international trade disputes, tariffs and sanctions;
(b) negative impacts to the Company's business, results of operations, financial position or liquidity, disruption to the Company's supply chains, negative impacts to customer demand or operations, and availability and health of employees, as a result of COVID-19 or other pandemics and associated governmental measures such as restrictions on travel and manufacturing operations;
(c) the effects of fluctuations in customer demand on sales, product mix and prices in the industries in which the Company operates. This includes: the ability of the Company to respond to rapid changes in customer demand, disruptions to the Company's supply chain, logistical issues associated with port closures or congestion, delays or increased costs , the effects of customer or supplier bankruptcies or liquidations, the impact of changes in industrial business cycles, the effects of distributor inventory corrections reflecting de-stocking of the supply chain and whether conditions of fair trade continue in the Company's markets;
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(d) competitive factors, including changes in market penetration, increasing price competition by existing or new foreign and domestic competitors, the introduction of new products or services by existing and new competitors, competition for skilled labor and new technology that may impact the way the Company’s products are produced, 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 and manufacturing capacity; availability and cost of raw materials and energy; disruptions to the Company's supply chain and logistical issues associated with port closures or congestion, delays or increased costs; changes in the expected costs associated with product warranty claims; changes resulting from inventory management and cost reduction initiatives; the effects of unplanned plant shutdowns; the effects of government-imposed restrictions and commercial requirements meant to address climate change; and changes in the cost of labor and benefits;
(f) the impact of inflation on employee expenses, shipping costs, raw material costs, energy and fuel costs and other production costs;
(g) the success of the Company’s operating plans, announced programs, initiatives and capital investments; the ability to integrate acquired companies and to address material issues not uncovered during the Company's due diligence review; and the ability of acquired companies to achieve satisfactory operating results, including results being accretive to earnings, realization of synergies and expected cash flow generation;
(h) the Company’s ability to maintain appropriate relations with unions or works councils that represent Company associates in certain locations in order to avoid disruptions of business and to maintain the continued service of our management and other key employees;
(i) unanticipated litigation, claims, investigations or assessments. This includes: claims, investigations or problems related to intellectual property, product liability or warranty, foreign export and trade laws, government procurement regulations, competition and anti-bribery laws, environmental or health and safety issues, data privacy and taxes;
(j) changes in worldwide financial and capital markets, including availability of financing and interest rates on satisfactory terms, which affect the Company’s cost of funds and/or ability to raise capital, as well as customer demand and the ability of customers to obtain financing to purchase the Company’s products or equipment that contain the Company’s products;
(k) the Company's ability to satisfy its obligations and comply with covenants under its debt agreements, maintain favorable credit ratings and its ability to renew or refinance borrowings on favorable terms;
(l) the impact on the Company's pension obligations and assets due to changes in interest rates, investment performance and other tactics designed to reduce risk; and
(m) those items identified under Item 1A. Risk Factors on pages 8 through 17 .
Additional risks relating to the Company’s business, the industries in which the Company operates or the Company’s common shares 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.
Readers are cautioned that it is not possible to predict or identify all of the risks, uncertainties and other factors that may affect future results and that the above list should not be considered to be a complete list. 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.
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