TISOP - Timken

Transcription

TISOP - Timken

THE TIMKEN COMPANY
1835 Dueber Avenue, SW
Canton, Ohio 44706-2798
USA
Phone: +1 – 330 – 438 – 3000
www.timken.com
The Timken Company International Stock Ownership Plan
(TISOP)
Prospectus dated April 25, 2007
for Employees
of Subsidiaries of The Timken Company
in Germany, Italy and Spain
TABLE OF CONTENTS
I.
GERMAN TRANSLATION OF THE SUMMARY/ ZUSAMMENFASSUNG DES
PROSPEKTS.......................................................................................................................................... 6
1.
2.
3.
4.
II.
Hinweis für den Leser .............................................................................................................................. 6
ÜBER TIMKEN ........................................................................................................................................... 6
ZUSAMMENFASSUNG DER WESENTLICHEN FINANZDATEN ........................................................................ 7
THE TIMKEN COMPANY INTERNATIONAL STOCK OWNERSHIP PLAN ........................................................ 7
Überblick.................................................................................................................................................. 8
Die Aktien der Gesellschaft ..................................................................................................................... 8
Verwaltung des Programms ..................................................................................................................... 8
RISIKOFAKTOREN ...................................................................................................................................... 9
Risiken bezogen auf die Branche der Gesellschaft................................................................................... 9
Risiken bezogen auf die Geschäftstätigkeit der Gesellschaft ................................................................... 9
Risiken bezogen auf die Aktien der Gesellschaft ................................................................................... 10
SUMMARY OF PROSPECTUS......................................................................................................... 11
1.
2.
3.
4.
III.
1.
2.
3.
IV.
1.
2.
3.
V.
Notice to the Reader............................................................................................................................... 11
ABOUT TIMKEN....................................................................................................................................... 11
SUMMARY OF KEY FINANCIAL DATA...................................................................................................... 12
THE TIMKEN COMPANY INTERNATIONAL STOCK OWNERSHIP PLAN ...................................................... 12
Overview ................................................................................................................................................ 13
The Company Stock ............................................................................................................................... 13
Administration of the Plan ..................................................................................................................... 13
RISK FACTORS ........................................................................................................................................ 13
Risks Related to the Company's Industry............................................................................................... 13
Risks Related to the Company's Business .............................................................................................. 14
Risks Related to the Company's Stock ................................................................................................... 14
RISK FACTORS .................................................................................................................................. 15
RISKS RELATED TO TIMKEN'S INDUSTRIES .............................................................................................. 15
RISKS RELATED TO TIMKEN'S BUSINESS ................................................................................................. 16
RISKS RELATED TO TIMKEN'S COMMON STOCK...................................................................................... 20
ABOUT THIS PROSPECTUS............................................................................................................ 22
LEGAL BASIS .......................................................................................................................................... 22
RESPONSIBILITY FOR THE CONTENTS OF THE PROSPECTUS ..................................................................... 22
APPROVAL AND NOTIFICATION ............................................................................................................... 22
THE TIMKEN COMPANY INTERNATIONAL STOCK OWNERSHIP PLAN........................ 23
1.
2.
3.
4.
5.
INTRODUCTION ....................................................................................................................................... 23
THE COMPANY STOCK OFFERED ............................................................................................................. 23
OVERVIEW OF THE PLAN ......................................................................................................................... 23
ADMINISTRATION OF THE PLAN .............................................................................................................. 24
The Committee....................................................................................................................................... 24
The Plan Administrator .......................................................................................................................... 24
The Trustee............................................................................................................................................. 24
Monthly Share Purchases ....................................................................................................................... 25
Plan Administration Costs...................................................................................................................... 25
PARTICIPATION AND CONTRIBUTIONS ..................................................................................................... 25
Minimum Participant Contributions....................................................................................................... 25
Limits on Matching Contributions ......................................................................................................... 26
Discretionary Additional Employer Contributions................................................................................. 26
Discretionary Cash Payment .................................................................................................................. 26
2
6.
7.
8.
9.
10.
11.
12.
13.
14.
VI.
1.
2.
3.
4.
5.
6.
7.
PAYMENT OF CONTRIBUTIONS TO THE TRUST ......................................................................................... 27
SALE AND TRANSFER OF SHARES; DISTRIBUTION OF CONTRIBUTIONS ................................................... 27
Sale and Transfer of Participant Shares.................................................................................................. 27
Withdrawing Matched Shares ................................................................................................................ 27
Death and Disability............................................................................................................................... 27
Leave Service ......................................................................................................................................... 27
Transfer to Another Timken Unit or Assignment to the United States .................................................. 28
All Other Cases ...................................................................................................................................... 28
TREATMENT OF DIVIDENDS .................................................................................................................... 28
INTEREST IN THE PLAN MAY NOT BE TRANSFERRED .............................................................................. 28
ACCOUNT INFORMATION ........................................................................................................................ 29
NAMING A BENEFICIARY ......................................................................................................................... 29
CLAIMING BENEFITS ............................................................................................................................... 29
VOTING OF COMPANY STOCK AND TENDER OFFERS ............................................................................... 29
DURATION, MODIFICATION, AND CONTINUATION OF THE PLAN ............................................................. 30
INFORMATION ABOUT THE TIMKEN COMPANY .................................................................. 31
DESCRIPTION OF TIMKEN AND ITS BUSINESS .......................................................................................... 31
General ................................................................................................................................................... 31
Products.................................................................................................................................................. 31
Industry Segments .................................................................................................................................. 33
Geographical Financial Information....................................................................................................... 33
Sales and Distribution ............................................................................................................................ 33
Competition............................................................................................................................................ 34
Trade Law Enforcement......................................................................................................................... 34
Continued Dumping and Subsidy Offset Act (CDSOA)........................................................................ 34
Backlog .................................................................................................................................................. 35
Raw Materials ........................................................................................................................................ 35
Environmental Matters ........................................................................................................................... 36
Patents, Trademarks and Licenses.......................................................................................................... 36
Research ................................................................................................................................................. 36
Legal Proceedings .................................................................................................................................. 37
Properties................................................................................................................................................ 37
Subsidiaries ............................................................................................................................................ 38
Investments ............................................................................................................................................ 40
Principal Investments in Progress .......................................................................................................... 40
Joint Ventures......................................................................................................................................... 41
Divestitures ............................................................................................................................................ 41
Related Party Transactions..................................................................................................................... 42
Material Contracts; Financial Arrangements.......................................................................................... 42
FINANCIAL OVERVIEW ............................................................................................................................ 43
Results for 2006 ..................................................................................................................................... 43
Results for 2005 ..................................................................................................................................... 44
Results for 2004 ..................................................................................................................................... 45
SELECTED FINANCIAL INFORMATION ...................................................................................................... 46
Periods 2004 – 2006............................................................................................................................... 46
CAPITAL RESOURCES AND INDEBTEDNESS .............................................................................................. 48
LIQUIDITY AND WORKING CAPITAL STATEMENT.................................................................................... 49
HISTORICAL FINANCIAL INFORMATION ................................................................................................... 49
Consolidated Balance Sheet for 2006 and 2005 ..................................................................................... 49
Consolidated Balance Sheet for 2005 and 2004 ..................................................................................... 50
Consolidated Statement of Income......................................................................................................... 51
Consolidated Statement of Shareholders’ Equity ................................................................................... 53
Consolidated Statement of Cash Flows .................................................................................................. 54
Accounting Policies and Explanatory Notes .......................................................................................... 56
RECENT TRENDS ..................................................................................................................................... 56
3
VII.
THE CAPITAL STOCK...................................................................................................................... 58
1.
2.
3.
4.
COMMON STOCK ..................................................................................................................................... 58
General ................................................................................................................................................... 58
Dividend Rights...................................................................................................................................... 58
Other Shareholders' Rights..................................................................................................................... 59
PREFERRED STOCK.................................................................................................................................. 59
CHANGE OF SHAREHOLDERS' RIGHTS ..................................................................................................... 60
WITHHOLDING OF TAX ON DIVIDENDS ................................................................................................... 60
VIII.
CORPORATE ORGANIZATION ..................................................................................................... 61
1.
PARTICULAR PROVISIONS OF TIMKEN'S ARTICLES OF INCORPORATION AND REGULATIONS ................... 61
The Company's Objects and Purposes.................................................................................................... 61
Shareholder Meetings............................................................................................................................. 61
The Board of Directors........................................................................................................................... 61
Officers................................................................................................................................................... 62
TAKEOVER RESTRICTIONS IN THE COMPANY'S REGULATIONS AND OHIO CORPORATE LAW .................. 62
Anti-takeover Provisions in the Regulations .......................................................................................... 62
Restrictions to Consolidation, Merger or Sale........................................................................................ 63
Anti-takeover Effect of Ohio Corporate Law......................................................................................... 63
ABOUT TIMKEN'S CURRENT DIRECTORS ................................................................................................. 64
Related Parties; Independence of Directors; Conflicts of Interest.......................................................... 66
Good Standing of Directors.................................................................................................................... 66
Directors' Beneficial Ownership of Common Stock .............................................................................. 67
Director Compensation........................................................................................................................... 68
Employee Directors' Summary Compensation Table............................................................................. 70
Termination Benefits for Employee Directors ....................................................................................... 71
STOCK OPTIONS GRANTED TO EMPLOYEES ............................................................................................ 72
OTHER STOCK PURCHASE PLANS FOR TIMKEN ASSOCIATES................................................................... 72
ACCRUED PENSION BENEFITS ................................................................................................................. 72
OTHER MAJOR SHAREHOLDERS .............................................................................................................. 72
COMMITTEES .......................................................................................................................................... 74
Audit Committee .................................................................................................................................... 74
Finance Committee ................................................................................................................................ 74
Compensation Committee ...................................................................................................................... 74
Nominating and Corporate Governance Committee .............................................................................. 75
COMPLIANCE WITH CORPORATE GOVERNANCE STANDARDS .................................................................. 75
2.
3.
4.
5.
6.
7.
8.
9.
IX.
1.
2.
3.
4.
FINANCIAL INFORMATION........................................................................................................... 76
CONSOLIDATED FINANCIAL STATEMENTS .............................................................................................. 76
AUDITORS ............................................................................................................................................... 76
ANNUAL REPORT TO THE SHAREHOLDERS FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006............. 77
Introductory Note ................................................................................................................................... 77
Table of Contents ................................................................................................................................... 78
Consolidated Statement of Income....................................................................................................... 120
Consolidated Balance Sheet ................................................................................................................. 121
Consolidated Statement of Cash Flows ................................................................................................ 122
Consolidated Statement of Shareholders' Equity.................................................................................. 123
Notes to Consolidated Financial Statements ........................................................................................ 125
Auditors' Reports.................................................................................................................................. 151
ANNUAL REPORT TO THE SHAREHOLDERS FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005........... 155
Introductory Note ................................................................................................................................. 155
Table of Contents ................................................................................................................................. 156
Consolidated Staement of Cash Flows ................................................................................................. 194
4
5.
X.
ANNUAL REPORT TO THE SHAREHOLDERS FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004........... 225
Introductory Note ................................................................................................................................. 225
Table of Contents ................................................................................................................................. 226
Consolidated Statement of Cash Flows ................................................................................................ 248
AVAILABLE INFORMATION / DOCUMENTS ON DISPLAY / SIGNATURE....................... 280
Available Information .......................................................................................................................... 280
Documents on Display ......................................................................................................................... 280
Signature Page...................................................................................................................................... 281
5
I.
GERMAN TRANSLATION OF THE SUMMARY/
ZUSAMMENFASSUNG DES PROSPEKTS
Hinweis für den Leser
Die Begriffe "Timken" und die "Gesellschaft" sind in diesem Prospekt austauschbar und beziehen sich
beide auf The Timken Company, sofern sich aus dem Zusammenhang nichts Anderes ergibt. The
Timken Company ist die Emittentin und Anbieterin der Anteile, die ihren Mitarbeitern im Rahmen
des Mitarbeiterbeteiligungsprogramms "The Timken Company International Stock Ownership Plan"
("TISOP") angeboten werden.
Timken weist den Leser auf Folgendes hin:

Diese Zusammenfassung ist als Einführung zu diesem Prospekt zu verstehen;

Der Anleger sollte jede Entscheidung zur Anlage in die betreffenden Wertpapiere auf die Prüfung
des gesamten Prospekts stützen;

Für den Fall, dass vor einem Gericht Ansprüche aufgrund der in diesem Prospekt enthaltenen
Informationen geltend gemacht werden, könnte der als Kläger auftretende Anleger in Anwendung
der einzelstaatlichen Rechtsvorschriften der Staaten der EU oder des Europäischen Wirtschaftsraums die Kosten für die Übersetzung des Prospekts vor Prozessbeginn zu tragen haben; und

Diejenigen Personen, die die Verantwortung für die Zusammenfassung einschließlich einer
Übersetzung hiervon übernommen haben, oder von denen deren Erlass ausgeht, können hierfür
haftbar gemacht werden, jedoch nur für den Fall, dass die Zusammenfassung irreführend,
unrichtig oder widersprüchlich ist, wenn sie zusammen mit den anderen Teilen des Prospekts
gelesen wird.
1. Über Timken1
The Timken Company ist ein weltweit führender Hersteller von hochtechnisierten Lagern und
legiertem Stahl sowie Anbieter verwandter Produkte und Dienstleistungen. Als Nachfolgerin eines
ursprünglich im Jahr 1899 gegründeten Unternehmens wurde die Gesellschaft im Jahr 1904 nach dem
Recht des US-Bundesstaates Ohio errichtet. Im März 2007 verfügte Timken über Standorte in 26
Ländern auf sechs Kontinenten und beschäftigte 25.001 Mitarbeiter. Timkens Tätigkeitsgebiet ist in
drei Geschäftsbereiche unterteilt: Automotive Group, Industrial Group sowie Steel Group. Die
Geschäftsbereiche Automotive und Industrial befassen sich mit der Entwicklung, Herstellung und
dem Vertrieb verschiedener Lager und verwandter Produkte und Dienstleistungen. Der Kundenkreis
des Geschäftsbereichs Automotive besteht aus Erstausrüstern für Personenwagen, LKW und
Anhänger. Der Kundenkreis des Geschäftsbereichs Industrial besteht sowohl aus Erstausrüstern als
auch aus Vertriebshändlern aus den Bereichen Landwirtschaft, Bauindustrie, Bergbau, Energieerzeugung, Fabrikindustrie, Werkzeugmaschinen, Luftfahrt und Schienenverkehr. Die Produkte des
Geschäftsbereichs Stahl umfassen verschiedene Legierungen in Form von Barren und Rohren sowie
Präzisionsstahl-Bauteilen für Automobil- und Industriekunden und den Einsatz in Lagern.
1
In dieser Zusammenfassung groß geschriebene Begriffe beziehen sich entweder auf Eigennamen oder auf
Begriffe, die in dem der Zusammenfassung folgenden Haupttext definiert sind.
6
Timken hat ein Direktorium (Board of Directors) mit dreizehn Mitgliedern (Directors). Die Directors
werden bei der ordentlichen oder einer außerordentlichen Hauptversammlung für einen Zeitraum von
jeweils drei Jahren gewählt.
2. Zusammenfassung der wesentlichen Finanzdaten
Die folgenden wesentlichen Finanzdaten wurden unverändert dem Jahresbericht von Timken an die
Aktionäre für das am 31. Dezember 2006 abgelaufene Geschäftsjahr entnommen:
2006
2005
Nettoumsatzerlöse
Wertminderungs- und Restrukturierungsaufwand
Gewinn vor Ertragsteuern
Rückstellungen für Ertragsteuern
Gewinn aus fortgeführten Geschäftsaktivitäten
Gewinn aus eingestellten Geschäftsaktivitäten,
nach Ertragssteuern
Nettogewinn
$ 4.973.365
$
44.881
$ 254.234
$
77.795
$ 176.439
$ 4.823.167
$
26.093
$ 346.538
$ 112.882
$ 233.656
$
$
46.088
222.527
$
$
26.625
260.281
Ergebnis je Aktie
Ergebnis je Aktie – verwässert
Dividenden je Aktie
$
$
$
2,38
2,36
0,62
$
$
$
2,84
2,81
0,60
(In tausend US-Dollar, außer bei Aktienangaben)
Nettoumsatzerlöse
(in Mrd. US-$)
Gewinn je Aktie
(verwässert) (in US-$)
Dividende je Aktie
in US-$
2,81
4,8
5,0
0,60
2,36
4,3
0,62
3,6
1,49
2,4
0,52 0,52 0,52
0,62
2002 2003 2004 2005 2006
0,44
2002 2003 2004 2005 2006
2002 2003 2004 2005 2006
3. The Timken Company International Stock Ownership Plan
The Timken Company hat gemeinsam mit den örtlichen Timken-Gesellschaften beschlossen, die
Teilnahme bestimmter Mitarbeiter von Timken, die außerhalb der USA arbeiten und wohnen, an
einem Mitarbeiterbeteiligungsprogramm namens "The Timken Company International Stock
7
Ownership Plan" (TISOP oder Programm) zu fördern. Die Teilnehmer müssen mindestens 18 Jahre
alt und seit mindestens sechs Monaten bei einer Timken-Gesellschaft beschäftigt sein.
Überblick
Das Programm ist ein Anlageförderungsprogramm (matched savings program), bei dem jeder
Teilnehmer in jeder Zahlungsperiode einen Teil seines Gehalts in das Programm einzahlen kann. Die
örtliche Timken-Gesellschaft leistet bis zu den festgelegten Höchstbeträgen ergänzend Beiträge, die
der vollen Höhe der Teilnehmerbeiträge entsprechen.
Die Teilnehmerbeiträge und die für einen Teilnehmer geleisteten Beiträge der örtlichen TimkenGesellschaft werden im Namen des jeweiligen Teilnehmers eingezahlt und treuhänderisch verwaltet.
Die Gesellschaft hat einen Treuhandfonds eingerichtet, durch den Timken-Aktien erworben und
neben sonstigem Programmvermögen zugunsten des Programmteilnehmers verwahrt werden.
Die Aktien der Gesellschaft
Das im Rahmen des Programms abgegebene Angebot bezieht sich auf die Stammaktien von Timken.
Die Stammaktien unterliegen den Bestimmungen des US-amerikanischen Wertpapiergesetzes (US
Securities Act) von 1933 und des US-amerikanischen Wertpapierhandelsgesetzes (US Securities
Exchange Act) von 1934. Sämtliche ausgegebenen und im Umlauf befindlichen Stammaktien sind
nennwertlose, voll eingezahlte und zum Handel an der New York Stock Exchange zugelassene
Aktien. Die US-amerikanische Wertpapier-Kennnummer (CUSIP) der Stammaktien von Timken
lautet 887389104, und die Kurzbezeichnung an der New Yorker Börse lautet "TKR".
Sämtliche Stammaktien, die im Rahmen von TISOP angeboten werden, sind verbriefte und frei
handelbare Namensaktien. Jede Aktie gewährt ein Stimmrecht und berechtigt den Inhaber zum
vollständigen und gleichberechtigten Erhalt von Dividenden. Sofern die Gesellschaft eine
Dividendenausschüttung beschlossen hat, erfolgt die Dividendenausschüttung vierteljährlich, im
Allgemeinen im März, Juni, September und Dezember.
Verwaltung des Programms
Das Programm wird von einem internationalen Ausschuss, einem Programmverwalter und einem
Treuhänder verwaltet. Der Ausschuss ist für die allgemeine Verwaltung und das Management des
Programms verantwortlich. Es liegt im freien Ermessen des Ausschusses, die Bestimmungen des
Programms auszulegen, Vorschriften für die Verwaltung des Programms zu erlassen sowie
Tatsachenfeststellungen im Hinblick auf sich im Zusammenhang mit dem Programm ergebende
Angelegenheiten zu machen. Der Programmverwalter ist für das Tagesgeschäft, die Buchführung und
Kommunikation mit den Programmteilnehmern zuständig und übt bestimmte sonstige, in dem
Programm festgelegte, Verwaltungsfunktionen aus.
Die Gesellschaft hat die Lloyds TSB Offshore Trust Company Limited, eine Treuhandgesellschaft mit
Sitz in Jersey, Kanalinseln, zur Treuhänderin bestimmt. Die Treuhänderin verwaltet das Programmvermögen, fasst die durch alle Teilnehmer oder zu ihren Gunsten geleisteten Beiträge zusammen und
verwendet die gesamten Beiträge für den Erwerb von Stammaktien am freien Markt zu Marktkursen.
Die Treuhänderin ist solange die Eigentümerin der im Rahmen des Programms erworbenen
Stammaktien, bis die Teilnehmer diese Aktien gemäß den Programmvorschriften aus dem Programm
entnehmen. Die Teilnehmer haben das Recht, die Stimmrechtsausübung und Veräußerung ihrer
Aktien innerhalb des Programms zu kontrollieren.
Die im Rahmen der Verwaltung des Programms und Treuhandfonds entstehenden Kosten und
Ausgaben, einschließlich der Vergütung der Treuhänderin und des Programmverwalters und
Ausgaben wie Börsenmaklergebühren und -provisionen, werden von den örtlichen, das Programm
unterhaltenden Timken-Gesellschaften getragen.
8
4. Risikofaktoren
Eine Anlage in die Aktien der Gesellschaft birgt diverse Risiken hinsichtlich der Branche, der
Geschäftstätigkeit und der Stammaktien von Timken.
Risiken bezogen auf die Branche der Gesellschaft

Die (Kugel-) Lagerbranche ist stark durch Wettbewerb geprägt, wobei dieser Wettbewerb einen
erheblichen Preisdruck für Timkens Produkte bedeutet, der die Erlöse und Ertragskraft der
Gesellschaft beeinträchtigen könnte.

Der Wettbewerb und die Konsolidierungstendenzen in der Stahlindustrie sowie mögliche weltweite Überkapazitäten könnte zu erheblichem Preisdruck für die Stahlprodukte von Timken
führen.

Schwächephasen in den Branchen, in denen Timkens Kunden tätig sind, sowie die Konjunkturabhängigkeit der Geschäftsbereiche von Timkens Kunden im Allgemeinen können sich infolge
sinkender Nachfrage und Margendruck nachteilig auf die Erlöse und Ertragskraft der Gesellschaft
auswirken.

Ein erhöhter Einsatz von Ersatzprodukten für Stahlerzeugnisse könnte sich ebenfalls nachteilig
auf die Erlöse und Ertragskraft der Gesellschaft auswirken, indem die Nachfrage sowie die
Margen sinken.

Geringere Ausschüttungen gemäß dem US-amerikanischen Gesetz über Ausgleichszahlungen für
anhaltende Dumping- und Subventionspraktiken (US Continued Dumping and Subsidy Offset Act)
würden in Zukunft die Einkünfte und den Cash Flow von Timken vermindern.
Risiken bezogen auf die Geschäftstätigkeit der Gesellschaft

Jede Änderung der Verfügbarkeit und Kosten von Rohstoffen und Energieressourcen oder der
einschlägigen Preisabsicherungs-Mechanismen der Gesellschaft kann erhebliche nachteilige
Auswirkungen auf die Einkünfte von Timken haben.

Timken könnte es misslingen, das Project O.N.E. erfolgreich umzusetzen oder die erwarteten
Einspareffekte aus dem Project O.N.E. zu erzielen.

Geltend gemachte Ansprüche aus Gewährleistung und Produkthaftung sowie Kosten aus Rückrufmaßnahmen können erhebliche nachteilige Auswirkungen auf die Einkünfte von Timken haben.

Das Nichterreichen der erwarteten Ergebnisziele aus den Initiativen im Geschäftsbereich Automotive kann erhebliche nachteilige Auswirkungen auf die Einkünfte von Timken haben.

Das Nichterreichen der erwarteten Einsparungen aufgrund der Rationalisierungsinitiative für den
Lagerherstellungsbetrieb in Canton, Ohio, kann erhebliche nachteilige Auswirkungen auf die
Einkünfte von Timken haben.

Für Timken kann sich ein weiterer Wertminderungs- und Restrukturierungsaufwand ergeben,
welcher die Profitabilität der Gesellschaft erheblich beeinträchtigen kann.

Die fehlende Ausfinanzierung der Verpflichtungen aus bestehenden Pensionsplänen Timkens hat
eine erhebliche Verminderung des Eigenkapitals der Aktionäre verursacht und kann dies auch
weiterhin verursachen.

Die Unterkapitalisierung von Pensionsfondsvermögen wird dazu führen, dass Timken zusätzliche
Leistungen zur Finanzierung der Pensionsverpflichtungen erbringen muss, so dass weniger Mittel
zu anderen Zwecken zur Verfügung stehen könnten.

Arbeitsunterbrechungen und ähnliche Schwierigkeiten können zu erheblichen Störungen des
Produktionsbetriebs von Timken führen, die Einnahmen der Gesellschaft vermindern und erhebliche nachteilige Auswirkungen auf die Einkünfte der Gesellschaft haben.
9

Unvorhergesehene Maschinenausfälle oder andere Störungen des Produktionsbetriebs der
Gesellschaft können Timkens Kosten erhöhen, zu Engpässen bzw. Stillständen bei der Produktion
führen und so die Verkäufe und Einkünfte der Gesellschaft verringern.

Umweltrechtliche Vorschriften verursachen erhebliche Kosten und Beschränkungen für den
Geschäftsbetrieb von Timken, und die Umsetzung von Compliance-Maßnahmen könnte sich
kostspieliger als erwartet herausstellen.

Globale politische Instabilität und andere Risiken des Auslandsgeschäfts können erhebliche
nachteilige Auswirkungen auf die Produktionskosten, Einkünfte und die Preise von Produkten der
Gesellschaft haben.
Risiken bezogen auf die Aktien der Gesellschaft

Beträchtliche Veräußerungen von Timken-Stammaktien können zu einem Rückgang des Aktienkurses führen.

Die Aktien der Gesellschaft könnten in Zukunft schwankungsanfälliger werden, was zu
erheblichen Verlusten für Anleger führen kann, die Stammaktien von Timken erwerben. Anleger
könnten ihre Timken-Stammaktien möglicherweise nicht zum oder über dem Erwerbspreis am
öffentlichen Kapitalmarkt verkaufen.

Allgemeiner Rückgang der Aktienkurse.

Möglicher Totalverlust der Anlage im Insolvenzfalle Timkens.

Timkens Satzungsvorschriften sowie die gesellschaftsrechtlichen Bestimmungen des US-Bundesstaates Ohio könnten eine gegebenenfalls von einem Aktionär befürwortete Änderung der Eigentümerverhältnisse (change of control) verzögern oder verhindern.
10
II.
SUMMARY OF PROSPECTUS
Notice to the Reader
The terms "Timken" and the "Company" are used interchangeably in this prospectus and both refer to
The Timken Company unless the context otherwise requires. The Timken Company is the issuer and
the offeror of the shares offered to its associates under The Timken Company International Stock
Ownership Plan ("TISOP").
Timken warns the reader that:

This summary should be read as an introduction to the prospectus;

Any decision to invest in the securities should be based on consideration of the prospectus as a
whole by the investor;

Where a claim relating to the information contained in a prospectus is brought before a court, the
plaintiff investor might, under the national legislation of the EU or EEA Member States, have to
bear the costs of translating the prospectus before the legal proceedings are initiated; and

Civil liability attaches to those persons who have tabled the summary, including any translation
thereof, and applied for its notification, but only if the summary is misleading, inaccurate or
inconsistent when read together with the other parts of the prospectus.
1. About Timken1
The Timken Company is a leading global manufacturer of highly engineered bearings and alloy steels
and a provider of related products and services. An outgrowth of a business originally founded in
1899, the Company was incorporated under the laws of the US State of Ohio in 1904. As of March
2007, Timken had facilities in 26 countries on six continents and had 25,001 associates. Timken
operates under three segments: Automotive Group, Industrial Group and Steel Group. The
Automotive and Industrial Groups design, manufacture and distribute a range of bearings and related
products and services. Automotive Group customers include original equipment manufacturers of
passenger cars, trucks and trailers. Industrial Group customers include both original equipment
manufacturers and distributors for agriculture, construction, mining, energy, mill, machine tooling,
aerospace, and rail applications. Steel Group products include different alloys in both solid and
tubular sections, as well as custom-made steel products, for both automotive and industrial
applications, including bearings.
Timken has a Board of Directors consisting of thirteen Directors. The Directors are elected at the
annual meeting or at a special meeting of shareholders for a term of three years.
1
Capitalized terms used in this summary refer to either proper names or terms defined in the main text
following this summary.
11
2. Summary of Key Financial Data
The following key financial data is extracted without adjustment from Timken’s Annual Report to the
shareholders for the fiscal year ended December 31, 2006:
2006
2005
Net sales
Impairment and restructuring charges
Income Before Income Taxes
Provision for income taxes
Income from continuing operations
Income from discontinued operations, net of income taxes
Net Income
$ 4,973,365
$
44,881
$ 254,234
$
77,795
$ 176,439
$
46,088
$ 222,527
$ 4,823,167
$
26,093
$ 346,538
$ 112,882
$ 233,656
$
26,625
$ 260,281
Basic earnings per share
Diluted earnings per share
Dividends per share
$
$
$
$
$
$
(US dollars in thousands, execept per share data)
Net Sales
(US $ in Billions)
Net Income Per Share
(Diluted) (in US $)
2.38
2.36
0.62
Dividends Per Share
(in US $)
2.81
4.8
5.0
0.62
0.60
2.36
4.3
2.84
2.81
0.60
3.6
1.49
2.4
0.52 0.52 0.52
0.62
2002 2003 2004 2005 2006
0.44
2002 2003 2004 2005 2006
2002 2003 2004 2005 2006
3. The Timken Company International Stock Ownership Plan
The Timken Company, in conjunction with Timken's Local Business Units, has chosen to sponsor the
participation of certain qualified Timken associates who work and reside outside the United States in
an employee stock offer program called "The Timken Company International Stock Ownership Plan"
(TISOP or Plan). To participate in the Plan, the individual must be at least 18 years old and have been
a Timken associate for at least six months.
12
Overview
The Plan is a matched savings program allowing each Participant to contribute a portion of his or her
salary to the Plan each payment period. The Local Business Unit matches the Participant
Contributions 100% up to specified limits.
The Participant Contributions and the Local Business Unit’s contributions made on behalf of a
Participant are deposited and held in a trust in the name of the respective Participant. The Company
has established a trust, which acquires and holds Company Stock and other Plan assets for the benefit
of Plan Participants.
The Company Stock
The offer under the Plan refers to Timken's common stock. The common stock is regulated under the
US Securities Act of 1933 and the US Securities Exchange Act of 1934. All common stock issued and
outstanding is without par value, fully paid and admitted to trading on the New York Stock Exchange.
The US security identification (CUSIP) number of Timken's common stock is 887389104, and the
short code at the New York Stock Exchange is "TKR".
All shares of common stock offered under the Plan are registered, certificated and freely transferable.
Each share entitles the holder to one vote and to fully and equally receive dividends. When, and if,
dividends are declared by the Company, they are generally paid quarterly, usually in March, June,
September and December.
Administration of the Plan
The Plan is administered by an international Committee, a Plan Administrator and a Trustee. The
Committee is responsible for the general administration and management of the Plan. The Committee
has full discretionary power to interpret the provisions of the Plan, to make rules for the
administration of the Plan and to make factual findings with respect to any issues arising under the
Plan. The Plan Administrator provides day-to-day processing, record keeping and communications
services for the benefit of Plan Participants and performs certain other administrative functions
specified in the Plan.
The Company has selected Lloyds TSB Offshore Trust Company Limited, a trust company located in
Jersey, Channel Islands, as the Trustee. The Trustee administers the Plan assets, combines the
contributions made by or on behalf of all Participants and uses the combined contributions to purchase
Company Stock in the open market at market prices. The Trustee is the legal owner of the shares of
Company Stock acquired under the Plan until the Participants withdraw those shares from the Plan
under the Plan rules. The Participants, however, control the voting and sale of their shares in the Plan.
The costs and expenses incurred in the administration of the Plan and trust, including the
compensation of the Trustee and the Plan Administrator and such expenses as brokerage fees and
commissions, are paid by the Local Business Units sponsoring the Plan.
4. Risk Factors
An investment in the Company's shares is confronted with various risks that are related to the
industry, the business and the common stock of Timken.
Risks Related to the Company's Industry

The bearing industry is highly competitive, and this competition results in significant pricing
pressure for Timken's products, which could affect the Company's revenues and profitability.
13

Competition and consolidation in the steel industry, together with potential global overcapacity,
could result in significant pricing pressure for Timken's products.

Weakness in any of the industries in which Timken's customers operate, as well as the cyclical
nature of Timken customers’ businesses in general, could adversely impact the Company's revenues and profitability by reducing demand and margins.

An increase in the use of substitutes for steel products could also adversely impact the Company's
revenues and profitability by reducing demand and margins.

Any reduction of distributions under the US Continued Dumping and Subsidy Offset Act
(CDSOA) in the future would reduce Timken's earnings and cash flows.
Risks Related to the Company's Business

Any change in the Company's operation of raw material surcharge mechanisms or the availability
or cost of raw materials and energy resources could materially affect Timken's earnings.

Timken may not be able to realize the anticipated benefits from, or successfully execute, Project
O.N.E.

Warranty, recall or product liability claims could materially adversely affect Timken's earnings.

The failure to achieve the anticipated results of the Company's Automotive Group initiatives
could materially affect Timken's earnings.

The failure to achieve the anticipated results of the Canton bearing operation rationalization
initiative could materially adversely affect Timken's earnings.

Timken may incur further impairment and restructuring charges that could materially affect the
Company's profitability.

Underfunding of Timken's defined benefit and other postretirement plans has caused and may
continue to cause a significant reduction in shareholders’ equity.

The underfunded status of Timken's pension fund assets will cause the Company to prepay the
funding of its pension obligations which may divert funds from other uses.

Work stoppages or similar difficulties could significantly disrupt Timken's operations, reduce its
revenues and materially affect its earnings.

Unexpected equipment failures or other disruptions of the Company's operations may increase
Timken's costs and reduce its sales and earnings due to production curtailments or shutdowns.

Environmental regulations impose substantial costs and limitations on Timken's operations and
environmental compliance may be more costly than the Company expects.

Global political instability and other risks of international operations may adversely affect the
Company's operating costs, revenues and the price of its products.
Risks Related to the Company's Stock

Substantial sales of shares of Timken's common stock could cause the stock price to decline.

The Company's stock price may become more volatile in the future, resulting in substantial losses
for investors purchasing shares of Timken's common stock. Investors may not be able to resell
their shares of Timken's common stock at or above the purchase price to the public.

General decline of stock markets.

Possible total loss of investment in case of Timken's insolvency.

Timken's articles of incorporation, regulations and Ohio corporate law could delay or prevent a
change of control that a stockholder may favor.
14
III.
RISK FACTORS
The reader should carefully consider the following main risk factors, as well as other information
contained in this prospectus, that could negatively affect Timken's business, financial condition and
result of operations, before making an investment in the Company's common stock.
1. Risks Related to Timken's Industries

The bearing industry is highly competitive, and this competition results in significant
pricing pressure for Timken's products, which could affect the Company's revenues and
profitability.
The global bearing industry is highly competitive. Timken competes with domestic manufacturers
and many foreign manufacturers of anti-friction bearings, including SKF, INA, NTN, Koyo and
NSK. The bearing industry is also capital-intensive and profitability is dependent on factors such
as labor compensation and productivity and inventory management, which are subject to risks that
Timken may not be able to control. Due to the competitiveness within the bearing industry,
Timken may not be able to increase prices for products to cover increases in costs and, in many
cases, Timken may face pressure from its customers to reduce prices, which could adversely
affect its revenues and profitability.

Competition and consolidation in the steel industry, together with potential global
overcapacity, could result in significant pricing pressure for Timken's products.
Competition within the steel industry, both domestically and worldwide, is intense and is expected
to remain so. Global production overcapacity has occurred in the past and may reoccur in the
future, which, when combined with high levels of steel imports into the United States, may exert
downward pressure on domestic steel prices and result in, at times, a dramatic narrowing, or with
many companies the elimination, of gross margins. In addition, many of Timken's competitors are
continuously exploring and implementing strategies, including acquisitions, which focus on
manufacturing higher margin products that compete more directly with Timken's steel products.
These factors could lead to significant downward pressure on prices for Timken's steel products,
which could have a materially adverse effect on the Company's revenues and profitability.

Weakness in any of the industries in which Timken's customers operate, as well as the
cyclical nature of its customers’ businesses generally, could adversely impact the Company's
revenues and profitability by reducing demand and margins.
Timken's revenues may be negatively affected by changes in customer demand, changes in the
product mix and negative pricing pressure in the industries in which Timken operates. Many of
the industries in which Timken's end customers operate are cyclical. Margins in those industries
are highly sensitive to demand cycles, and Timken's customers in those industries historically
have tended to delay large capital projects, including expensive maintenance and upgrades, during
economic downturns. As a result, the Company's business is also cyclical and its revenues and
earnings are impacted by overall levels of industrial production.
Certain automotive industry companies have recently experienced significant financial downturns.
In 2005, the Company increased its reserve for accounts receivable relating to its automotive
industry customers. If any of its automotive industry customers become insolvent or file for
bankruptcy, the Company's ability to recover accounts receivable from that customer would be
adversely affected and any payment the Company received in the preference period prior to a
bankruptcy filing may be potentially recoverable. In addition, financial instability of certain
15
companies that participate in the automotive industry supply chain could disrupt production in the
industry. A disruption of production in the automotive industry could have a materially adverse
effect on the Company's financial condition and earnings.

An increase in the use of substitutes for steel products could adversely impact the
Company's revenues and profitability by reducing demand and margins.
In the case of certain product applications, steel competes with other materials, including plastic,
aluminum, graphite composites and ceramics. The incorporation of more of these steel substitutes
in automobiles and other applications could reduce the demand, and therefore the prices Timken
is able to charge for its steel products. This reduced demand and any resulting reduced margins
for its products could have a materially adverse impact on Timken's revenues and profitability.

Any reduction of distributions under the US Continued Dumping and Subsidy Offset Act
(CDSOA) in the future would reduce Timken's earnings and cash flows.
The CDSOA provides for distribution of monies collected by US Customs from antidumping
cases to qualifying domestic producers where the domestic producers have continued to invest in
their technology, equipment and people. The Company reported CDSOA receipts, net of
expenses, of $87.9 million, $77.1 million and $44.4 million in 2006, 2005 and 2004, respectively.
In February 2006, US legislation was enacted that would end CDSOA distributions for imports
covered by antidumping duty orders entering the United States after September 30, 2007. Instead,
any such antidumping duties collected would remain with the US Treasury. This legislation is not
expected to have a significant effect on potential CDSOA distributions in 2007, but would be
expected to reduce any distributions in years beyond 2007, with distributions eventually ceasing.
In separate cases in July and September 2006, the US Court of International Trade (CIT) ruled
that the procedure for determining recipients eligible to receive CDSOA distributions is
unconstitutional. The CIT has not finally ruled on other matters, including any remedy as a result
of its ruling. The Company expects that the ruling of the CIT will be appealed. The Company is
unable to determine, at this time, if these rulings will have a material adverse impact on the
Company’s financial results.
In addition to the CIT ruling, there are a number of other factors that can affect whether the
Company receives any CDSOA distributions and the amount of such distributions in any year.
These factors include, among other things, potential additional changes in the law, other ongoing
and potential additional legal challenges to the law, and the administrative operation of the law. It
is possible that CIT rulings might prevent Timken from receiving any CDSOA distributions in
2007. Any reduction of CDSOA distributions would reduce the Company's earnings and cash
flow.
2. Risks Related to Timken's Business

Any change in the Company's operation of raw material surcharge mechanisms or the
availability or cost of raw materials and energy resources could materially affect Timken's
earnings.
Timken requires substantial amounts of raw materials, including scrap metal and alloys and
natural gas, to operate its business. Many of Timken's customer contracts contain surcharge
pricing provisions. The surcharges are tied to a widely-available market index for that specific
raw material. Any change in the relationship between the market indices and Timken's underlying
costs could materially affect the Company's earnings.
16
Moreover, future disruptions in the supply of raw materials or energy resources could impair
Timken's ability to manufacture products for its customers, or require Timken to pay higher prices
in order to obtain these raw materials or energy resources from other sources. Any increase in the
prices for such raw materials or energy resources could materially affect the Company's costs and
therefore its earnings.

Timken may not be able to realize the anticipated benefits from, or successfully execute,
Project O.N.E.
During 2005, Timken began implementing Project O.N.E., a multi-year program designed to
improve business processes and systems to deliver enhanced customer service and financial
performance. During 2007, the Company expects the first major US implementation of Project
O.N.E. The Company may not be able to realize the anticipated benefits from or successfully
execute this program. Timken's future success will depend, in part, on its ability to improve its
business processes and systems. The Company may not be able to successfully do so without
substantial costs, delays or other difficulties. The Company may face significant challenges in
improving our processes and systems in a timely and efficient manner.
Implementing Project O.N.E. will be complex and time-consuming, may be distracting to
management and disruptive to the Company's businesses, and may cause an interruption of, or a
loss of momentum in, its businesses as a result of a number of obstacles, such as:

The loss of key associates or customers;

The failure to maintain the quality of customer service that Timken has historically
provided;

The need to coordinate geographically diverse organizations; and

The resulting diversion of management’s attention from Timken's day-to-day business
and the need to dedicate additional management personnel to address obstacles to the
implementation of Project O.N.E.
If Timken is not successful in executing Project O.N.E., or if it fails to achieve the anticipated
results, then the Company's operations, margins, sales and reputation could be adversely affected.

Warranty, recall or product liability claims could materially adversely affect Timken's
earnings.
In Timken's business, the Company is exposed to warranty and product liability claims. In
addition, the Company may be required to participate in the recall of a product. A successful
warranty or product liability claim against the Company, or a requirement that the Company
participate in a product recall, could have a materially adverse effect on its earnings.

The failure to achieve the anticipated results of Timken's Automotive Group initiatives
could materially affect its earnings.
During 2005, Timken began restructuring its Automotive Group operations to address challenges
in the automotive markets. The Company expects that this restructuring will cost approximately
$80 million to $90 million (pretax) and is targeting annual pretax savings of approximately $40
million by 2008. In response to reduced production demand from North American automotive
manufacturers, in September 2006, the Company announced further planned reductions in its
Automotive Group workforce of approximately 700 associates. Timken expects that this
workforce reduction will cost approximately $25 million (pretax) and is targeting annual pretax
savings of approximately $35 million by 2008. The failure to achieve the anticipated results of the
17
Automotive Group's restructuring and workforce reduction initiatives, including the targeted
annual savings, could adversely affect the Company's earnings.

The failure to achieve the anticipated results of the Canton bearing operation
rationalization initiative could materially adversely affect Timken's earnings.
After reaching a new four-year agreement with the union representing employees in the Canton,
Ohio bearing and steel plants in 2005, Timken refined its plans to rationalize the Canton bearing
operations. The Company expects that this rationalization initiative will cost approximately $35
million to $40 million (pretax) over the next three years and is targeting annual pretax savings of
approximately $25 million. The failure to achieve the anticipated results of this initiative,
including our targeted annual savings, could adversely affect the Company's earnings.

Timken may incur further impairment and restructuring charges that could materially
affect its profitability.
Timken has taken approximately $82.6 million in impairment and restructuring charges for its
Automotive Group restructuring and workforce reduction and the rationalization of its Canton
bearing operations during 2006 and 2005 and expects to take additional charges in connection
with these initiatives. Changes in business or economic conditions, or the Company's business
strategy, may result in additional restructuring programs and may require the Company to take
additional charges in the future, which could have a materially adverse effect on its earnings.

Underfunding of Timken's defined benefit and other postretirement plans has caused and
may continue to cause a significant reduction in its shareholders’ equity.
As a result of recent accounting standards, the underfunded status of Timken's pension fund assets
and its postretirement health care obligations, the Company was required to take a total net
reduction of $276 million, net of income taxes, against our shareholders’ equity in 2006. Timken
may be required to take further charges related to pension and other postretirement liabilities in
the future and these charges may be significant.

The underfunded status of Timken's pension fund assets will cause the Company to prepay
the funding of its pension obligations which may divert funds from other uses.
The increase in the Company's defined benefit pension obligations, as well as its ongoing practice
of managing funding obligations over time, have obligated Timken to prepay a portion of its
funding obligations under the pension plans. Timken made cash contributions of $243 million,
$226 million and $185 million in 2006, 2005 and 2004, respectively, to its US-based pension
plans and currently expects to make cash contributions of $80 million in 2007 to such plans.
However, the Company cannot predict whether changing economic conditions or other factors
will require making contributions in excess of the current expectations, thereby diverting funds
the Company would otherwise apply to other uses.

Work stoppages or similar difficulties could significantly disrupt Timken's operations,
reduce its revenues and materially affect its earnings.
A work stoppage at one or more of Timken's facilities could have a materially adverse effect on
its business, financial condition and results of operations. Also, if one or more of the Company's
customers were to experience a work stoppage, that customer would likely halt or limit purchases
of the Company's products, which could have a materially adverse effect on its business, financial
condition and results of operations.
18

Unexpected equipment failures or other disruptions of the Company's operations may
increase Timken's costs and reduce its sales and earnings due to production curtailments or
shutdowns.
Interruptions in production capabilities, especially in Timken's Steel Group, would inevitably
increase production costs and reduce sales and earnings for the affected period. In addition to
equipment failures, Timken's facilities are also subject to the risk of catastrophic loss due to
unanticipated events such as fires, explosions or violent weather conditions. Timken's manufacturing processes are dependent upon critical pieces of equipment, such as furnaces, continuous
casters and rolling equipment, as well as electrical equipment, such as transformers, and this
equipment may, on occasion, be out of service as a result of unanticipated failures. In the future,
Timken may experience material plant shutdowns or periods of reduced production as a result of
these types of equipment failures.

Environmental regulations impose substantial costs and limitations on Timken's operations
and environmental compliance may be more costly than the Company expects.
Timken is subject to the risk of substantial environmental liability and limitations on its
operations due to environmental laws and regulations. The Company is subject to various federal,
state, local and foreign environmental, health and safety laws and regulations concerning issues
such as air emissions, wastewater discharges, solid and hazardous waste handling and disposal
and the investigation and remediation of contamination. The risks of substantial costs and
liabilities related to compliance with these laws and regulations are an inherent part of the
Company's business, and future conditions may develop, arise or be discovered that create
substantial environmental compliance or remediation liabilities and costs.
Compliance with environmental legislation and regulatory requirements may prove to be more
limiting and costly than Timken anticipates. New laws and regulations, including those which
may relate to emissions of greenhouse gases, stricter enforcement of existing laws and
regulations, the discovery of previously unknown contamination or the imposition of new cleanup requirements could require the Company to incur costs or become the basis for new or
increased liabilities that could have a material adverse effect on its business, financial condition or
results of operations. Timken may also be subject from time to time to legal proceedings brought
by private parties or governmental authorities with respect to environmental matters, including
matters involving alleged property damage or personal injury.

Global political instability and other risks of international operations may adversely affect
the Company's operating costs, revenues and the price of its products.
Timken's international operations expose the Company to risks not present in a purely domestic
business, including primarily:
•
Changes in tariff regulations, which may make Timken's products more costly to export;
•
Difficulties in establishing and maintaining relationships with local OEMs, distributors and
dealers;
•
Import and export licensing requirements;
•
Compliance with a variety of foreign laws and regulations, including unexpected changes in
taxation and environmental or other regulatory requirements, which could increase the
Company's operating and other expenses and limit its operations; and
•
Difficulty in staffing and managing geographically diverse operations.
These and other risks may also increase the relative price of Timken's products compared to those
manufactured in other countries, reducing the demand for Timken's products in the markets in
19
which the Company operates, which could have a materially adverse effect on its revenues and
earnings.
3. Risks Related to Timken's Common Stock

Substantial sales of shares of Timken's common stock could cause the stock price to decline.
Timken may, in the future, sell additional shares of common stock in subsequent public offerings
and may also issue additional shares of common stock to finance future acquisitions. A substantial
number of shares of Timken's common stock is also available for future sale pursuant to stock
options that the Company has granted to its associates. Sales of substantial amounts of common
stock, or the perception that such sales could occur, may adversely affect prevailing market prices
for shares of common stock and could impair Timken's ability to raise capital through future
offerings.

Timken's stock price may become more volatile in the future.
The trading price of Timken's common stock may become more volatile in the future. Many
factors may contribute to this volatility, including the risks described above, as well as:
•
Changes in marketing, product pricing and sales strategies or development of new products by
Timken or its competitors;
•
Variations in the Company's results of operations;
•
Perceptions about market conditions in the industries served;
•
General market conditions (i.e., general decline of stock markets); and
•
Possible total loss of investment in case of Timken's insolvency.
Volatility may have a significant impact on the market price of Timken's common stock.
Moreover, the possibility exists that the stock market could experience extreme price and volume
fluctuations that may materially adversely affect the stock price regardless of the Company's
operating results. This volatility makes it difficult to ascribe a stable valuation to a shareholder’s
holdings of Timken's common stock.

Timken's articles of incorporation, regulations and Ohio corporate law could delay or
prevent a change of control that an investor may favor.
Timken's articles of incorporation, regulations and Ohio corporate law contain provisions that
could delay, defer or prevent a change of control of the Company or its management. These
provisions could also discourage proxy contests and make it more difficult for shareholders to
elect directors and take other corporate actions. These provisions:
•
Divide the Board of Directors into three classes, with members of each class to be elected for
staggered three-year terms; and
•
Regulate how shareholders may present proposals or nominate directors for election at
shareholder meetings.
Additionally, Ohio corporate law provides that certain notice and informational filings and special
shareholder meeting and voting procedures must be followed prior to consummation of a
proposed "control share acquisition," as defined in the Ohio statute. Assuming compliance with
the notice and information filings prescribed by statute, the proposed control share acquisition
may be made only if, at a special meeting of shareholders, the acquisition is approved by both a
20
majority of the voting power of the Company represented at the meeting and a majority of the
voting power remaining after excluding the combined voting power of the "interested shares," as
defined in the statute. Together, these provisions of the Company's articles and regulations and
Ohio corporate law may discourage transactions that otherwise could provide for the payment of a
premium over prevailing market prices for Timken's common stock and could also limit the price
that investors may be willing to pay in the future for common stock.
21
IV.
ABOUT THIS PROSPECTUS
1. Legal Basis
This prospectus has been prepared in accordance with:

the Directive 2003/71/EC of the European Parliament and of the Council of November 4, 2003,
on the prospectus to be published when securities are offered to the public or admitted to trading
(the "Prospectus Directive");

the Commission Regulation (EC) No. 809/2004 of April 29, 2004, implementing Directive
2003/71/EC of the European Parliament and of the Council in regard to information contained in
prospectuses as well as the format, incorporation by reference and publication of such
prospectuses and dissemination of advertisements (the "Prospectus Regulation"); and

the German Securities Prospectus Act (Wertpapierprospektgesetz).
2. Responsibility for the Contents of the Prospectus
The Timken Company accepts responsibility for the information contained in this prospectus. The
address of its principal executive offices is 1835 Dueber Avenue, S.W., Canton, Ohio 44706-2798,
United States of America. To the best knowledge and belief of The Timken Company, the information
contained in this prospectus is in accordance with the facts and does not omit any material
circumstances.
3. Approval and Notification
This prospectus has been filed with and approved by the German Federal Financial Supervisory
Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) (the "German Financial Supervisory Authority") in its capacity as competent authority under the Prospectus Directive and the
German Securities Prospectus Act for Timken's common stock offered under the The Timken
Company International Stock Ownership Plan (TISOP) up to the expiry of twelve months from the
date of publication of this prospectus. The German Financial Supervisory Authority has provided each
of the Italian regulator (the Commissione Nazionale per le Società e la Borsa – Consob) and the
Spanish regulator (the Comisión Nacional del Mercado de Valores - CNMV) with a certificate of
approval attesting that the prospectus has been drawn up in accordance with the German Securities
Prospectus Act, which implemented the Prospectus Directive (each, a "Certificate of Approval"). The
Timken Company will apply to the German Financial Supervisory Authority to issue additional
Certificates of Approval to the competent authorities of such other Member States as and when it
deems it appropriate or necessary.
22
V.
THE TIMKEN COMPANY INTERNATIONAL
STOCK OWNERSHIP PLAN
1. Introduction
The Timken Company, in conjunction with its Local Business Units, has chosen to sponsor the
participation of certain qualified Timken associates who work and reside outside the United States
(the "Participants") in an employee stock offer program called "The Timken Company International
Stock Ownership Plan" ("TISOP") (also referred to as the "Plan"). Through the stock offer program,
Timken intends to strengthen the associates' work motivation and loyalty to the Company and to
provide a long-term opportunity for designated associates to own shares of the Company´s common
stock.
The Timken Company is the issuer and the offeror of the shares offered to the Participants under the
Plan. The documents describing the Plan, including this prospectus, may be supplemented or updated
from time to time, and the local Timken business unit to which a participating employee belongs (the
"Local Business Unit") will provide each Participant with these supplements and updates.
2. The Company Stock Offered
The offer under the Plan concerns Timken's common stock (also referred to in the following
paragraphs as the "Company Stock"), which is regulated under the US Securities Act of 1933 and the
US Securities Exchange Act of 1934. All common stock issued and outstanding is without par value,
fully paid and admitted to trading on the New York Stock Exchange. The stock is quoted in US
dollars. The stock's US security identification (CUSIP) number is 887389104, and its short code at the
New York Stock Exchange is "TKR".
All shares of common stock offered under the Plan are registered, certificated and freely transferable.
Each share entitles the holder to one vote held on all matters presented to the shareholders in annual
or special meetings of the Company. It also entitles the shareholder to fully and equally receive
dividends, without limitation, from funds legally available in the amount when, as and if declared by
the board of directors. When, and if, dividends are declared by the Company, dividends are generally
paid quarterly, usually in March, June, September and December (see further stock description
below).
3. Overview of the Plan
The Plan is a matched savings program allowing each Participant to contribute a portion of his or her
salary every payment period to the Plan ("Participant Contributions"). The Local Business Unit
matches the Participant Contributions 100% up to specified limits described below ("Matching
Contributions"). A Participant may contribute more than his or her Local Business Unit will match,
but Participant Contributions above the limits for Matching Contributions will not be matched.
The Participant Contributions and the Local Business Unit’s contributions made on behalf of a
Participant are deposited and held in a trust in the name of the respective Participant. A trustee
combines these contributions with those made by or on behalf of other associates and uses the
combined contributions to purchase Company Stock in the open market at market prices. The
Company Stock bought with the contributions made by or on behalf of the Participants is held for the
23
Participants in the trust. Each Participant may withdraw his or her Company Stock, together with any
income earned on it, in cash or stock under the procedures described below.
To participate in the Plan, the individual must be at least 18 years old and have been a Timken
associate for at least six months. In addition, the individual's place of employment and residence must
be outside the United States. An associate will not be eligible to join if he or she is a United States
resident or is eligible to participate in a similar stock ownership or stock purchase plan sponsored by
another Timken business unit.
The Plan is maintained in the United Kingdom at the offices of the Plan administrator (see below).
This is where the official Plan records used to determine and pay the Participants' benefits are kept
and from where the Participants will receive statements reflecting their benefits under the Plan.
4. Administration of the Plan
The Committee
The Plan is administered by an international Committee (the "Committee") composed of not fewer
than three individuals appointed by the Company. Each member of the Committee is an associate of a
Timken unit. The Company reserves the right to appoint or remove members of the Committee at any
time. The Committee is headquartered in the United Kingdom and meets once a year at a location
outside the United States.
The Committee is responsible for the general administration and management of the Plan. The
Committee has full discretionary power to interpret the provisions of the Plan, to make rules for the
administration of the Plan and to make factual findings with respect to any issues arising under the
Plan.
The Plan Administrator
The Committee has selected HBOS Employee Equity Solutions, a benefits and financial services
company located in the United Kingdom, as the Plan administrator ("Plan Administrator"). The Plan
Administrator provides day-to-day processing, record keeping and communications services for the
benefit of Plan participants and performs certain other ministerial functions specified in the Plan.
Although the Plan Administrator must follow the rules of the Plan, it is otherwise independent of the
Company and the Local Business Units. The Committee may remove the Plan Administrator at any
time and appoint a new Plan Administrator.
The Trustee
The Company has established a trust located in Jersey, Channel Islands, into which all contributions
are deposited and which acquires and holds Company Stock and other Plan assets for the benefit of
Plan Participants with Lloyds TSB Offshore Trust Company Limited as the trustee (the "Trustee").
The Trustee administers the Plan assets, investing them in Company Stock in accordance with the
rules of the Plan. The Trustee is the legal owner of the shares of Company Stock acquired under the
Plan until the Participants withdraw those shares from the Plan under the Plan rules. The Participants,
however, control the voting and sale of their shares in the Plan under the terms described below.
Although the Trustee must follow the rules of the Plan and the trust, it is otherwise independent from
the Company and the Local Business Units. The Company may remove the Trustee and appoint a new
Trustee under certain terms specified in thc agreement establishing the trust.
24
Monthly Share Purchases
The Trustee and Plan Administrator effect the monthly share purchases on behalf of the Participants
as follows:
No later than on the 12th UK working day of the month (unless otherwise required by local law), or
the next working day when the Trustee and Plan Administrator and the New York Stock Exchange are
open for business, the Trustee instructs CIBC World Markets, the Plan stockbroker, to invest all
Participant Contributions in the purchase of Company Stock at the full market price available at the
time of dealing. Whole shares and fractional shares (to five decimal places) are allocated to
Participants' accounts, ensuring that the US dollar amount contributed by each Participant is fully
invested to the nearest cent.
The Trustee settles the purchase of shares with the stockbroker and receives ownership of the shares
on behalf of the Participants.
Stockbrokers' commissions are charged separately. The Plan Administrator passes the stockbroker's
annual account to The Timken Company for settlement. The Timken Company allocates the
stockbroker's charges among the Local Business Units in relation to the number of Participants
employed by each participating Local Business Unit.
The Plan Administrator maintains a register of Plan shareholdings, differentiating shares arising from
the total of each Participant's basic and additional associate contributions ("Participant Shares") from
those arising from matching Timken contributions or additional employer contributions ("Matched
Shares").
Plan Administration Costs
The costs and expenses incurred in the implementation and administration of the Plan and trust,
including the compensation of the Trustee and the Plan Administrator and such expenses as brokerage
fees and commissions, are paid proportionally by the Local Business Units sponsoring the Plan.
Under certain circumstances, and depending on applicable law, Company Stock and other assets held
in the trust for the benefit of Participants could be subject to liens for the debts of Participants. If the
Company or a Local Business Unit is deemed under applicable tax law to have taxable earnings on the
actual investment of the Plan assets, the Company or the Local Business Unit could request the
Trustee to reimburse the Company or the Local Business Unit from the Plan assets for the amount of
income tax liability resulting from these taxable earnings.
5. Participation and Contributions
The Plan year begins March 1st of each year as long as the Plan is in effect. Each February, the
participating associate must complete a new election form to be eligible to make contributions or have
contributions made on his or her behalf and to instruct the Local Business Unit as to the amount it
should deduct from his or her salary each payment period in the following Plan year. If an associate
becomes eligible to join the Plan in the midst of a Plan year, he or she must complete a similar
election form within 30 days after becoming eligible to join. As further described below, the
Company reserves the right to amend or terminate the plan, in whole or in part, at any time.
Minimum Participant Contributions
To make contributions to the Plan, the amount of the Participant Contributions must total a minimum
amount per Plan year. If a Participant makes contributions for less than an entire Plan year, he or she
is required to contribute only a portion of the minimum contribution, based on the period of time that
25
he or she makes contributions. The Local Business Unit informs each Participant of the minimum
contribution requirement that applies to him or her at the beginning of each Plan year.
Currently, the minimum contribution level per Plan year for Participants in Germany, Italy and Spain
is the equivalent of US $10 in euros.
Participants can stop their contributions to the Plan at anytime, but they cannot restart the
contributions until the earlier of three months after the time at which such termination becomes
effective or the first day of the following Plan year.
Limits on Matching Contributions
At the beginning of each Plan year, the management of each Local Business Unit determines the
amount of associate contributions to be complemented with Matching Contributions based on the
profitability of the Local Business Unit during the preceding year. Matching Contributions must not
exceed an amount equal to a maximum percentage of the Participant's base compensation. In no event
will Matching Contributions on behalf of any Participant exceed an absolute maximum amount. The
Participant will be informed of the maximum amount of Matching Contributions available to him or
her at the beginning of each Plan year. Currently, the maximum amount of Matching Contributions
made on behalf of any Participant in Germany, Italy and Spain will not exceed the equivalent of
US $4,500 in euros.
If a Participant chooses to contribute an amount greater than the amount that the Local Business Unit
currently matches, the amount of the Participant Contributions exceeding the maximum amount is
used to buy Company Stock, but is not matched. The amount of Participant Contributions may be
limited by the respective Local Business Unit, and the Committee may also limit the amount of
Participant Contributions to as little as the amount of Matching Contributions permitted by the Local
Business Unit.
Discretionary Additional Employer Contributions
The Plan also provides for Local Business Units to make discretionary contributions to the Plan on
behalf of a Participant in addition to Matching Contributions ("Additional Employer Contributions").
The Local Business Unit is not required to make Additional Employer Contributions. However, if it
does, the Local Business Unit determines the amount of these contributions and the time at which they
will be made. If the Local Business Unit makes Additional Employer Contributions on a Participant's
behalf, they will be deposited in the trust and used by the Trustee to purchase Company Stock on the
open market at market prices for the Participant's account in the Plan. These contributions would be
available for the Participant to withdraw from the Plan only at the time and under the circumstances
under which Matching Contributions made at the same time would be available.
Discretionary Cash Payment
The Local Business Unit, at its discretion, also may make a cash payment ("Cash Payment") directly
to a Participant to offset, in full or in part, any additional tax liability incurred by the Participant as a
result of his or her Local Business Unit’s Matching Contributions or Additional Employer
Contributions. The Local Business Unit is not required to make any Cash Payments. However, if it
does, the Local Business Unit determines the amount of the payment and the time at which it will be
made. If the Local Business Unit makes a Cash Payment, none of the payment will be deposited in the
trust or be used to buy Company Stock for the Participant.
26
6. Payment of Contributions to the Trust
The Local Business Unit deposits the Participant Contributions, its Matching Contributions and any
Additional Employer Contributions made on behalf of a Participant in the trust. After depositing these
contributions in the trust, neither the Company nor any Local Business Unit can direct the Trustee to
return (except for satisfaction of income taxes arising because of trust investment earnings) any of the
assets held in the trust for any Participant until all Plan benefits have been paid out in full to
Participants and their beneficiaries. If any assets remain in the trust after payment of all expenses and
all Plan benefits, the remaining assets are returned to the Local Business Units.
7. Sale and Transfer of Shares; Distribution of Contributions
Sale and Transfer of Participant Shares
Shares purchased with Participant Contributions are available for sale or for transfer into the direct
ownership of the Participant at four sales dates throughout the calendar year (end of March, June,
September and December). Fractions of shares may be sold, but cannot be transferred. In the event of
a transfer of shares, the Trustee will instruct Timken's transfer agent to transfer shares out of the trust
and into the direct ownership of the Participants. The Plan Administrator will send confirmation
directly to the home address of the Participant that the transfer has been initiated. The transfer agent
will then forward the resultant share certificate to the Participant by certified post.
Once a Participant has shares transferred into his or her ownership, the Plan has no further involvement in those shares. The Participant is entered on The Timken Company register of shareholders, and
the Participant, not the Trustee or the Plan Administrator, will be responsible for managing his or her
own shares.
Withdrawing Matched Shares
Participants generally can receive the shares purchased with Matching Contributions, or their value in
cash, at the beginning of the fifth Plan year following the Plan year in which the Matching
Contributions were made to the Plan ("Vested Matched Shares"). A Participant can receive Vested
Matched Shares, or their value in cash, at the end of March, June, September and December. Under
certain circumstances (e.g., death or disability, described below), a Participant can or will receive the
Matched Shares, or their value in cash, earlier than the beginning of the fifth Plan year. In addition,
even absent these certain circumstances, the respective Local Participation Agreement (defined
below) may allow a Participant to receive the Matched Shares, or their value in cash, earlier than the
beginning of the fifth Plan year.
Death and Disability
If a Participant dies while employed by a Timken unit, or employment with Timken is terminated as a
result of disability, the Participant or his or her beneficiary will automatically receive cash or stock for
all contributions made to the Plan by the Participant and the Local Business Unit. The distribution will
be made promptly after the date of death or termination.
Leave Service
If (a) a Participant retires from Timken with the consent of a Timken unit, (b) employment with
Timken is terminated without cause, or (c) employment with Timken is terminated under a mutual
agreement with a Timken unit that specifically contemplates that the Participant will receive all
contributions made by the Local Business Unit, the Participant will automatically receive cash or
27
stock for all contributions made to the Plan by him or her and the Local Business Unit. The
distribution will be made promptly after the date of termination.
Transfer to Another Timken Unit or Assignment to the United States
In general, if a Participant is transferred to another Timken unit by mutual agreement or is assigned to
work in the United States, the Committee will determine whether Matching Contributions must
remain in the Plan for the five-year period or be distributed to the Participant immediately. In
addition, as a result of the transfer or assignment, all contributions made by or on behalf of the
Participant, including Matching Contributions, may be distributed to the Participant, and the
Participant may no longer be eligible to participate in the Plan. However, if an associate is transferred
to another Timken unit but remains on the payroll of the Local Business Unit, the Company, with the
consent of the Local Business Unit, may allow the transferee to continue his or her active participation
in the Plan.
All Other Cases
If a Participant leaves Timken or is discharged under any other circumstance, he or she will receive
cash or stock for all of the contributions made by the Participant. He or she also will receive cash or
stock for any Matching Contributions that have been in the Plan for five Plan years or more. Matching
Contributions that have been in the Plan for less than five Plan years will be forfeited. These forfeited
contributions will be applied toward the payment of future contributions made under the Plan by the
respective Local Business Unit.
8. Treatment of Dividends
Dividends and other income ("Earnings") on the contributions made by or for a Participant are used to
buy more stock for the Participant's account under the Plan. The Participant can or will receive
Earnings on Participant Contributions or on contributions made by his or her employer from the Plan
at the same time as the Participant Contributions or the contributions made by the employer,
respectively, on which they were earned. For information on withholding tax on dividends, please
refer to Section VII. 4. below.
9. Interest in the Plan May Not Be Transferred
The Plan does not permit any Participant or beneficiary of a Participant to assign or otherwise transfer
the Participant’s or beneficiary’s interest in the Plan. For example, a Participant cannot pledge his or
her interest in the Plan as security for a debt.
In addition to the shares of Company Stock offered under the Plan, which have been registered under
the US Securities Act of 1933, the Plan may be deemed to involve separate participation interests that
may be considered securities under applicable United States law or other countries' laws and
regulations. These participation interests have not been registered under the law of any jurisdiction
and may not be offered or sold (a) in the United States or in any member state of the European Union
and the European Economic Area, (b) to any individual who is resident in the US, EU or EEA, or
(c) to any partnership, corporation, estate, trust, agency or account with a material connection to the
US, EU, and EEA, unless these participation interests are registered under the applicable local
legislation, or an exemption from the registration requirements of such legislation is available. Any
sale or transfer of an interest in participation in the Plan will be null and void.
28
10. Account Information
All Participants receive an account statement from the Plan Administrator at least once each year.
This statement includes important information concerning the Participant's account under the Plan,
including the amount of contributions made by the Participant and the Local Business Unit, the total
number of shares of Company Stock and other assets held for benefit under the Plan, the amount of
dividends earned on each account and reinvested in Company Stock, the amount of cash or stock a
Participant has withdrawn from the Plan, and any information that may be required under applicable
law. Participants should review their account statements closely. They must contact the Plan
Administrator within 90 days after receiving a statement if the Participants believe the statement does
not accurately reflect information concerning their account.
11. Naming a Beneficiary
When a Participant elects to make contributions to the Plan, he or she is asked to choose one or more
beneficiaries. If the Participant dies before receiving the full value of the account under the Plan, the
value will be paid to his or her beneficiary(ies). Each beneficiary must be an individual and may not
be a resident in the United States. Each beneficiary designation is subject to applicable law. If a
conflict exists between the designation and applicable law, amounts payable upon the Participant's
death will be paid as required by applicable law.
12. Claiming Benefits
If a Participant or a beneficiary believes that either of them is entitled to Plan benefits that they have
not received, a written claim for those benefits should be filed with the Plan Administrator, specifying
the basis for and the facts underlying the claim. If the claim for a benefit is denied in whole or in part,
the applicant will receive a written statement from the Plan Administrator, giving reasons for the
denial and explaining the Plan’s claim review procedures. The applicant then has up to 60 days to
appeal the denial by filing a written request with the Committee for a review of and final decision on
the claim. Within 60 days of the date the written request for review is filed, the Committee will
conduct a review of the decision. Within 60 days of the date of that review, the Committee will issue a
final decision on review, specifying the reasons and Plan provisions on which it is based.
13. Voting of Company Stock and Tender Offers
Before each annual or special meeting of the Company’s shareholders, each Participant is sent a copy
of the proxy solicitation material and a form requesting instructions to the Trustee on how to vote the
whole shares of Company Stock allocated to the Participant’s account under the Plan as of a specified
date provided in the proxy information and instruction form. The Trustee votes the shares as
instructed. If instructions are not received for any portion of the shares of Company Stock held under
the Plan, those shares will be voted by the Trustee in the same proportion as the votes directed by the
other Participants.
Except to the extent necessary to satisfy requests for distributions or withdrawals from the Plan, the
Trustee is not expected to sell any shares of Company Stock held by it under the Plan. However, in
the event of a tender offer (as determined by the Board of Directors of the Company) for shares of
Company Stock, each Participant or beneficiary under the Plan who has any shares held in the trust
will be sent all pertinent information regarding that offer, including all the terms and conditions of the
offer. Each of these Participants and beneficiaries will also be sent a form on which he or she may
29
direct the Trustee to tender or sell in the offer all or part of the shares held for his or her benefit in the
trust. Participants and beneficiaries also may, to the extent the terms of the offer permit, direct the
withdrawal of the same shares from the tender. The Trustee will set a deadline for receipt of
directions. It will tender or sell only those shares for which valid and timely directions are received
and only if those directions have not been validly revoked in a timely manner.
The instructions regarding the voting or tender of shares of Company Stock will be received by the
Trustee, not the Company.
14. Duration, Modification, and Continuation of the Plan
The Company and Local Business Units have established the Plan for the sole benefit of participating
associates of the Local Business Units, and expect to continue it. The Company, however, has
voluntarily offered the Plan to Local Business Units and voluntarily made it available to certain
international associates. Therefore, the Company reserves the right, in its sole discretion and for any
reason or no reason, to change, modify, continue or terminate the Plan in whole or in part for any or
all Local Business Units, Participants or associates at any time without the consent of any Local
Business Unit, Participant, beneficiary or associate. No Participant has a right to continued participation in the Plan, and no associate or beneficiary has a right to continuation of the Plan or any benefits
offered under the Plan.
The Company and the Local Business Unit, without the consent of the Participant or beneficiary or
any associate, may also amend the individual, local participation agreement entered into between the
Company and the Local Business Unit governing each associate's participation in the Plan (the "Local
Participation Agreement"). The Local Business Unit, with the consent of the Company, also may elect
to withdraw from the Plan with respect to all or a group of its associates, which would terminate the
Plan with respect to those associates.
If the Plan is terminated, each affected Participant’s shares purchased with Matching Contributions
and any Additional Employer Contributions will be available for withdrawal and will no longer be
subject to forfeiture (as is always the case with Participant Shares). No amendment or termination of
the Plan or Local Participation Agreement may, without the Participant's consent (or, in the case of
death, the consent of the beneficiary), adversely affect the shares or other assets held under the Plan
for the Participant or the beneficiary that are available for withdrawal at that time.
30
VI.
INFORMATION ABOUT THE TIMKEN COMPANY
1. Description of Timken and Its Business
The Timken Company (herein referred to as "Timken" or the "Company") is an outgrowth of a
business originally founded in 1899. Timken, an Ohio corporation, was incorporated under the laws of
the US State of Ohio on December 16, 1904. It is registered with the Ohio Secretary of State located
in Columbus, Ohio, with Charter No. 26206. The Company's principal executive offices are located at
1835 Dueber Avenue, S. W., Canton, Ohio 44706-2798, USA; phone: +1–330–438–3000; IRS
Employer Identification No. 34-0577130.
General
Timken is a leading global manufacturer of highly engineered bearings, alloy and specialty steel and
related components. The Company is the world's largest manufacturer of tapered roller bearings and
alloy seamless mechanical steel tubing and the largest North American-based bearings manufacturer
2
(Source: The Freedonia Group, a leading international research company). As of March 2007,
Timken had facilities in 26 countries on six continents and had 25,001 associates.
Products
The Timken Company manufactures two basic product lines: anti-friction bearings and steel products.
Differentiation in these two product lines comes in two different ways: (1) differentiation by bearing
type or steel type, and (2) differentiation in the applications of bearings and steel.
Tapered Roller Bearings. In the bearing industry, Timken is best known for the tapered roller bearing,
which was originally patented by the Company's founder, Henry Timken. The tapered roller bearing is
Timken's principal product in the anti-friction industry segment. It consists of four components: (1)
the cone or inner race, (2) the cup or outer race, (3) the tapered rollers, which roll between the cup and
cone, and (4) the cage, which serves as a retainer and maintains proper spacing between the rollers.
Timken manufactures or purchases these four components and then sells them in a wide variety of
configurations and sizes.
The tapered rollers permit ready absorption of both radial and axial load combinations. For this
reason, tapered roller bearings are particularly well adapted to reducing friction where shafts, gears or
wheels are used. The applications for tapered roller bearings are diverse and include applications on
passenger cars, light and heavy trucks, and trains, as well as a wide range of industrial applications,
ranging from very small gear drives to bearings over two meters in diameter for wind energy
machines. A number of applications utilize bearings with sensors to measure parameters such as
speed, load, temperature or overall bearing condition.
Matching bearings to the specific requirements of customers' applications requires engineering, and
often sophisticated analytical techniques. The design of Timken's tapered roller bearing permits
distribution of unit pressures over the full length of the roller. This design, combined with high
precision tolerances, proprietary internal geometry and premium quality material, provides Timken
bearings with high load carrying capacity, excellent friction-reducing qualities and long life.
2
Timken confirms that this information has been accurately reproduced, and that, as far as Timken is aware and
is able to ascertain from information published by The Freedonia Group, no facts have been omitted which
would render this information inaccurate or misleading.
31
Precision Cylindrical and Ball Bearings. Timken's aerospace and super precision facilities produce
high-performance ball and cylindrical bearings for ultra high-speed and/or high-accuracy applications
in the aerospace, medical and dental, computer and other industries. These bearings utilize ball and
straight rolling elements and are in the super precision end of the general ball and straight roller
bearing product range in the bearing industry. A majority of Timken's aerospace and super precision
bearings products are custom-designed bearings and spindle assemblies. They often involve specialized materials and coatings for use in applications that subject the bearings to extreme operating
conditions of speed and temperature.
Spherical and Cylindrical Bearings. Timken produces spherical and cylindrical roller bearings for
large gear drives, rolling mills and other process industry and infrastructure development applications.
Timken's cylindrical and spherical roller bearing capability was significantly enhanced with the
acquisition of Torrington's broad range of spherical and heavy-duty cylindrical roller bearings for
standard industrial and specialized applications. These products are sold worldwide to original equipment manufacturers, and industrial distributors serving major industries, including construction and
mining, natural resources, defense, pulp and paper production, rolling mills and general industrial
goods.
Needle Bearings. With the acquisition of the engineered solutions business of Ingersoll-Rand
Company Limited (referred to as "Torrington") in 2003, the Company became a leading global
manufacturer of highly engineered needle roller bearings. Timken produces a broad range of radial
and thrust needle roller bearings, as well as bearing assemblies, which are sold to original equipment
manufacturers and industrial distributors worldwide. Major applications include automotive,
consumer, construction, agriculture and general industrial.
Bearing Reconditioning. A small part of the business involves providing bearing reconditioning
services for industrial and railroad customers, both internationally and domestically. These services
accounted for less than 5% of the Company's net sales for the year ended December 31, 2006.
Aerospace Aftermarket Products and Services. Through strategic acquisitions and ongoing product
development, Timken continues to expand its portfolio of replacement parts and services for the
aerospace aftermarket, where they are used in both civil and military aircraft. In addition to a wide
variety of power transmission and drive train components and modules, Timken supplies
comprehensive maintenance, repair and overhaul services for gas turbine engines, gearboxes and
accessory systems in rotary- and fixed-wing aircraft. Specific parts in addition to bearings include
airfoils (such as blades, vanes, rotors and diffusers), nozzles, gears, and oil coolers. Services range
from aerospace bearing repair and component reconditioning to the complete overhaul of engines,
transmissions and fuel controls.
Steel. Steel products include steels of low and intermediate alloy, as well as some carbon grades.
These products are available in a wide range of solid and tubular sections with a variety of lengths and
finishes. These steel products are used in a wide array of applications, including bearings, automotive
transmissions, engine crankshafts, oil drilling components, aerospace parts and other similarly
demanding applications.
Timken also produces custom-made steel products, including steel components for automotive and
industrial customers. This steel components business has provided the Company with the opportunity
to further expand its market for tubing and capture higher value-added steel sales. It also enables
Timken's traditional tubing customers in the automotive and bearing industries to take advantage of
higher performing components that cost less than current alternative products. Customizing of
products is an important portion of the Company's steel business.
32
Industry Segments
The Company has three reportable segments: Automotive Group, Industrial Group and Steel Group.
For details, please refer to the segment information contained in Note 14 to Consolidated Financial
3
Statements of the Annual Report to the shareholders for the fiscal year ended December 31, 2006.
Export sales from the US and Canada are less than 10% of revenue. The Company's Automotive and
Industrial Groups' businesses have historically participated in the global bearing industry, while the
Steel Group has concentrated primarily on US customers.
Geographical Financial Information
4
Consolidated
$ 849,915
285,840
$ 753,206
266,557
$ 4,973,365
2,131,253
$ 3,295,171
1,413,575
$ 812,960
337,657
$ 715,036
177,988
$ 4,823,167
1,929,220
$ 2,900,749
1,399,155
$ 779,478
398,925
$ 606,970
221,112
$ 4,287,197
2,019,192
United States
Europe
2006
Net sales
Non-current assets
$ 3,370,244
1,578,856
2005
Net sales
Non-current assets
2004
Net sales
Non-current assets
Other Countries
(US dollars in thousands)
For further information about Timken's principal markets and the geographic distribution of revenues,
please refer to the geographic financial information included in Timken's Annual Reports to the
5
shareholders for the fiscal years 2004 to 2006.
Sales and Distribution
Timken's products in the Automotive Group and Industrial Group are sold principally by their own
internal sales organizations. A portion of the Industrial Group's sales are made through authorized
distributors.
Traditionally, a main focus of the Company's sales strategy has consisted of collaborative projects
with customers. For this reason, Timken's sales forces are primarily located in close proximity to its
customers rather than at production sites. In some instances, the sales forces are located inside
customer facilities. Timken's sales force is highly trained and knowledgeable regarding all bearings
products, and associates assist customers during the development and implementation phases and
provide support.
Timken's steel products are sold principally by its own sales organization. Most orders are customized
to satisfy customer-specific applications and are shipped directly to customers from Timken's steel
3
4
5
2006 Annual Report, pages 146 et seq., below.
Other countries: China, India, Singapore, Brazil, Canada, South Africa, Argentina, Australia, Mexico, Japan,
Korea, Turkey.
See 2006 Annual Report, pp. 146 et seq., below; 2005 Annual Report, pp. 214 et seq., below; 2004 Annual
Report, pp. 266 et seq., below.
33
manufacturing plants. Approximately 10% of Timken's Steel Group net sales are intersegment sales.
In addition, sales are made to other anti-friction bearing companies and to the automotive and truck,
forging, construction, industrial equipment, oil and gas drilling and aircraft industries and to steel
service centers.
Timken has entered into individually negotiated contracts with some of its customers in its
Automotive Group, Industrial Group and Steel Group. These contracts may extend for one or more
years and, if a price is fixed for any period extending beyond current shipments, customarily include a
commitment by the customer to purchase a designated percentage of its requirements from Timken.
Contracts extending beyond one year that are not subject to price adjustment provisions do not
represent a material portion of Timken's sales. Timken does not believe that there is any significant
loss of earnings risk associated with any given contract.
Competition
The anti-friction bearing business is highly competitive in every country in which Timken sells
products. Timken competes primarily based on price, quality, timeliness of delivery, product design
and the ability to provide engineering support and service on a global basis. The Company competes
with domestic manufacturers and many foreign manufacturers of anti-friction bearings, including
SKF, INA, NTN Corporation, Koyo Seiko Co., Ltd. and NSK Ltd.
Competition within the steel industry, both domestically and globally, is intense and is expected to
remain so. However, the recent combination of a weakened US dollar, worldwide rationalization of
uncompetitive capacity, raw material cost increases and North American and global market strength
have allowed steel industry prices to increase and margins to improve. Timken’s worldwide
competitors for steel bar products include North American producers such as Republic, Mac Steel,
Mittal, Steel Dynamics, Nucor and a wide variety of offshore steel producers who export into North
America. Competitors for seamless mechanical tubing include Dofasco, Plymouth Tube, Michigan
Seamless Tube, V & M Tube, Sanyo Special Steel, Ovako and Tenaris. Competitors in the precision
steel components sector include Formtec, Linamar, Jernberg and overseas companies such as Tenaris,
Ovako, Stackpole and FormFlo.
Maintaining high standards of product quality and reliability while keeping production costs
competitive is essential to Timken's ability to compete with domestic and foreign manufacturers in
both the anti-friction bearing and steel businesses.
Trade Law Enforcement
The US government has six antidumping duty orders in effect covering ball bearings from five
countries and tapered roller bearings from China. The five countries covered by the ball bearing
orders are France, Germany, Italy, Japan and the United Kingdom. The Company is a producer of
these products in the United States. The US government determined in August 2006 that each of these
six antidumping duty orders should remain in effect for an additional five years.
Continued Dumping and Subsidy Offset Act (CDSOA)
The CDSOA provides for distribution of monies collected by US Customs from antidumping cases to
qualifying domestic producers where the domestic producers have continued to invest in their
technology, equipment and people. The Company reported CDSOA receipts, net of expenses, of
$87.9 million, $77.1 million and $44.4 million in 2006, 2005 and 2004, respectively.
The amount for 2004 was net of the amount that Timken delivered to the seller of the Torrington
business, pursuant to the terms of the agreement under which the Company had purchased Torrington
in 2003. In 2004, Timken delivered to the seller of the Torrington business 80% of the CDSOA
payments received in 2004 for Torrington’s bearing business.
34
In September 2002, the World Trade Organization (WTO) ruled that CDSOA payments are not
consistent with international trade rules. In February 2006, US legislation was enacted that would end
CDSOA distributions for imports covered by antidumping duty orders entering the US after
September 30, 2007. Instead, any such antidumping duties collected would remain with the US
Treasury. This legislation is not expected to have a significant effect on potential CDSOA
distributions in 2007, but would be expected to reduce likely distributions in years beyond 2007, with
distributions eventually ceasing.
In separate cases in July and September 2006, the US Court of International Trade (CIT) ruled that the
procedure for determining recipients eligible to receive CDSOA distributions is unconstitutional. The
CIT has not ruled on other matters, including any remedy as a result of its ruling. The Company
expects that these rulings of the CIT will be appealed. The Company is unable to determine, at this
time, if these rulings will have a material adverse impact on the Company’s financial results.
In addition to the CIT rulings, there are a number of factors that can affect whether the Company
receives any CDSOA distributions and the amount of such distributions in any year. These factors
include, among other things, potential additional changes in the law, ongoing and potential additional
legal challenges to the law and the administrative operation of the law. Accordingly, the Company
cannot reasonably estimate the amount of CDSOA distributions it will receive in future years, if any.
If the Company does receive CDSOA distributions in 2007, they likely will be received in the fourth
quarter.
Backlog
The backlog of orders of Timken’s domestic and overseas operations is estimated to have been $1.96
billion at December 31, 2006 and $1.98 billion at December 31, 2005. Actual shipments are
dependent upon ever-changing production schedules of the customer. Accordingly, Timken does not
believe that its backlog data and comparisons thereof, as of different dates, are reliable indicators of
future sales or shipments.
Raw Materials
The principal raw materials used by Timken in its North American bearing plants to manufacture
bearings are its own steel tubing and bars, purchased strip steel and energy resources. Outside North
America, the Company purchases raw materials from local sources with whom it has worked closely
to ensure steel quality, according to its demanding specifications.
The principal raw materials used by Timken in steel manufacturing are scrap metal, nickel and other
alloys. The availability and prices of raw materials and energy resources are subject to curtailment or
change due to, among other things, new laws or regulations, changes in demand levels, suppliers’
allocations to other purchasers, interruptions in production by suppliers, changes in exchange rates
and prevailing price levels. For example, the weighted average price of scrap metal increased 87.1%
from 2003 to 2004, decreased 7.7% from 2004 to 2005 and increased 7.9% from 2005 to 2006. Prices
for raw materials and energy resources continue to remain high compared to historical levels.
The Company continues to expect that it will be able to pass a significant portion of these increased
costs through to customers in the form of price increases or raw material surcharges.
Disruptions in the supply of raw materials or energy resources could temporarily impair the
Company’s ability to manufacture its products for its customers or require the Company to pay higher
prices in order to obtain these raw materials or energy resources from other sources, which could
affect the Company’s sales and profitability. Any increase in the prices for such raw materials or
energy resources could materially affect the Company’s costs and its earnings.
35
Timken believes that the availability of raw materials and alloys is adequate for its needs, and, in
general, it is not dependent on any single source of supply.
Environmental Matters
The Company continues its efforts to protect the environment and comply with environmental
protection laws. Additionally, it has invested in pollution control equipment and updated plant
operational practices. The Company is committed to implementing a documented environmental
management system worldwide and to becoming certified under the ISO 14001 standard where
appropriate to meet or exceed customer requirements. By the end of 2006, 30 of the Company's plants
had obtained ISO 14001 certification.
The Company believes it has established adequate reserves to cover its environmental expenses and
has a well-established environmental compliance audit program, which includes a proactive approach
to bringing its domestic and international units to higher standards of environmental performance.
This program measures performance against applicable laws, as well as standards that have been
established for all units worldwide. It is difficult to assess the possible effect of compliance with
future requirements that differ from existing ones. As reported in previous Annual Reports filed with
the US Security and Exchange Commission, the Company is unsure of the future financial impact to
the Company that could result from the United States Environmental Protection Agency's (EPA's)
final rules to tighten the National Ambient Air Quality Standards for fine particulate and ozone. The
Company is also unsure of potential future financial impacts to the Company that could result from
possible future legislation regulating emissions of greenhouse gases.
The Company and certain US subsidiaries have been designated as potentially responsible parties by
the United States EPA for site investigation and remediation at certain sites under the US
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), known as the
Superfund, or state laws similar to CERCLA. The claims for remediation have been asserted against
numerous other entities, which are believed to be financially solvent and are expected to fulfill their
proportionate share of the obligation.
Management believes any ultimate liability with respect to pending actions will not materially affect
the Company's operations, cash flows or consolidated financial position. The Company is also
conducting voluntary environmental investigations and/or remediations at a number of current or
former operating sites. Any liability with respect to such investigations and remediations, in the
aggregate, is not expected to be material to the operations or financial position of the Company.
New laws and regulations, stricter enforcement of existing laws and regulations, the discovery of
previously unknown contamination or the imposition of new clean-up requirements may require the
Company to incur costs or become the basis for new or increased liabilities that could have a material
adverse effect on Timken's business, financial condition or results of operations.
Patents, Trademarks and Licenses
Timken owns a number of US and foreign patents, trademarks and licenses relating to certain
products. While Timken regards these as important, it does not deem its business as a whole, or any
industry segment, to be materially dependent upon any one item or group of items.
Research
Timken has developed a significant global footprint of technology centers.
The Company operates four corporate innovation and development centers. The largest technical
center is located in North Canton, Ohio, near Timken’s world headquarters, and it supports innovation
and know-how for friction management product lines, such as tapered roller bearings and needle
36
bearings. In 2006, Timken opened a new technical center in Greenville, South Carolina, to support
innovation and know–how for power transmission product lines. The Company also supports related
technical capabilities with facilities in Bangalore, India and Brno, Czech Republic.
In addition, Timken’s business groups operate several technology centers for product excellence
within the United States in Mesa, Arizona, and Keene and Lebanon, New Hampshire. Within Europe,
technology is developed in Ploiesti, Romania; Colmar, France; and Halle (Westfalen), Germany.
The Company’s technology commitment is to develop new and improved friction management and
power transmission product designs, such as tapered roller bearings and needle bearings, with a heavy
influence in related steel materials and lean manufacturing processes.
Expenditures for research, development and application amounted to approximately $67.9 million,
$60.1 million, and $56.7 million in 2006, 2005 and 2004, respectively. Of these amounts, $8.0
million, $7.2 million and $6.7 million, respectively, were funded by others.
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
materially adverse effect on the Company's consolidated financial position or results of operations.
In July 2006, the Company entered into a settlement agreement with the State of Ohio concerning
both a violation of Ohio air pollution control laws, which was discovered by the Company and
voluntarily disclosed to the State of Ohio more than ten years ago, as well as a failed grinder bag
house stack test, which was corrected within three days. Pursuant to the terms of the settlement
agreement, the Company has agreed to pay $200,000. The Company will receive a credit of $22,500
of the total settlement amount due to the Company’s investments in approved supplemental
environmental projects. Pursuant to the terms of the settlement agreement, the Company also
conducted additional testing of certain equipment.
Properties
Timken has Automotive Group, Industrial Group and Steel Group manufacturing facilities at multiple
locations in the United States and in a number of countries outside the United States. The aggregate
floor area of these facilities worldwide is approximately 16,669,000 square feet, all of which, except
for approximately 1,619,000 square feet, is owned in fee. The facilities not owned in fee are leased.
The buildings occupied by Timken are principally made of brick, steel, reinforced concrete and
concrete block construction. All buildings are in satisfactory operating condition in which to conduct
business.
Timken’s Automotive and Industrial Groups’ manufacturing facilities in the United States are located
in Bucyrus, Canton, New Philadelphia, and Niles, Ohio; Altavista, Virginia; Randleman, Iron Station
and Rutherfordton, North Carolina; Carlyle, Illinois; South Bend, Indiana; Gaffney, Clinton, Union,
Honea Path and Walhalla, South Carolina; Cairo, Norcross, Sylvania, Ball Ground and Dahlonega,
Georgia; Pulaski and Mascot, Tennessee; Keene and Lebanon, New Hampshire; Lenexa, Kansas;
Ogden, Utah; Mesa, Arizona; and Los Alamitos, California. These facilities, including the research
facility in Canton, Ohio, and warehouses at plant locations, have an aggregate floor area of
approximately 7,193,000 square feet. The Company’s Watertown, Connecticut facility was sold on
December 18, 2006.
Timken’s Automotive and Industrial Groups’ manufacturing plants outside the United States are
located in Benoni, South Africa; Brescia, Italy; Colmar, Vierzon, Maromme and Moult, France;
Northampton and Wolverhampton, England; Medemblik, The Netherlands; Bilbao, Spain; Halle
(Westfalen), Germany; Olomouc, Czech Republic; Ploiesti, Romania; Mexico City, Mexico; Sao
37
Paulo, Brazil; Singapore, Singapore; Jamshedpur, India; Sosnowiec, Poland; St. Thomas and Bedford,
Canada; and Yantai and Wuxi, China. The facilities, including warehouses at plant locations, have an
aggregate floor area of approximately 5,199,000 square feet. The Company’s Nova Friburgo, Brazil
facility was sold on December 18, 2006.
Timken’s Steel Group’s manufacturing facilities in the United States are located in Canton and Eaton,
Ohio; and Columbus, North Carolina. These facilities have an aggregate floor area of approximately
3,624,000 square feet. The Company’s Wauseon and Vienna, Ohio; Franklin and Latrobe,
Pennsylvania; and White House, Tennessee facilities were sold on December 8, 2006.
Timken’s Steel Group’s manufacturing facilities outside the United States are located in Leicester and
Sheffield, England. These facilities have an aggregate floor area of approximately 653,000 square
feet. The Company’s Fougeres and Marnaz, France facilities were sold on June 30, 2006.
In addition to the manufacturing and distribution facilities discussed above, Timken owns warehouses
and steel distribution facilities in the United States, United Kingdom, France, Singapore, Mexico,
Argentina, Australia, Brazil, Germany and China, and leases several relatively small warehouse
facilities in cities throughout the world.
During 2006, the utilization by plant varied significantly due to decreasing demand across all
automotive markets, and decreasing demand in industrial sectors served by Automotive Group plants.
The overall Automotive Group plant utilization was between approximately 75% and 85%, lower than
2005. In 2006, as a result of the higher industrial global demand, Industrial Group plant utilization
was between 85% and 90%, which was the same as 2005. Also, in 2006, Steel Group plants operated
at near capacity, which was similar to 2005.
As per Timken's balance sheet for the fiscal year of 2006, the net worth of all property, plant and
equipment is $1,601.6 million. The Company and its subsidiaries lease a variety of real property and
equipment. Rent expense under operating leases amounted to $31.0 million, $22.8 million and $17.5
million in 2006, 2005 and 2004, respectively. At December 31, 2006, future minimum lease payments
for noncancelable operating leases totaled $133.8 million and are payable as follows (numbers are
rounded and in millions): 2007—$28.7; 2008—$22.1; 2009—$16.9; 2010—$13.3; 2011—$10.8; and
$42.1 thereafter.
Subsidiaries
The Timken Company is the parent company of the Timken group and has itself no parent company.
The active subsidiaries of the Company as of December 31, 2006, (all of which are included in the
consolidated financial statements of the Company and its subsidiaries, and which are members of the
Timken group) are as follows:
Name of subsidiary
MPB Corporation
Timken Super Precision — Europa B.V.
Timken Super Precision — Singapore Pte. Ltd.
Timken UK, Ltd.
Australian Timken Proprietary, Limited
Timken do Brasil Comercio e Industria, Ltda.
British Timken Limited
Timken Communications Company
Timken Alloy Steel Europe Limited
EDC, Inc.
Timken Engineering and Research - India Private Limited
Timken Espana, S.L.
Timken Germany GmbH
State or sovereign
power under laws
of which organized
Percentage of voting
securities owned
directly or indirectly
by Company
Delaware
Netherlands
Singapore
England
Victoria, Australia
Sao Paulo, Brazil
England
Ohio
England
Ohio
India
Spain
Germany
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
38
Name of subsidiary
State or sovereign
power under laws
of which organized
Percentage of voting
securities owned
directly or indirectly
by Company
Timken Europe B.V.
HHC1, Inc.
Timken India Limited
Timken Industrial Services, LLC
Timken Italia, S.R.L.
Timken Korea Limited Liability Corporation
Timken de Mexico S.A. de C.V.
MPB Export Corporation
Nihon Timken K.K.
Timken Polska Sp.z.o.o.
Rail Bearing Service Corporation
Timken Alcor Aerospace Technologies, Inc.
Timken (China) Investment Co., Ltd.
Timken Bearing Services South Africa (Proprietary) Limited
Timken Canada GP Inc.
Timken Canada LP
Timken Rail Service Company
Timken Receivables Corporation
Timken Romania S.A.
The Timken Corporation
The Timken Service & Sales Co.
Timken Servicios Administrativos S.A. de C.V.
Timken Singapore Pte. Ltd.
Timken Limited (Hong Kong)
Timken South Africa (Pty.) Ltd.
Timken de Venezuela C.A.
Yantai Timken Company Limited
Timken Argentina Sociedad De Responsabilidad Limitada
Timken Scandinavia AB
Timken (Shanghai) Distribution & Sales Co., Ltd.
Timken Benelux, SA
Timken Ceska Republika S.R.O.
Timken France SAS
Timken Industries SAS
Timken GmbH
Timken IRB SA
Nadella SA
Timken Coventry Limited
Timken Luxembourg Holdings SARL
Timken US Corporation
KILT Holdings, Inc.
Timken Canada Holdings ULC
Timken Holdings, Inc.
Timken SH Holdings ULC
Timken U.S. Holdings LLC
Timken (Wuxi) Bearings Company Limited
Timken (Wuxi) Power Transmission Products Co., Ltd
Timken Distribution & Sales Co. Ltd.
TTC Asia Limited
TTC Sales Company, Inc.
Bearing Inspection, Inc.
Timken (Mauritius) Limited
Timken India Manufacturing Private Limited
Netherlands
Delaware
India
Delaware
Italy
Korea
Mexico
Delaware
Japan
Poland
Virginia
Delaware
China
South Africa
Canada
Canada
Russia
Delaware
Romania
Ohio
Ohio
Mexico
Singapore
China
South Africa
Venezuela
China
Argentina
Sweden
China
Belgium
Czech Republic
France
France
Germany
Spain
Switzerland
England
Luxembourg
Delaware
Delaware
Canada
Delaware
Canada
Delaware
China
China
China
Cayman Islands
Barbados
California
Mauritius
India
100%
100%
80%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
74%
100%
100%
100%
100%
94%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
The Company also has a number of inactive subsidiaries that were incorporated for name-holding
purposes, and a foreign sales corporation subsidiary.
39
Investments
The Company purchased the assets of Turbo Engines, Inc., a provider of aircraft engine overhaul and
repair services, in December 2006 for $13.5 million, including acquisition costs. The Company has
preliminarily allocated the purchase price to assets of $15.0 million, including $4.5 million of
amortizable intangible assets and liabilities of $1.5 million. The excess of the purchase price over the
fair value of the net assets acquired was recorded as goodwill in the amount of $1.9 million. The
Company also purchased the assets of Turbo Technologies, Inc., a provider of aircraft engine overhaul
and repair services, in July 2006 for $4.5 million, including acquisition costs. The Company acquired
net assets of $4.3 million, including $1.3 million of amortizable intangible assets. The Company
assumed no liabilities. The excess of the purchase price over the fair value of the net assets acquired
was recorded as goodwill in the amount of $0.2 million. The results of the operations of Turbo
Engines and Turbo Technologies are included in the Company’s consolidated statement of income for
the periods subsequent to the effective date of acquisition. Pro forma results of the operations are not
presented because the effect of the acquisitions are not significant.
The Company purchased the stock of Bearing Inspection, Inc. (Bii), a provider of bearing inspection,
reconditioning and engineering services during October 2005 for $42.4 million, including acquisition
costs. The Company acquired net assets of $36.4 million, including $27.2 million of amortizable
intangible assets. The Company also assumed liabilities with a fair value of $9.3 million. The excess
of the purchase price over the fair value of the net assets acquired was recorded as goodwill in the
amount of $15.3 million. The results of the operations of Bii are included in the Company’s
consolidated statement of income for the periods subsequent to the effective date of the acquisition.
Pro forma results of the operations are not presented because the effect of the acquisition was not
significant.
During 2004, the Company finalized several acquisitions. The total cost of these acquisitions
amounted to $8.4 million. The purchase price was allocated to the assets and liabilities acquired,
based on their fair values at the dates of acquisition. The fair value of the assets acquired was $5.5
million in 2004 and the fair value of the liabilities assumed was $0.8 million. The excess of the
purchase price over the fair value of the net assets acquired was allocated to goodwill. The
Company’s consolidated statement of income includes the results of operations of the acquired
businesses for the periods subsequent to the effective date of the acquisitions. Pro forma results of the
operations have not been presented because the effect of these acquisitions was not significant.
All described acquisitions were financed with cash generated from operating activities and/or by
means of the Company’s Asset Securitization and Senior Credit Facility (as described in the Section
"Material Contracts; Financial Arrangements", below).
Principal Investments in Progress
In 2005, the Company initiated Project O.N.E., a multi-year program designed to improve business
processes and systems to deliver enhanced customer service and financial performance. With an
expected cost of $90 million, Project O.N.E. is targeted to achieve annual savings of approximately
$75 million upon project completion, as well as improved working capital management. The
Company also launched a major growth initiative in Asia with the objective of increasing market
share, influencing major design centers and expanding our network of sources of globally competitive
friction management products. In addition, the Company began restructuring automotive operations to
address challenging market issues, with expected costs of $80 to $90 million and targeted annual
savings of approximately $40 million by 2008. In response to reduced production demand from North
American automotive manufacturers, in September 2006, the Company announced further planned
reductions in its Automotive Group workforce of approximately 700 associates. Timken expects that
this workforce reduction will cost approximately $25 million (pretax) and is targeting annual pretax
savings of approximately $35 million by 2008. The Company expects that any cash requirements for
the financing of these projects, which continue in 2007, in excess of cash generated from operating
40
activities will be met by the availability under its Asset Securitization and its Senior Credit Facility
(as described in the Section "Material Contracts; Financial Arrangements", below).
Joint Ventures
The Company has a joint venture in North America focused on joint logistics and e-business services.
This alliance is called CoLinx, LLC and was founded by Timken, SKF, INA and Rockwell
Automation. The e-business service was launched in April 2001, and is focused on information and
business services for authorized distributors in the Industrial Group. The Company also has another ebusiness joint venture which focuses on information and business services for authorized industrial
distributors in Europe, Latin America and Asia. This alliance, which Timken founded with SKF,
Sandvik AB, INA and Reliance, is called Endorsia.com International AB.
During 2002, the Company’s Automotive Group formed a joint venture, Advanced Green
Components, LLC (AGC), with Sanyo Special Steel Co., Ltd. (Sanyo) and Showa Seiko Co., Ltd.
(Showa). AGC is engaged in the business of converting steel to machined rings for tapered bearings
and other related products. The Company had been accounting for its investment in AGC under the
equity method since AGC’s inception. During the third quarter of 2006, AGC refinanced its long-term
debt of $12.2 million. The Company guaranteed half of this obligation. The Company concluded the
refinancing represented a reconsideration event to evaluate whether AGC was a variable interest
entity under FASB Interpretation No. 46 (revised December 2003). The Company concluded that
AGC was a variable interest entity and the Company was the primary beneficiary. Therefore, the
Company consolidated AGC, effective September 30, 2006. As of September 30, 2006, the net assets
of AGC were $9.0 million. All of AGC’s assets are collateral for its obligations. Except for AGC’s
indebtedness for which the Company is a guarantor, AGC’s creditors have no recourse to the assets of
the Company.
The balances related to investments accounted for under the equity method are reported in other noncurrent assets on the consolidated balance sheet, which were approximately $12.1 million and $19.9
million at December 31, 2006 and 2005, respectively.
Divestitures
In December 2006, the Company completed the divestiture of its subsidiary, Latrobe Steel. Latrobe
Steel is a leading global producer and distributor of high-quality, vacuum melted specialty steels and
alloys. This business was part of the Steel Group for segment reporting purposes. The following
results of operations for this business have been treated as discontinued operations for all periods
presented:
2006
2005
2004
$ 328,181
53,510
33,239
12,849
$ 345,267
44,008
26,625
—
$ 226,474
2,188
1,610
—
Net sales
Earnings before income taxes
Net income
Gain on divestiture, net of tax
The gain on divestiture in 2006 was net of tax of $8.4 million. As of December 31, 2006, there were
no assets or liabilities remaining from the divestiture of Latrobe Steel. The assets of discontinued
operations as of December 31, 2005 primarily consisted of $54.5 million of accounts receivable, net,
$98.1 million of inventory and $73.0 million of property, plant and equipment, net. The liabilities of
discontinued operations as of December 31, 2005, primarily consisted of $30.5 million of accounts
payable and other liabilities, $11.2 million of salaries, wages and benefits and $29.5 million of
accrued pension and postretirement benefit costs.
41
In December 2006, the Company completed the divestiture of its automotive steering business. This
business was part of the Automotive Group. The divestiture of the automotive steering business did
not qualify for discontinued operations because it was not a component of an entity as defined by
SFAS No. 144. The Company recognized a pretax loss on divestiture of $54.3 million, and the loss is
reflected in Loss on divestitures in the Consolidated Statement of Income.
In June 2006, the Company completed the divestiture of its Timken Precision Components — Europe
business. This business was part of the Steel Group. The Company recognized a pretax loss on
divestiture of $10.0 million, and the loss was reflected in Loss on divestitures in the consolidated
statement of income. The results of operations and net assets of the divested businesses were
immaterial to the consolidated results of operations and financial position of the Company.
During 2000, the Company’s Steel Group invested in a joint venture, PEL, to commercialize a
proprietary technology that converts iron units into engineered iron oxides for use in pigments,
coatings and abrasives. In the fourth quarter of 2003, the Company concluded its investment in PEL
was impaired due to the following indicators of impairment: history of negative cash flow and losses;
2004 operating plan with continued losses and negative cash flow; and the continued required support
from the Company or another party. In the fourth quarter of 2003, the Company recorded a non-cash
impairment loss of $45.7 million. The Company concluded that PEL was a variable interest entity and
that the Company was the primary beneficiary. In accordance with FIN 46, "Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51," the Company
consolidated PEL effective March 31, 2004. All of PEL’s assets were collateral for its obligations.
Except for PEL’s indebtedness for which the Company was a guarantor, PEL’s creditors had no
recourse to the general credit of the Company.
In the first quarter of 2006, plans were finalized to liquidate the assets of PEL, and the Company
recorded a related gain of approximately $3.5 million. In January 2006, the Company repaid, in full,
the $23.0 million balance outstanding of the revenue bonds held by PEL. In June 2006, the Company
continued to liquidate PEL, with land and buildings exchanged and the buyer’s assumption of the
fixed-rate mortgage, which resulted in a gain of $2.8 million.
In 2006, the Company sold a portion of CoLinx, LLC due to the addition of another company to the
joint venture. In 2005, the Company achieved a gain of $8.9 million on the sale of certain nonstrategic assets, including NRB Bearings, a joint venture based in India, and the Industrial Group’s
Linear Motion Systems business, based in Europe.
Related Party Transactions
Since 2004, the Company has not entered into any related party transaction that by its nature and
extent – as a single transaction or in its entirety – could be considered material to the Company's
business.
Material Contracts; Financial Arrangements
Besides the investments and the joint venture agreements described in the foregoing, the Company is
party to certain other material contracts.
On June 30, 2005, the Company entered into a $500 million Amended and Restated Credit Agreement
("Senior Credit Facility") that replaced the Company's previous credit agreement dated December 31,
2002. The Senior Credit Facility matures on June 30, 2010, and provides for a $500 million revolving
credit facility. Under this credit facility, the Company has two financial covenants: a consolidated
leverage ratio and a consolidated interest coverage ratio. At December 31, 2006, the Company was in
full compliance with the covenants under this Senior Credit Facility and its other debt agreements. At
December 31, 2006, the Company had no outstanding borrowings under its $500 million Senior
42
Credit Facility, and letters of credit outstanding totaling $33.8 million, which reduced the availability
under the Senior Credit Facility to $466.2 million.
On December 30, 2005, the Company entered into a new Amended and Restated Accounts
Receivable Securitization Financing Agreement ("Asset Securitization"), replacing a $125 million
Asset Securitization Financing Agreement. The Asset Securitization provides for borrowings up to
$200 million, limited to certain borrowing base calculations, and is secured by certain domestic trade
receivables of the Company. 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. The Company
may also use this facility to issue up to $150 million of letters of credit. The facility was renewed in
December 2006 and expires on December 28, 2007. At December 31, 2006, there were no borrowings
outstanding under this facility. Any amounts outstanding under this facility would be reported on the
Company’s consolidated balance sheet under short-term debt. 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 income. At December 31, 2006, there were
letters of credit outstanding totaling $16.7 million, which reduced the availability under the Asset
Securitization to $183.3 million.
The lines of credit for certain of the Company’s European and Asian subsidiaries provide for
borrowings up to $217.1 million. At December 31, 2006, the Company had borrowings outstanding of
$27.0 million, which reduced the availability under these facilities to $190.1 million.
In December 2005, the Company entered into a 57.8 million Canadian Dollar unsecured loan in
Canada. The principal balance of the loan is payable in full on December 22, 2010. The interest rate is
variable based on the Canadian LIBOR rate and interest payments are due quarterly.
2. Financial Overview
Results for 2006
The Timken Company reported net sales for 2006 of approximately $5.0 billion, compared to $4.8
billion in 2005, an increase of 3.1%. Sales were higher across the Industrial and Steel Groups, offset
by lower sales in the Automotive Group. In December 2006, the Company completed the divestiture
of its Latrobe Steel subsidiary. Discontinued operations represent the operating results and related
gain on sale, net of tax, of this business. For 2006, earnings per diluted share were $2.36, compared to
$2.81 per diluted share for 2005. Income from continuing operations per diluted share was $1.87,
compared to $2.52 per diluted share for 2005.
2006 compared to 2005
2006
2005
$ Change
% Change
$ 4,973.4
176.4
46.1
222.5
$ 4,823.2
233.7
26.6
260.3
$ 150.2
(57.3)
19.5
(37.8)
3.1 %
(24.5)%
73.3 %
(14.5)%
$ 1.87
0.49
$ 2.36
94,294,716
$ 2.52
0.29
$ 2.81
92,537,529
$ (0.65)
0.20
$ (0.45)
—
(25.8)%
69.0 %
(16.0)%
1.9 %
(US dollars in millions, except earnings per share)
Net sales
Income from discontinued operations
Net income
Diluted earnings per share:
Continuing operations
Discontinued operations
Net income per share
Average number of shares — diluted
43
The ongoing strength of global industrial markets drove the increase in Industrial and Steel Group
sales, while the declines in North American automotive demand during the second half of 2006
constrained results. The Company’s growth initiatives, loss on divestitures and restructuring the
Company’s operations, also constrained overall results. The Company continued its focus on
increasing production capacity in targeted areas, including major capacity expansions for industrial
products at several manufacturing locations around the world.
Sales by Segment:
2006
2005
$ Change
% Change
Industrial Group
Automotive Group
Steel Group
$ 2,072.5
1,573.0
1,327.9
$ 1,925.2
1,661.1
1,236.9
$ 147.3
(88.1)
91.0
7.7 %
(5.3)%
7.4 %
Total Company
$ 4,973.4
$ 4,823.2
$ 150.2
3.1 %
(US dollars in millions, and excluding intersegment
sales)
Industrial Group. Sales by the Industrial Group include global sales of bearings and other products
and services (other than steel) to a diverse customer base, including: industrial equipment; construction and agriculture; rail; and aerospace and defense customers. The Industrial Group also includes
aftermarket distribution operations, including automotive applications, for products other than steel.
The Industrial Group’s net sales in 2006 compared to 2005 increased primarily due to higher demand
across most end markets, with the highest growth in aerospace, heavy industry and industrial
distribution. While sales increased in 2006, adjusted EBIT margin was lower compared to 2005
primarily due to higher manufacturing costs associated with ramping up new facilities to meet
customer demand and investments in the Asian growth initiative and Project O.N.E., mostly offset by
higher volume and increased pricing.
Automotive Group. The Automotive Group includes sales of bearings and other products and services
(other than steel) to automotive original equipment manufacturers and suppliers. The Automotive
Group’s net sales in 2006 compared to 2005 decreased primarily due to significantly lower volume,
driven by reductions in vehicle production by North American original equipment manufacturers,
partially offset by improved pricing. Profitability for 2006 compared to 2005 decreased primarily due
to lower volume, leading to the underutilization of manufacturing capacity, and an increase of $18.8
million in warranty reserves, partially offset by improved pricing and a decrease in allowances for
automotive industry credit exposure.
Steel Group. The Steel Group sells steel of low and intermediate alloy and carbon grades in both solid
and tubular sections, as well as custom-made steel products for both automotive and industrial
applications, including bearings. In December 2006, the Company completed the sale of its Latrobe
Steel subsidiary. Sales and Adjusted EBIT from these operations are included in discontinued
operations. Previously reported amounts for the Steel Group have been adjusted to remove the
Latrobe Steel operations. The Steel Group’s net sales in 2006 increased from 2005 primarily due to
increased pricing and surcharges to recover high raw material and energy costs, as well as strong
demand in industrial and energy market sectors, partially offset by lower sales to automotive
customers. The increase in the Steel Group’s profitability in 2006 compared to 2005 was primarily
due to a favorable sales mix, improved manufacturing productivity and increased pricing.
Results for 2005
Timken reported net sales for 2005 of approximately $4.8 billion compared to $4.3 billion in 2004
(both excluding the business relating to the Company’s Latrobe Steel subsidiary sold in December
2006), an increase of 12.5 percent. Sales were higher across all three business segments (Automotive,
44
Industrial and Steel). For 2005, earnings per diluted share were $2.81, compared to $1.49 per diluted
share for 2004.
Higher demand across a broad range of industrial markets drove sales. The Company expanded its
presence in the aerospace aftermarket through acquisitions and alliances. The Company also
leveraged demand and continued the use of surcharges and price increases to recover high raw
material costs. The Company improved its product mix and increased production capacity in targeted
areas, including significant investments in the United States, China and Romania. The Company
launched two significant initiatives: (1) Project O.N.E., a five-year program designed to improve
business processes and systems; and (2) a growth initiative in Asia with the objective of increasing
market share, influencing major design centers and expanding the Company’s network of sources of
globally competitive friction management products. In addition, the Company announced significant
restructuring within its Automotive Group.
Sales by segment:
2005
2004
$ Change % Change
(US dollars in millions, and excluding intersegment sales)
Industrial Group
Automotive Group
Steel Group
Total Company
$ 1,925.2
1,661.0
1,236.9
$ 4,823.2
$ 1,709.8
1,582.2
995.2
$ 4287.2
$
215.4
78.8
241.7
$ 536.0
12.6%
5.0%
24.3%
12.5%
Industrial Group Results. In 2005, the Industrial Group’s net sales increased 12.6% to $1.9 billion
from 2004. The increase was the result of higher volume and improved product mix. Many end
markets were strong, especially mining, metals, rail, aerospace, oil and gas, which also drove strong
distribution sales. The Industrial Group also benefited from growth in emerging markets, especially
China. The Industrial Group’s profitability in 2005 increased from 2004, reflecting volume growth
and price increases, partially offset by investments in Project O.N.E. and Asian growth initiatives.
Automotive Group Results. The Automotive Group’s net sales in 2005 increased 5.0% to $1.7 billion.
Sales grew as a result of favorable pricing actions and growth in medium and heavy truck markets.
The Automotive Group had a loss in 2005. The positive impact of increased volume and pricing were
more than offset by higher manufacturing costs associated with ramping up plants serving industrial
customers and from reduced unit volume from light vehicle customers. Automotive results were also
impacted by investments in Project O.N.E. and an increase in the accounts receivable reserve.
Steel Group Results. In 2005, the Steel Group’s net sales (excluding the Latrobe Steel business) were
$1.2 billion, up 24.3% from 2004. The sales growth reflected record shipments, driven by strong
industrial markets, as well as surcharges and price increases to offset higher raw material and energy
costs. For 2005, the Steel Group’s profitability increased from 2004 as a result of higher volume, raw
material surcharges, price increases, high capacity utilization and record productivity.
Results for 2004
For 2004, Timken reported net sales of approximately $4.3 billion (excluding the Latrobe Steel
business), an increase of 18.2% from 2003. Sales were higher across all three business segments.
The Company achieved record sales and strong earnings growth, compared to 2003, despite unprecedented high raw material costs. In 2004, the Company leveraged higher volume from the industrial
recovery, implemented surcharges and price increases to begin to recover high raw material costs, and
continued to expand in emerging markets. The integration of Torrington continued in 2004, with
savings from purchasing synergies, workforce consolidation and other integration activities.
45
The Industrial Group’s net sales increased due to higher demand, increased prices and favorable
foreign currency translation. Many end markets recorded substantial growth, especially construction,
agriculture, rail, and general industrial equipment. The Automotive Group’s net sales benefited from
increased light vehicle penetration from new products, strong medium and heavy truck production and
favorable foreign currency translation. For both the Industrial and Automotive Groups, a portion of
the net sales increase was attributable to Torrington’s results only being included from February 18,
2003, the date it was acquired. The increase in the Steel Group’s net sales resulted primarily from
surcharges and price increases, which were driven by higher raw material costs, as well as increased
volume. Demand increased across steel customer segments, led by strong industrial demand.
3. Selected Financial Information
Periods 2004 – 2006
The following table provides an overview of key consolidated financial data extracted without
adjustment from the Company's annual consolidated financial statements for the period ended
December 31, 2006:
Summary of Operations and Other Comparative Data
2006
2005
2004
(US dollars in thousands, except per share data)
Statements of Income
Net Sales
Industrial
Automotive
Steel
Total net sales
Gross profit
Selling, administrative and general expenses
Loss on divestitures
Operating income
Other income (expense) — net
Earnings before interest and taxes (EBIT) (1)
Interest expense
Income from discontinued operations, net of
income taxes
Net income
$ 2,072,495
1,573,034
1,327,836
4,973,365
$ 1,925,211
1,661,048
1,236,908
4,823,167
$ 1,709,770
1,582,226
995,201
4,287,197
1,005,844
677,342
44,881
64,271
219,350
79,666
299,016
49,387
176,439
999,957
646,904
26,093
—
326,960
67,726
394,686
51,585
233,656
824,376
575,910
13,538
—
234,928
12,100
247,028
50,834
134,046
$
46,088
222,527
$
26,625
260,281
$
1,610
135,656
46
2006
2005
2004
$
$
$
Balance Sheets
Inventories — net
Property, plant and equipment — net
Total assets
Total debt:
Commercial paper
Short-term debt
Current portion of long-term debt
Long-term debt
Total debt:
Net debt:
Total debt
Less: cash and cash equivalents
Net debt: (2)
Total liabilities
Shareholders’ equity
Capital:
Net debt
Net debt + shareholders’ equity (capital)
Other Comparative Data
Income from continuing operations/Net sales
EBIT /Net sales
Return on equity (3)
Net sales per associate (4)
Capital expenditures
Depreciation and amortization
Capital expenditures /Net sales
Dividends per share
Earnings per share (5)
Earnings per share — assuming dilution (5)
Net debt to capital (2)
Number of associates at year-end (6)
Number of shareholders (7)
952,310
1,601,559
4,031,533
900,294
1,474,074
3,993,734
799,717
1,508,598
3,942,909
—
40,217
10,236
547,390
597,843
—
63,437
95,842
561,747
721,026
—
157,417
1,273
620,634
779,324
597,843
(101,072)
496,771
2,555,353
$ 1,476,180
721,026
(65,417)
655,609
2,496,667
$ 1,497,067
779,324
(50,967)
728,357
2,673,061
$ 1,269,848
496,771
1,476,180
1,972,951
655,609
1,497,067
2,152,676
728,357
1,269,848
1,998,205
3.5%
6.0%
12.0%
191.5
296,093
196,592
6.0%
0.62
2.38
2.36
25.2%
25,418
42,608
4.8%
8.2%
15.6%
186.7
217,411
209,656
4.5%
0.60
2.84
2.81
30.5%
26,528
54,514
3.1%
5.8%
10.6%
170.0
143,781
201,173
3.4%
0.52
1.51
1.49
36.5%
25,128
42,484
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Footnotes
(1)
EBIT is defined as operating income plus other income (expense) — net.
(2)
The Company presents net debt because it believes net debt is more representative of the Company’s
indicative financial position due to temporary changes in cash and cash equivalents.
(3)
Return on equity is defined as income from continuing operations divided by ending shareholders’ equity.
(4)
Based on average number of associates employed during the year.
(5)
Based on average number of shares outstanding during the year and includes discontinued operations for all
periods presented.
(6)
Adjusted to exclude Latrobe Steel for all periods.
(7)
Includes an estimated count of shareholders having common stock held for their accounts by banks, brokers
and trustees for benefit plans.
47
4. Capital Resources and Indebtedness
Total debt was $597.8 million at December 31, 2006 compared to $720.9 million at December 31,
2005. Net debt was $496.7 million at December 31, 2006 compared to $655.5 million at December
31, 2005. The net debt to capital ratio was 25.2% at December 31, 2006 compared to 30.5% at
December 31, 2005.
The following table shows the reconciliation of total debt to net debt and the ratio of net debt to
shareholders’ equity (capital):
Net Debt:
December 31,
2006
2005
$
$
(US dollars in millions)
Short-term debt
Long-term debt
Total debt
Net debt
63.4
95.8
561.7
720.9
(65.4)
$ 655.5
40.2
10.2
547.4
597.8
(101.1)
$ 496.7
Ratio of Net Debt to Capital:
December 31,
2006
2005
$
$
(US dollars in millions)
Net debt
Ratio of net debt to capital
496.7
1,476.2
$ 1,972.9
25.2%
655.5
1,497.1
$ 2,152.6
30.5%
The Company presents net debt because it believes net debt is more representative of the Company’s
indicative financial position.
The decrease in short-term debt was the result of the repayment of debt held by PEL, an equity
investment of the Company. The current portion of long-term debt decreased primarily due to the
payment of debt, partially offset by the reclassification of debt maturing within the next twelve
months to current. In August 2006, the Company repaid, in full, the $24.0 million balance outstanding
under the variable-rate State of Ohio Water Development Authority Solid Waste Revenue Bonds. The
decrease in long-term debt was primarily due to the reclassification of long-term debt to current for
debt maturing within the next twelve months, partially offset by debt assumed in the consolidation of
a joint venture.
Total debt at March 31, 2007 was $668.5 million (of which: short-term debt $137.9 million; long-term
debt including current maturities $530.6 million), or 30.5% of capital. Debt was higher than the 2006
year-end level of $597.8 million due to seasonal working capital requirements. Net debt at March 31,
2007 was $567.7 million, or 27.2% of capital.
All debt is unsecured. The Company's principal external sources of financing are its Asset Securitization and its Senior Credit Facility (see Section VI. 1. about "Material Contracts; Financial
Arrangements", above, p. 42).
48
5. Liquidity and Working Capital Statement
The Company expects that any cash requirements in excess of cash generated from operating
activities will be met by the availability under its Asset Securitization and its Senior Credit Facility.
The Company believes that it has sufficient working capital to meet its obligations in the immediate
future.
6. Historical Financial Information
The historical financial information covering the Company's latest three fiscal years presented below
is extracted without adjustment from the Company's audited annual consolidated financial statements
6
for the periods ending December 31 of 2006, 2005 and 2004, respectively. The historical financial
information includes the consolidated balance sheet, statement of income, statement of shareholders'
equity and statement of cash flows with respect to the latest three fiscal years of the Company.
7
Consolidated Balance Sheet for 2006 and 2005
December 31,
2005
2006
ASSETS
Current Assets
Cash and cash equivalents
Accounts receivable, less allowances: 2006 - $36,673; 2005 - $37,473
Inventories, net
Deferred income taxes
Deferred charges and prepaid expenses
Current assets of discontinued operations
Other current assets
Total Current Assets
$
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Short-term debt
Accounts payable and other liabilities
Salaries, wages and benefits
Income taxes payable
6
7
$
65,417
657,237
900,294
97,712
17,926
162,237
82,486
1,983,309
1,601,559
1,474,074
201,899
104,070
169,417
—
54,308
529,694
$ 4,031,533
204,129
179,043
1,918
81,205
70,056
536,351
$ 3,993,734
$
$
Property, Plant and Equipment-Net
Other Assets
Goodwill
Other intangible assets
Non-current assets of discontinued operations
Other non-current assets
Total Other Assets
Total Assets
101,072
673,428
952,310
85,576
11,083
—
76,811
1,900,280
40,217
506,301
225,409
52,768
638
63,437
470,966
364,028
30,497
4,880
See the financial information included in the Company's Annual Reports to the shareholders for the fiscal
years 2006, 2005 and 2004, respectively, provided in Sections IX. 3., 4. and 5. of this prospectus, below.
From the 2006 Annual Report, p. 121, below.
49
December 31,
2005
2006
Current liabilities of discontinued operations
Total Current Liabilities
Non-Current Liabilities
Long-term debt
Accrued pension cost
Accrued postretirement benefits cost
Non-current liabilities of discontinued operations
Other non-current liabilities
Total Non-Current Liabilities
Shareholders’ Equity
Class I and II Serial Preferred Stock without par value:
Authorized - 10,000,000 shares each class, none issued
Common stock without par value:
Authorized - 200,000,000 shares Issued (including shares in treasury)
(2006 - 94,244,407 shares; 2005 - 93,160,285 shares)
Stated capital
Other paid-in capital
Earnings invested in the business
Accumulated other comprehensive loss
Treasury shares at cost (2006 - 80,005 shares; 2005 - 154,374 shares)
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
—
10,236
835,569
41,676
95,842
1,071,326
547,390
410,438
682,934
6,659
—
72,363
1,719,784
561,747
242,414
488,506
36,556
35,878
60,240
1,425,341
—
53,064
753,095
1,217,167
(544,562)
(2,584)
1,476,180
$ 4,031,533
—
53,064
719,001
1,052,871
(323,449)
(4,420)
1,497,067
$ 3,993,734
8
Consolidated Balance Sheet for 2005 and 2004
December 31,
2004
2005
ASSETS
Current Assets
Accounts receivable, less allowances: 2005-$40,618; 2004-$36,279
Inventories, net
65,417
711,783
998,368
104,978
21,225
81,538
1,983,309
50,967
706,098
874,833
113,300
20,325
73,675
1,839,198
Property, Plant and Equipment - Net
1,547,044
1,583,425
204,129
184,624
5,834
68,794
189,299
178,986
85,192
66,809
Other Assets
Goodwill
8
From the 2005 Annual Report, p. 193, below. These historical numbers include the Latrobe Steel business sold
in December 2006.
50
December 31,
2004
2005
Total Other Assets
Total Assets
463,381
3,993,734
520,286
3,942,909
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Short-term debt
63,437
500,939
375,264
34,131
4,862
95,842
1,074,475
157,417
501,832
334,654
18,969
16,478
1,273
1,030,623
Long-term debt
561,747
246,692
513,771
42,891
57,091
1,422,192
620,634
468,644
490,366
15,113
47,681
1,642,438
-
-
53,064
719,001
1,052,871
(323,449)
(4,420)
53,064
658,730
847,738
(289,486)
(198)
1,497,067
3,993,734
1,269,848
3,942,909
Shareholders' Equity
Authorized-10,000,000 shares each class, none issued
Authorized-200,000,000 shares
Issued (including shares in treasury)
(2005 - 93,160,285 shares; 2004 - 90,511,833 shares)
Stated capital
Treasury shares at cost (2005 - 154,374 shares; 2004 - 7,501
shares)
Total Shareholders' Equity
Total Liabilities and Shareholders' Equity
Consolidated Statement of Income
9
Year Ended December 31,
2006
2005
2004
Net sales
Cost of products sold
Gross Profit
9
$ 4,973,365
3,967,521
1,005,844
$ 4,823,167
3,823,210
999,957
$ 4,287,197
3,462,821
824,376
677,342
44,881
64,271
646,904
26,093
—
575,910
13,538
—
51
2005
2006
2004
Operating Income
Interest expense
Interest income
Receipt of Continued Dumping & Subsidy
Offset Act (CDSOA) payment, net of
expenses
Other expense — net
income taxes
Net Income
Earnings Per Share:
326,960
219,350
234,928
(49,387)
4,605
(51,585)
3,437
(50,834)
1,397
$
87,907
(8,241)
254,234
77,795
176,439
$
77,069
(9,343)
346,538
112,882
233,656
$
44,429
(32,329)
197,591
63,545
134,046
$
46,088
222,527
$
26,625
260,281
$
1,610
135,656
$
$
$
$
$
1.89
0.49
2.38
1.87
0.49
2.36
$
$
$
$
$
2.55
0.29
2.84
2.52
0.29
2.81
$
$
$
$
$
1.49
0.02
1.51
1.48
0.01
1.49
Gross profit margin decreased in 2006 compared to 2005, primarily due to the impact of lower
volume in the Automotive Group, driven by reductions in vehicle production by North American
original equipment manufacturers, leading to underutilization of manufacturing capacity, as well as an
increase in product warranty reserves. The impact of lower volumes and the increase in product
warranty reserves in the Automotive Group more than offset favorable sales volume from the
Industrial and Steel businesses, price increases, and increased productivity in the Company’s other
businesses.
In 2006, rationalization expenses included in cost of products sold related to the Company’s Canton,
Ohio Industrial Group bearing facilities, certain Automotive Group domestic manufacturing facilities,
certain facilities in Torrington, Connecticut and the closure of the Company’s seamless steel tube
manufacturing operations located in Desford, England. In 2005, rationalization expenses included in
cost of products sold related to the rationalization of the Company’s Canton, Ohio bearing facilities
and costs for certain facilities in Torrington, Connecticut.
In 2005, gross profit benefited from price increases and surcharges, favorable sales volume and mix.
Manufacturing rationalization and integration charges related to the rationalization of the Company’s
Canton, Ohio bearing facilities and costs for certain facilities in Torrington, Connecticut. In 2004,
manufacturing rationalization and integration charges related primarily to expenses associated with
the integration of Torrington.
52
Consolidated Statement of Shareholders’ Equity
Total
10
Common stock
Stated
Other
capital
paid in
capital
Earnings
invested
in the
business
Accumulated
other compre- Treasury
stock
hensive
loss
(US dollars in thousands, except per share
data)
Year Ended December 31, 2004
Balance at January 1, 2004
Net income
Foreign currency translation adjustments
(net of income tax of $18,766)
Minimum pension liability adjustment
Change in fair value of derivative
financial instruments, net of
reclassifications
reclassifications
Total comprehensive income
Dividends — $0.52 per share
Tax benefit from stock compensation
Issuance (net) of 3,100 shares from
treasury(1)
Issuance of 1,435,719 shares from
authorized(1)
Balance at December 31, 2004
Net income
$1,089,627
135,656
$636,272
$758,849
135,656
$(358,382)
105,736
105,736
(36,468)
(36,468)
(372)
204,552
(46,767)
3,068
(372)
20,435
$1,269,848
$(176)
(46,767)
3,068
(1,067)
(1,045)
$53,064
20,435
$658,730
260,281
(22)
$847,738
$(289,486)
$(198)
260,281
(49,940)
13,395
reclassifications
2,582
226,318
(55,148)
8,151
(5,831)
treasury(1)
20,435
authorized(1)
$1,497,067
Net income
222,527
Foreign currency translation
adjustments (net of income tax of
$386)
56,293
prior to adoption of SFAS No. 158 (net
of income tax of $31,723)
56,411
reclassifications
(1,451)
333,780
10
$53,064
(49,940)
13,395
2,582
(55,148)
8,151
(1,609)
$53,064
20,435
$719,001
(4,222)
$1,052,871
$(323,449)
$(4,420)
222,527
56,293
56,411
(1,451)
53
Total
Common stock
Stated
Other
capital
paid in
capital
Earnings
invested
in the
business
Accumulated
other compre- Treasury
stock
hensive
loss
(US dollars in thousands, except per share
data)
Adjustment recognized upon adoption
of SFAS No. 158 (net of income tax of
$184,453)
treasury(1)
authorized(1)
(1)
(332,366)
(58,231)
4,526
(332,366)
(58,231)
4,526
1,829
29,575
$1,476,180
(7)
$53,064
29,575
$753,095
1,836
$1,217,167
$(544,562)
$(2,584)
Share activity was in conjunction with employee benefit and stock option plans.
The increase in common stock in 2006 related to stock option exercises by employees and the related
income tax benefits. Earnings invested in the business were increased in 2006 by net income, partially
reduced by dividends declared. The increase in accumulated other comprehensive loss was primarily
due to the amounts recorded in conjunction with the adoption of SFAS No. 158, partially offset by the
increase in the foreign currency translation adjustment. The increase in the foreign currency
translation adjustment was due to weakening of the US dollar relative to other currencies, such as the
Romanian lei, the Brazilian real and the euro.
Consolidated Statement of Cash Flows
11
2006
Year ended December 31,
2005
2004
CASH PROVIDED (USED)
Operating Activities
Net income
Net (income) from discontinued operations
Adjustments to reconcile income from
continuing operations to net cash provided by
operating activities:
Loss on sale of assets
Deferred income tax (benefit) provision
Stock-based compensation expense
Changes in operating assets and liabilities:
Accounts receivable
Inventories
Other assets
Accounts payable and accrued expenses
Foreign currency translation (gain) loss
11
$ 222,527
(46,088)
$ 260,281
(26,625)
$ 135,656
(1,610)
196,592
15,267
65,405
(26,395)
15,594
209,656
770
211
81,393
9,293
201,173
10,154
6,062
56,859
2,775
(5,987)
(6,743)
4,098
(122,326)
(19,319)
(12,399)
(137,329)
(22,888)
(50,533)
5,157
(102,848)
(116,332)
7,107
(59,201)
2,690
54
2006
Year ended December 31,
2005
2004
Net Cash Provided by Operating Activities —
Continuing Operations
Net Cash Provided (Used) by Operating
Activities — Discontinued Operations
Net Cash Provided by Operating Activities
Investing Activities
Proceeds from disposals of property, plant and
equipment
Divestitures
Acquisitions
Other
Net Cash Used by Investing Activities —
Continuing Operations
Net Cash Used by Investing Activities —
Discontinued Operations
Net Cash Used by Investing Activities
Financing Activities
Cash dividends paid to shareholders
Net proceeds from common share activity
Accounts receivable securitization financing
borrowings
Accounts receivable securitization financing
payments
Proceeds from issuance of long-term debt
Payments on long-term debt
Short-term debt activity — net
Net Cash Used by Financing Activities
Effect of exchange rate changes on cash
Increase In Cash and Cash Equivalents
Cash and cash equivalents at beginning of
year
Cash and Cash Equivalents at End of Year
292,625
316,987
142,485
44,303
336,928
1,714
318,701
(21,956)
120,529
(296,093)
(217,411)
(143,781)
9,207
203,316
(17,953)
(2,922)
5,271
21,838
(48,996)
4,622
5,223
50,690
(9,359)
(7,626)
(104,445)
(234,676)
(104,853)
(26,423)
(130,868)
(8,126)
(242,802)
(3,728)
(108,581)
(58,231)
22,963
(55,148)
39,793
(46,767)
17,628
170,000
231,500
198,000
(170,000)
272,549
(392,100)
(21,891)
(176,710)
6,305
35,655
(231,500)
346,454
(308,233)
(79,160)
(56,294)
(5,155)
14,450
(198,000)
335,068
(328,651)
20,860
(1,862)
12,255
22,341
65,417
$ 101,072
50,967
$ 65,417
28,626
$ 50,967
The net cash provided by operating activities of $336.9 million for 2006 increased from 2005 with
operating cash flows from discontinued operations increasing $42.6 million, partially offset by
operating cash flows from continuing operations decreasing $24.4 million. The decrease in net cash
provided by operating activities from continuing operations was primarily the result of lower income
from continuing operations of $176.4 million, adjusted for non-cash items of $266.5 million in 2006,
compared to income from continuing operations of $233.7 million, adjusted for non-cash items of
$301.3 million, in 2005. The decrease in non-cash items was driven by a deferred tax benefit in 2006
compared to expense in 2005, partially offset by higher impairment and restructuring charges and
losses on the sale of non-strategic assets. The lower net income from continuing operations, adjusted
for non-cash items, was partially offset by the reduction in the use of cash for working capital
requirements, primarily inventories, partially offset by accounts payable and accrued expenses.
Inventory was a use of cash of $6.7 million in 2006 compared to a use of cash of $137.3 million in
2005. Excluding cash contributions to the Company’s US-based pension plans, accounts payable and
accrued expenses were a source of cash of $120.3 million in 2006, compared to a source of cash of
$175.7 million in 2005. The Company made cash contributions to its US-based pension plans in 2006
of $242.6 million, compared to $226.2 million in 2005. The increase in operating cash flows from
discontinued operations was primarily due to working capital items, primarily inventory.
55
The decrease in net cash used by investing activities in 2006 compared to 2005 was primarily due to
higher cash proceeds from divestitures and lower acquisition activity, partially offset by higher capital
expenditures. The cash proceeds from divestitures increased $181.5 million primarily due to the sale
of the Company’s Latrobe Steel subsidiary. Capital expenditures increased $78.7 million in 2006
compared to 2005 primarily to fund Industrial Group growth initiatives and Project O.N.E. In
addition, cash used by investing activities of discontinued operations increased $18.3 million in 2006
primarily due to the buyout of a rolling mill operating lease in conjunction with the sale of Latrobe
Steel.
The increase in net cash used by financing activities was primarily due to the Company decreasing its
net borrowings $141.4 million in 2006 after decreasing its net borrowings $40.9 million in 2005. In
addition, proceeds from the exercise of stock options decreased during 2006 compared to 2005.
Since the end of the last financial period (December 31, 2006), there has been no significant change in
the financial or trading position of the Timken group.
Accounting Policies and Explanatory Notes
For a description of the applicable accounting policies and the explanatory notes to the consolidated
financial statements displayed above, please refer to pages 125 et seq. (regarding the fiscal year ended
December 31, 2006), pages 196 et seq. (regarding the fiscal year ended December 31, 2005) and
pages 250 et seq. (regarding the fiscal year ended December 31, 2004) of this prospectus.
7. Recent Trends
The Company expects the strength in industrial markets will continue in 2007 and drive year-overyear sales increases in both the Industrial and Steel Groups. While global industrial markets are
expected to remain strong, the improvements in the Company’s operating performance will be
partially constrained by investments, including Project O.N.E. and Asian growth initiatives. Project
O.N.E. is a program designed to improve the Company’s business processes and systems. In 2006, the
Company successfully completed a pilot program of Project O.N.E. in Canada. The objective of Asian
growth initiatives is to increase market share, influence major design centers and expand the
Company’s network of sources of globally competitive friction management products.
Industrial Group. The Company’s strategy for the Industrial Group is to pursue growth in selected
industrial markets and achieve a leadership position in targeted Asian markets. In 2006, the Company
invested in three new plants in Asia to build the infrastructure to support its Asian growth initiative.
The Company also expanded its capacity in aerospace products by investing in a new aerospace
aftermarket facility in Mesa, Arizona and through the acquisition of the assets of Turbo Engines, Inc.
in December 2006. The new facility in Mesa, which will include manufacturing and engineering
functions, more than doubles the capacity of the Company’s previous aerospace aftermarket
operations in Gilbert, Arizona. In addition, the Company is increasing large-bore bearing capacity in
Romania, China and the United States to serve heavy industrial markets. The Company is also
expanding its line of industrial seals to include large-bore seals to provide a more complete line of
friction management products to distribution channels. In May 2004, the Company announced plans
to rationalize the Company’s three bearing plants in Canton, Ohio within the Industrial Group. On
September 15, 2005, the Company reached a new four-year agreement with the United Steelworkers
of America, which went into effect on September 26, 2005, when the prior contract expired. This
rationalization initiative is expected to deliver annual pretax savings of approximately $25 million
through streamlining operations and workforce reductions, with pretax costs of approximately $35 to
$40 million over the next three years. The Company expects the Industrial Group to benefit from
continued strength in most industrial segments in 2007. The Industrial Group is also expected to
benefit from additional supply capacity in constrained products throughout 2007.
56
Automotive Group. The Company’s strategy for the Automotive Group is to make structural changes
to its business to improve its financial performance. In 2005, the Company disclosed plans for its
Automotive Group to restructure its business. These plans included the closure of its automotive
engineering center in Torrington, Connecticut and its manufacturing engineering center in Norcross,
Georgia. These facilities were consolidated into a new technology facility in Greenville, South
Carolina. Additionally, the Company announced the closure of its manufacturing facility in Clinton,
South Carolina. In February 2006, the Company announced plans to downsize its manufacturing
facility in Vierzon, France. In September 2006, the Company announced further planned reductions in
its Automotive Group workforce of approximately 700 associates. These plans are targeted to deliver
annual pretax savings of approximately $35 million by 2008, with pretax costs of approximately
$25 million. In December 2006, the Company completed the divestiture of its Steering business
located in Watertown, Connecticut and Nova Friburgo, Brazil, resulting in a loss on divestiture of
$54.3 million. The Steering business employed approximately 900 associates. The Automotive
Group’s sales are expected to stabilize in 2007 compared to the second half of 2006, and the
Automotive Group is expected to deliver improved margins due to its restructuring initiatives.
Steel Group. The Company’s strategy for the Steel Group is to focus on opportunities where the
Company can offer differentiated capabilities while driving profitable growth. In 2006, the Company
announced plans to invest in a new induction heat-treat line in Canton, Ohio, which will increase
capacity and the ability to provide differentiated product to more customers in its global energy
markets. In January 2007, the Company announced plans to invest approximately $60 million to
enable the Company to competitively produce steel bars down to 1-inch diameter for use in power
transmission and friction management applications for a variety of customers, including the rapidly
growing automotive transplants. In 2006, the Company also completed the divestiture of its Latrobe
Steel subsidiary and its Timken Precision Steel Components — Europe business. In addition, the
Company announced plans to exit during 2007 its seamless steel tube manufacturing operations
located in Desford, England. The Company expects the Steel Group to continue to benefit from strong
demand in industrial and energy market sectors. Scrap costs are expected to decline from their current
level, while alloy and energy costs are expected to remain at high levels. However, these costs are
expected to be recovered through surcharges and price increases.
The principal raw materials used by Timken in steel manufacturing are scrap metal, nickel and other
alloys. Prices for raw materials and energy resources continue to remain high. The Company
continues to expect that it will be able to pass a significant portion of these increased costs through to
customers in the form of price increases or raw material surcharges.
As a result of a new four-year agreement reached in 2005 with the United Steelworkers union,
covering employees in the Canton, Ohio bearing and steel plants, the Company has refined its plans to
rationalize the Canton bearing operations.
The Company expects to make cash contributions of $100.2 million to its global defined benefit
pension plans in 2007.
57
VII.
THE CAPITAL STOCK
As of December 31, 2006, Timken's authorized capital stock consisted of:

200,000,000 shares of common stock, without par value,
10,000,000 shares of Class I Serial Preferred Stock, without par value,
and 10,000,000 shares of Class II Serial Preferred Stock, without par value.
No shares of preferred stock were issued and outstanding.
On December 31, 2006, 94,164,402 shares of common stock (93,005,911 as at December 31, 2005)
were issued and outstanding. These numbers exclude common stock held by the Company and its
subsidiaries in treasury. The number of such treasury shares was 80,005 (154,374 as at December 31,
2005).
The number of shares issued and outstanding on January 31, 2007, was 94,174,971.
1. Common Stock
As stated above, the offer under the Plan concerns Timken's common stock only.
General
Timken's common stock is regulated by the US Securities Act of 1933 and the US Securities
Exchange Act of 1934. All common stock issued and outstanding is without par value and admitted to
trading on the New York Stock Exchange. The stock is quoted in US dollars, and its short code at the
New York Stock Exchange is "TKR".
The US security identification (CUSIP) number of Timken's common stock is 887389104. The
CUSIP number is the US equivalent of the international security identification number (ISIN).
All of Timken's issued and outstanding common stock is fully paid and non-assessable.
All shares of common stock are registered, certificated and freely transferable.
National City Bank, Cleveland, Ohio, is the Company`s stock transfer agent, registrar and dividend
reinvestment plan agent. The entity in charge of keeping the records of legal ownership of the shares
is National City Bank Shareholder Services, P.O. Box 92301, Cleveland, Ohio 44193-0900, USA.
Dividend Rights
All holders of common stock are entitled to fully and equally receive dividends from funds legally
12
available when, as and if declared by Timken's Board of Directors. When, and if, dividends are
declared by the Company, dividends are generally paid quarterly, usually in March, June, September
and December. The right for holders of common stock to receive a dividend arises upon his or her
registration in the Company's register of shareholders and lapses after five years, at which time the
State of Ohio is entitled to receive the dividends. Dividend payments are non-cumulative in nature.
12
Certain restrictions apply if preferred stock is issued (which is currently not the case), see description in
Section VII. 2. ("Preferred Stock"), below.
58
There are no dividend restrictions and no special procedures for stockholders residing in the EU and
the EEA.
Other Shareholders' Rights
The holders of common stock are entitled to one vote for each share held on all matters as to which
13
shareholders are entitled to vote.
The holders of common stock are entitled upon the Company's liquidation, dissolution or winding up
to receive pro rata the remaining net assets after satisfaction in full of the prior rights of the
Company's creditors and holders of any preferred stock.
The holders of common stock do not have any preferential, subscriptive or preemptive rights to
subscribe to or purchase any new or additional issue of shares of any class of stock or of securities
convertible into the Company's stock. The common stock is not subject to redemption and does not
have any conversion rights.
2. Preferred Stock
Timken's preferred stock is divided into two classes, Class I Serial Preferred Stock and Class II Serial
Preferred Stock. Holders of the Class I Serial Preferred have preference rights superior to both the
holders of Class II Serial Preferred and shares of common stock. The Class II Serial Preferred holders
have preference rights superior to the holders of common stock. The following description of Timken's preferred stock applies to both classes, unless otherwise specified.
The preferred stock may be issued from time to time in one or more series with such distinctive serial
designations as are fixed by the Board of Directors and with such rights, preferences and limitations
as are fixed by the Board of Directors or required by law. Currently, no shares of preferred stock are
issued and outstanding. Satisfaction of dividend preferences of any outstanding preferred stock would
reduce the amount of funds available for the payment of dividends on Timken's common stock. In
addition, holders of preferred stock would be entitled to receive a preferential payment before any
payment is made to holders of common stock in the event of the Company's voluntary or involuntary
liquidation, dissolution or winding up. Additionally, with respect to any dividend or dissolution
preferences, holders of Class I Serial Preferred Stock will receive preferential payment over holders of
Class II Serial Preferred Stock.
Subject to the exceptions listed below, the holders of Class I Serial Preferred Stock are not entitled, as
such, to notice of meetings of shareholders or to vote upon any matter presented to the shareholders.
However, the affirmative vote of the holders of at least two-thirds of the holders of Class I Serial
Preferred Stock, voting separately as a class, and in certain cases by series, is required to effect or
validate any amendment to the Company's amended articles of incorporation which:

Changes issued shares of Class I Serial Preferred Stock of all series then outstanding into a lesser
number of shares of the same class and series or into the same or a different number of shares of
any other class or series;

Changes the express terms of the Class I Serial Preferred Stock in any manner substantially
prejudicial to the holders of all series thereof then outstanding;
13
The holders of common stock vote jointly as a single class with the holders of Class II Serial Preferred Stock
(to apply only if preferred stock is issued, see description in the next Section VII. 2., below).
59

Authorizes shares of any class, or any security convertible into shares of any class, or authorizes
the conversion of any security into shares of any class, ranking prior to the Class I Serial Preferred
Stock; or

Changes the express terms of issued shares of any class ranking prior to the Class I Serial
Preferred Stock in any manner substantially prejudicial to the holders of all series of Class I Serial
Preferred Stock then outstanding.
In addition, if the payment of six quarterly dividends, whether or not consecutive, is in default,
holders of Class I Serial Preferred Stock, voting separately as a class, are entitled to elect two
additional members to Timken's Board of Directors. When all dividends in default on any Class I
Serial Preferred Stock have been paid, the holders’ power to elect the two additional directors at
subsequent elections of directors becomes null and void until a new default occurs. The holders of
Class I Serial Preferred Stock do not have cumulative voting rights or any preferential, subscriptive or
preemptive rights to subscribe to or purchase any new or additional issue of shares of any class of
stock or securities convertible into Timken stock.
If the shares of any series of either class of preferred stock are convertible into shares of any other
class or series of Timken stock, the stated capital, if any, will be modified accordingly to reflect such
conversion.
3. Change of Shareholders' Rights
The rights of holders of common stock may be changed only by a formal amendment of the articles of
incorporation as long as no preferred stock is issued. If preferred stock is issued, the terms and
conditions thereof are fixed by a resolution of the Board of Directors. By such a resolution, the Board
of Directors can also modify certain terms of the common stock.
4. Withholding of Tax on Dividends
In the USA, dividends are subject to withholding of income tax in the amount of 30% upon
distribution. The Company is responsible for the withholding of such tax at the source and has
instructed National City Bank Shareholder Services, Cleveland, Ohio, to withhold and pay the
withholding amount to the US tax authorities. Therefore, dividends are distributed to shareholders less
the applicable withholding tax amount. Should Participants that are non-US citizens become
shareholders, they may waive the withholding requirement if they make a certification on a W-8BEN
Form to National City Bank Shareholder Services.
Timken advises each Participant to consult a tax advisor for information about the specific tax
consequences and tax reporting obligations applying in his or her country of residence (for instance,
to which extent dividend payments are considered taxable income and withheld amounts in the US are
imputed under applicable double taxation treaties for the Participant's fulfillment of local tax
obligations).
60
VIII.
CORPORATE ORGANIZATION
Timken's corporate organization is governed by the Company's articles of incorporation, the
Company's regulations (or bylaws) and Ohio corporate law.
1. Particular Provisions of Timken's Articles of Incorporation and Regulations
The Company's Objects and Purposes
According to Article Third of the Company's Amended Articles of Incorporation, Timken is formed
for the purpose of developing, producing, manufacturing, buying, selling and generally dealing in
products, goods, wares, merchandise, tangible and intangible property and services of any and all
kinds and doing any and all things necessary or incidental thereto.
Shareholder Meetings
The regulations (or bylaws) of the Company contain a description of the conditions governing the
manner in which annual general meetings and extraordinary general meetings (called "special
meetings" in the Company's regulations) of shareholders are called. The information includes the
conditions of the shareholders' admission to these meetings.
The Company's regulations provide, in particular, that the annual meeting of the shareholders is
usually held on the third Tuesday of April in each year. Special meetings of the shareholders may be
called by the Chairman of the Board, the President or a majority of the Directors, or by persons who
hold of record not less than fifty percent of all the shares outstanding. The notice of the time, place
and purposes of the meeting, whether annual or special, shall be given in writing by the Chairman of
the Board, the President, a Vice President, or the Secrietary not more than eighty days nor less than
seven days before the date fixed for the meeting. The notice shall be served upon or mailed to each
shareholder entitled to notice or to vote at such meeting. If such notice is mailed, it shall be directed,
postage prepaid, to the shareholders at their respective addresses as they appear upon the records of
the Company, and notice shall be deemed to have been given on the day so mailed.
The Directors may fix a record date for the determination of shareholders entitled to notice of, or
entitled to vote at, any meeting of shareholders. Such record date shall not be more than one hundered
days preceding the date of the meeting and shall not be a date earlier than the date on which the record
date is fixed.
These rules governing the invitation of and voting of shareholders in annual or special meetings are
supplemented by the special provisions applying to Participants (see description of TISOP in Section
V. 13., above).
The Board of Directors
Timken's regulations also contain provisions with respect to the organization of the Company's Board
of Directors.
Election, Number and Term of Office. Directors are elected at the annual meeting of shareholders, or
if not so elected, at a special meeting of shareholders called for that purpose. The regular number of
eleven Directors may be changed to not less than nine nor more than eighteen by the vote of the
holders of two-thirds of the shares entitled to be voted at a meeting called to elect Directors, or by
resolution of the Directors in office. The Directors are divided into three classes, designated as Class
61
I, Class II and Class III, each class consisting of not less than three Directors nor more than six
Directors. Timken presently has thirteen Directors, with five Directors in Class I, four Directors in
Class II and four Directors in Class III. Directors of each class are elected to hold office for three
years. At the 2007 annual meeting of shareholders, five Directors will be elected to serve in Class I
for a three-year term to expire at the 2010 annual meeting of shareholders.
Removal. A Director may be removed from office, as permitted by statute, by the Directors then in
office or, upon the recommendation of two-thirds of the Directors then in office, by the vote of the
holders of two-thirds of the shares entitled to be voted to elect Directors.
Committees. The Directors may create and define the powers and duties of an Executive Committee
of the Board of Directors consisting of not fewer than three members. The Board of Directors also has
an Audit Committee, a Compensation Committee, a Nominating and Corporate Governance Committee and, since November 2006, a Finance Committee (as further described below).
Meetings. Meetings of the Directors are called by the Chairman of the Board, the President, any Vice
President, the Secretary, or by not less than one-third of the Directors then in office. During 2006,
there were seven meetings of the Board of Directors, ten meetings of its Audit Committee, four
meetings of its Compensation Committee, and four meetings of its Nominating and Corporate
Governance Committee. The Finance Committee was created in November 2006, and no meetings
were conducted in 2006. All Directors attended 75 percent or more of the meetings of the Board and
its Committees on which they served. All members of the Board of Directors are expected to attend
the annual meeting of shareholders. All Board members then in office attended the annual meeting of
shareholders in 2006. At each regularly scheduled meeting of the Board of Directors, the nonemployee Directors and the independent Directors also meet separately in executive sessions. The
chairpersons of the standing committees preside over those sessions on a rotating basis.
Quorum. A majority of the Directors constitute a quorum for the transaction of business at any Board
meeting. The act of a majority of the Directors present at any meeting at which a quorum is present is
considered to be the act of the Directors.
Officers
The Company has a Chairman of the Board and a President (both of whom must be Directors), a
Secretary and a Treasurer, all of whom are elected by the Directors.
2. Takeover Restrictions in the Company's Regulations and Ohio Corporate Law
The Company's regulations as well as Ohio corporate law contain provisions that may have an effect
of delaying, deferring or preventing a change in control of the issuer.
Anti-takeover Provisions in the Regulations
As stated above, pursuant to the Company's regulations, the Board of Directors is divided, with
respect to the terms for which the Directors severally hold office, into three classes, with the threeyear term of office of one class of Directors expiring each year.
These provisions of the regulations may be amended at a meeting of the shareholders by (i) the
affirmative vote of the shareholders of record entitling them to exercise a majority of the voting power
on the proposal, if such proposal has been recommended by a two-thirds vote of the Directors then in
office as being in the best interests of Timken and its shareholders, or (ii) the affirmative vote, at a
meeting, of the shareholders of record entitled to exercise two-thirds of the voting power on such
proposal, or (iii) the affirmative vote or approval of, and in a writing or writings signed by, all the
shareholders who would be entitled to notice of a meeting of the shareholders held for that purpose.
62
Although these provisions are intended to encourage potential acquiring persons to negotiate with the
Company's Board of Directors and to provide for continuity and stability of management, these
provisions may have an anti-takeover effect. By making it more time consuming for a substantial
shareholder to gain control of the Board of Directors, these provisions may render more difficult, and
may discourage, a proxy contest or the assumption of control of Timken or the removal of the
incumbent Board of Directors.
Restrictions to Consolidation, Merger or Sale
The offering of debt securities issued in the amount of $250,000,000 partially to finance the
Torrington acquisition in 2003 may also be considered as an indirect impediment to the Company's
ability to merge, consolidate, or sell, convey, transfer, lease or otherwise dispose of all or substantially
all of its assets. In particular, the indenture fixing the terms of the issued notes provide that:

Any successor corporation is a corporation organized under the laws of the United States of
America or any state thereof;

The successor corporation expressly assumes all of Timken's obligations under the applicable
indenture and any debt securities issued under the indenture;

There is no event of default immediately after giving effect to the merger, consolidation or sale;
and

Certain other conditions are met.
Anti-takeover Effect of Ohio Corporate Law
Additionally, Ohio corporate law provides that certain notice and informational filings and special
shareholder meeting and voting procedures must be followed prior to consummation of a proposed
"control share acquisition," as defined in the Ohio statute. Assuming compliance with the notice and
information filings prescribed by statute, the proposed control share acquisition may be made only if,
at a special meeting of shareholders, the acquisition is approved by both a majority of the voting
power of the Company represented at the meeting and a majority of the voting power remaining after
excluding the combined voting power of the "interested shares," as defined in the statute.
Together, these provisions of the Company's articles and regulations, the terms of the debt securities
issued and Ohio corporate law may discourage transactions that otherwise could provide for the
payment of a premium over prevailing market prices for Timken's common stock and could also limit
the price that investors may be willing to pay in the future for common stock.
63
3. About Timken's Current Directors
The following table, based on information obtained in part from the respective Directors and in part
from the records of the Company, sets forth information regarding each Director as of January 10,
14
2007. The business address for all Directors is The Timken Company, 1835 Dueber Avenue, S. W.,
Canton, Ohio 44706-2798, USA.
Name
Class
Age / Principal position or office/
Business experience for last five years/
Directorships of publicly held
companies
Director
continu–
ously
since
Term expires
at annual
meeting of
shareholders in
59, President and Chief Executive Officer of
Cox Financial Corporation, a financial
services company, since 1972.
Director of: Cincinnati Bell, Inc.; Diebold,
Incorporated; Duke Energy Corporation;
Touchstone Mutual Funds.
The Timken Company, since 2002.
Previous position: President and Chief
Operating Officer of The Timken Company,
1999-2002.
Director of: Goodrich Corporation.
2004
2008
1999
2010
Phillip R. Cox
II
James W. Griffith
I
Jerry J. Jasinowski
I
68, Retired President and Chief Executive
Officer of the National Association of
Manufacturers and Retired President of The
Manufacturing Institute, the education and
research arm of the National Association of
Manufacturers, the nation’s largest industrial
trade association, since 2006.
Previous positions: President – The
Manufacturing Institute, 2005-2006; President and Chief Executive Officer – National
Association of Manufacturers, 1990-2004.
Director of: webMethods, Inc.; Harsco Corporation; The Phoenix Companies, Inc.
2004
2010
John A. Luke, Jr.
I
58, Chairman and Chief Executive Officer
of MeadWestvaco Corporation, a leading
global producer of packaging, coated and
specialty papers, consumer and office
products, and specialty chemicals, since
2003.
Previous positions: Chairman, President and
Chief Executive Officer of MeadWestvaco
Corporation, 2003; President and Chief
Executive Officer of MeadWestvaco Corporation, 2002-2003.
Director of: The Bank of New York
Company, Inc.; FM Global; MeadWestvaco
1999
2010
14
The data concerning the expiration of each Director's term represents the status as of the date of Timken's next
general meeting of shareholders on May 1, 2007, assuming re-election of the five Class I Directors. The
Company will file a supplement to this prospectus if any of the five Class I Directors is not re-elected.
64
Name
Class
Robert W.
Mahoney
II
Joseph W. Ralston
III
John P. Reilly
III
Director
continu–
ously
since
Term expires
at annual
meeting of
shareholders in
1992
2008
2003
2009
2006
2009
RPM International Inc., a world leader in
specialty coatings, since 2002.
Previous position: President and Chief
Operating Officer, RPM International Inc.,
2001–2002.
Director of: RPM International Inc.
2003
2010
55, Private Investor.
1986
2009
companies
Corporation.
70, Chairman Emeritus of Diebold, Incorporated, a company specializing in the automation of self-service transactions, security
products, software and service for its
products, since 1999.
Director of: Cincinnati Bell, Inc.; SherwinWilliams Co.
63, Vice Chairman, The Cohen Group, an
organization that provides clients with
comprehensive tools for understanding and
shaping their business, political, legal,
regulatory and media environments, since
2003.
Previous positions: General – United States
Air Force (Retired); Supreme Allied
Commander, Europe, NATO, 2000-2003.
Director of: Lockheed Martin Corporation;
URS Corporation.
63, Retired Chairman, President and Chief
Executive Officer of Figgie International, an
international diversified operating company,
since 1998.
Director of: Exide Corporation (Chairman);
Material Sciences Corporation; Marshfield
Door Systems.
Frank C. Sullivan
I
John M. Timken,
Jr.
III
Ward J. Timken
I
64, President – Timken Foundation of
Canton, a private, charitable foundation to
promote civic betterment through capital
fund grants, since 2004.
Previous position: Vice President of The
Timken Company, 1992-2003.
1971
2010
Ward J. Timken,
Jr.
II
39, Chairman – Board of Directors of The
Timken Company, since 2005.
Previous positions: Vice Chairman and
President – Steel, 2005; Executive Vice
President and President – Steel, 2004-2005;
Corporate Vice President – Office of the
Chairman, 2000-2003.
2002
2008
Joseph F. Toot, Jr.
II
71, Retired President and Chief Executive
1968
2008
65
Name
Jacqueline F.
Woods
Class
III
companies
Officer of The Timken Company, since
1998.
Director of:
PSA Peugeot Citroen;
Rockwell Automation, Inc.; Rockwell
Collins, Inc.
59, Retired President of SBC/AT&T Ohio, a
telecommunications company, since 2000.
Director of: School Specialty, Inc.; The
Anderson’s Inc.
Director
continu–
ously
since
Term expires
at annual
meeting of
shareholders in
2000
2009
Related Parties; Independence of Directors; Conflicts of Interest
Ward J. Timken is the father of Ward J. Timken, Jr. and the cousin of John M. Timken, Jr. Please
refer to the sections about "Directors' beneficial ownership of common stock" and "Other major
shareholders", below, for additional information about the family relationship among certain Timken
stockholders.
The Board of Directors has adopted the independence standards of the New York Stock Exchange
listing requirements for determining the independence of Directors. The Board has determined that
the following continuing Directors have no material relationship with the Company and meet those
independence standards: Phillip R. Cox, Jerry J. Jasinowski, John A. Luke, Jr., Robert W. Mahoney,
Joseph W. Ralston, John P. Reilly, Frank C. Sullivan, John M. Timken, Jr., Joseph F. Toot, Jr., and
Jacqueline F. Woods. With respect to John M. Timken, Jr., the Board determined that Mr. Timken’s
family relationship to Ward J. Timken and Ward J. Timken, Jr. does not impair Mr. Timken’s
independence. Further, with respect to the finding that Joseph F. Toot, Jr., a former Chief Executive
Officer of the Company, is independent, important factors considered by the Board included the fact
that Mr. Toot retired as an executive of the Company in 1998 and that he receives no cash
compensation from the Company (excluding his pension) other than Director fees. The Board found
that the office space and administrative support supplied to Mr. Toot by the Company do not create a
material relationship.
The following Directors are employed with the Company: James W. Griffith and Ward J. "Tim"
Timken, Jr. All other Directors are nonemployee Directors.
The Company’s Directors and executive officers are subject to the Company’s Standard of Business
Ethics Policy, which requires that any potential conflicts of interest such as significant transactions
with related parties be reported to the Company’s General Counsel. In the event of any potential
conflict of interest, pursuant to the charter of the Nominating and Corporate Governance Committee
and the provisions of the Standards of Business Ethics Policy, the Committee would review and,
considering such factors as it deems appropriate under the circumstances, make a determination as to
whether to grant a waiver to the Policy for any such transaction. Any waiver would be promptly
disclosed to shareholders.
The Company is not aware of any specific conflicts of interest existing between the Directors' duties
towards Timken and their private interests and/or other duties.
Good Standing of Directors
The Company confirms that to the best of its knowledge and the information available to it, in the
previous five years, none of its Directors have been subject to:
66

Any convictions in relation to fraudulent offences;

Any bankruptcies, receiverships or liquidations with which a Director who was acting in the
capacity of any of the positions set out above was associated; and

Any official public incrimination and/or sanctions by statutory or regulatory authorities (including
designated professional bodies).
The Company also confirms that none of its Directors have ever been disqualified by a court from
acting as a member of the administrative, management or supervisory bodies of an issuer or from
acting in the management or conduct of the affairs of any issuer for at least the previous five years.
Directors' Beneficial Ownership of Common Stock
The following table shows, as of January 10, 2007, the beneficial ownership of common stock of the
Company by each continuing Director. Beneficial ownership of common stock has been determined
for this purpose in accordance with Rule 13d-3 under the US Securities Exchange Act of 1934 and is
based on the sole or shared power to vote or direct the voting or to dispose or direct the disposition of
common stock. The Rule includes as beneficial owners not only persons who hold such power alone,
but also those who share such power with other persons. Beneficial ownership as determined in this
manner does not necessarily bear on the economic incidents of ownership of common stock.
Name of Director
Amount and Nature of Beneficial Ownership of Common Stock
Sole voting or
investment
power (1)
Shared voting
or investment
power
Aggregate
amount (1)
Percent
of
class
Phillip R. Cox
7,300(2)
0
7,300(2)
0.00008%
James W. Griffith
607,371
40,964
648,335
0.007%
Jerry J. Jasinowski
11,300(2)
0
11,300(2)
0.0001%
John A. Luke, Jr.
27,440
0
27,440
0.0003%
Robert W. Mahoney
29,781
0
29,781
0.0003%
Joseph W. Ralston
21,001
0
21,001
0.0002%
2,020
0
2,020
0.00002%
13,200(2)
0
13,200(2)
612,623 (3)
983,277 (4)
1,595,900(3)
1.7%
Ward J. Timken
503,461
6,486,141(4)
6,989,602(4)
7.4%
Ward J. Timken, Jr.
284,952
5,309,754(4)
5,594,706(4)
5.9%
Joseph F. Toot, Jr.
141,808
200
142,008
0.002%
26,343
0
26,343
0.0003%
John P. Reilly
Frank C. Sullivan
John M. Timken, Jr.
Jacqueline F. Woods
0.0001%
67
Footnotes and additional information:
(1) Includes shares which the individual or group named in the table had the right to acquire, on or
before March 11, 2007, through the exercise of stock options pursuant to the Long-Term
Incentive Plan as follows: Phillip R. Cox – 3,000; James W. Griffith – 421,500; Jerry J.
Jasinowski – 6,000; John A. Luke, Jr. – 18,000; Robert W. Mahoney – 18,000; Joseph W.
Ralston – 9,000; Frank C. Sullivan – 6,000; John M. Timken, Jr. – 9,000; Ward J. Timken –
45,500; Ward J. Timken, Jr. – 123,250; Joseph F. Toot, Jr. – 68,000; Jacqueline F. Woods –
18,000. Also includes 3,500 deferred shares for Phillip R. Cox; 3,500 deferred shares for Jerry J.
Jasinowski; 4,500 deferred shares for Joseph W. Ralston; 5,000 deferred shares for Jacqueline
Woods; and 800 vested deferred restricted shares for Phillip Cox; 800 vested deferred restricted
shares for Jerry Jasinowski; and 1,200 vested deferred restricted shares for Frank Sullivan
awarded as annual grants under the Long-Term Incentive Plan, which will not be issued until a
later date under The Director Deferred Compensation Plan. Also includes 20,000 vested deferred
restricted shares held by James W. Griffith and deferred under the 1996 Deferred Compensation
Plan. The shares described in this footnote (1) have been treated as outstanding for the purpose of
calculating the percentage of the class beneficially owned by such individual or group, but not for
the purpose of calculating the percentage of the class owned by any other person.
(2) Does not include unvested deferred restricted shares held by the following individuals: Phillip R.
Cox – 1,200; Jerry J. Jasinowski – 1,200; and Frank C. Sullivan – 800.
(3) Includes 197,886 shares for which John M. Timken, Jr. has sole voting and investment power as
trustee of three trusts created as the result of distributions from the estate of Susan H. Timken.
(4) Includes shares for which another individual named in the table is also deemed to be the
beneficial owner, as follows: John M. Timken, Jr. – 517,500; Ward J. Timken – 5,818,444; Ward
J. Timken, Jr. – 5,300,944.
Director Compensation
Cash Compensation. Each nonemployee Director who served in 2006 was paid at the annual rate of
$60,000 for services as a Director. The chairperson of the Audit Committee receives $30,000 annually
in addition to base director compensation, and other members of the Audit Committee receive an
additional $15,000 annually for serving on the Audit Committee. The chairperson of the
Compensation Committee, the Nominating and Corporate Governance Committee and the Finance
Committee each receive $15,000 annually in addition to the base director compensation, and the other
members of the Compensation Committee, the Nominating and Corporate Governance Committee
and the Finance Committee receive an additional $7,500 annually for serving on each Committee.
Stock Compensation. Each nonemployee Director serving at the time of the annual meeting of
shareholders on April 18, 2006, received a grant of 2,500 shares of common stock under The Timken
Company Long-Term Incentive Plan, as amended and restated (the "Long-Term Incentive Plan"),
following the meeting. The shares received are required to be held by each nonemployee Director
until his or her departure from the Board of Directors. Upon a Director’s initial election to the Board,
each new nonemployee Director receives a grant of 2,000 restricted shares of common stock under the
Long-Term Incentive Plan, which vest over a five-year period. John P. Reilly received such a grant
upon his election on July 10, 2006.
Compensation Deferral. Any Director may elect to defer the receipt of all or a specified portion of his
or her cash and/or stock compensation in accordance with the provisions of The Director Deferred
Compensation Plan adopted by the Board on February 4, 2000. Pursuant to the plan, cash fees can be
deferred into a notional account and paid at a future date requested by the Director. The account will
be adjusted through investment crediting options, which include interest earned quarterly at a rate
based on the prime rate plus one percent or the total shareholder return of the Company’s common
68
stock, with amounts paid either in a lump sum or in installments in cash. Stock compensation can be
deferred to a future date and paid either in a lump sum or installments and is payable in shares plus a
cash amount representing dividend equivalents during the deferral period.
The following table provides details of the nonemployee Directors’ compensation in 2006:
Name
(1)
Phillip R. Cox
Jerry J. Jasinowski
John A. Luke, Jr.
Robert W. Mahoney
Joseph W. Ralston
John P. Reilly
Frank C. Sullivan
John M. Timken, Jr.
Ward J. Timken
Joseph F. Toot, Jr.
Jacqueline F. Woods
Fees earned or
paid in cash
$86,250
$75,000
$82,500
$90,000
$82,500
$34,238
$91,875
$76,875
$60,000
$67,500
$75,000
Stock awards
(2) (3)
$104,281
$103,923
$ 94,305
$ 94,305
$101,273
$ 5,550
$101,105
$ 94,305
$ 94,305
$ 94,305
$ 94,305
All other
compensation
$49,300(4)
Total
$190,531
$178,923
$176,805
$184,305
$183,773
$ 39,788
$192,980
$171,180
$154,305
$211,105
$169,305
(1) Ward J. Timken, Jr., Chairman of the Board of Directors, and James W. Griffith, President and
Chief Executive Officer, are not included in this table as they are employees of the Company and
receive no compensation for their services as Directors.
(2) The entire award of 2,500 shares of common stock on April 18, 2006, vested upon grant and
expense under FAS 123R was immediately recognized upon grant amounting to $85,825 for each
Director other than Mr. Reilly, who was not a Director on the date of grant.
(3) Each nonemployee Director also received a one-time grant of 3,000 non-qualified stock options
on April 19, 2005, that vested in one year, valued at $25,440 based on its Black-Scholes value
derived at the time of grant, other than Mr. Reilly, who was not a Director on the date of grant.
The expense recognized under FAS 123R for that stock option grant for 2006 is $8,480. The
remaining amounts shown in the table above are the expense recognized under FAS 123R for
2006 from the one-time grant of 2,000 restricted shares received by each Director upon joining
the Board. Those amounts are as follows: Mr. Cox – $9,976; Mr. Jasinowski – $9,618; Mr.
Ralston – $6,968; Mr. Reilly – $5,550; and Mr. Sullivan – $6,800.
As at December 31, 2006, each nonemployee Director has the following number of options
outstanding from grants in prior years: Mr. Cox – 3,000; Mr. Jasinowski – 6,000; Mr. Luke –
18,000; Mr. Mahoney – 18,000; Mr. Ralston – 9,000; Mr. Reilly – 0; Mr. Sullivan – 6,000; John
M. Timken, Jr. – 9,000; Ward J. Timken – 45,500; Mr. Toot – 68,000; Mrs. Woods – 18,000.
Totals for Ward J. Timken and Mr. Toot include outstanding option grants awarded when they
were employees of the Company.
The following Directors have unvested shares remaining from his or her grant of 2,000 restricted
shares upon his or her initial election to the Board: Mr. Cox – 1,200; Mr. Jasinowski – 1,200; Mr.
Ralston – 800; Mr. Reilly – 2,000; and Mr. Sullivan – 800.
(4) As a former chief executive officer of the Company, Mr. Toot is provided an office,
administrative support and home security system monitoring. These items are valued at the
69
Company’s cost, and the office and administrative support constitute approximately 99% of the
total value.
Employee Directors' Summary Compensation Table
The following table sets forth information concerning compensation for the Company’s employee
Directors, Mr. James W. Griffith (Chief Executive Officer), and Mr. Ward J. Timken, Jr. (Chairman
of the Board), during the year ended December 31, 2006. Footnotes and additional information can be
found below.
Name and principal
position
Salary
Stock
awards
Option
awards
(1)
(2)
Non-Equity
Incentive
Plan compensation
(3)
Change in
pension value
and nonqualified
deferred
compensation
earnings
All other
compensation
Total
(4)
James W. Griffith,
President and
Chief Executive
Officer
$950,000
$798,103
$1,068,120
$2,300,000
$1,414,000
$124,044
$6,654,267
Ward J. Timken,
Jr., Chairman of
the Board of
Directors
$750,000
$311,847
$398,519
$1,182,000
$314,000
$137,630
$3,093,996
(1) The amounts shown in this column represent the FAS123R compensation expense recognized in
2006 in connection with grants of deferred dividend equivalents, restricted shares and deferred
shares to the named executive officers, excluding the effect of certain forfeiture assumptions.
These amounts represent expense recognized in 2006 for financial reporting purposes related to
awards granted from 2002–2006.
Awards of restricted and deferred shares typically vest and are amortized over a four-year period.
Options granted by the Company prior to April 2002 provided for deferred dividend equivalents
to be earned when total net income per share of the outstanding common stock is at least two and
one-half times (or two times in the case of options granted prior to 1996) the total amount of cash
dividends paid per share during the relevant calendar year. Deferred dividend equivalents are not
traditional restricted stock, but deferred shares with no voting or statutory dividend rights. The
deferred shares are subject to forfeiture until issuance, which occurs four years after the date they
are earned provided the grantee remains continuously employed by the Company. These grants
are amortized over a four-year period.
The amount shown for Mr. Griffith includes expense booked in 2006 for 8,439 deferred dividend
equivalents granted in 2004 and 2005 and 150,000 restricted shares granted from 2002 to 2006.
The amount shown for Mr. Timken includes expense for 1,477 deferred dividend equivalents and
54,000 restricted shares.
FAS 123R compensation expense is determined based on the fair market value of common stock,
which is the average of the high and low price of the common stock on the date of the grant.
Dividends are paid on restricted shares at the same rate as paid to all shareholders.
(2) The amounts shown in this column represent the FAS 123R compensation expense for nonqualified stock options granted from 2004 to 2006, excluding the effect of certain forfeiture
70
assumptions. Stock options vest at a rate of 25% per year. Options granted prior to 2006 were
amortized over a period of 30 months. Beginning in 2006, all new grants are amortized over a
four year period for FAS 123R. The value shown for Mr. Griffith includes expense for the
unamortized portion of 402,000 shares granted from 2004 to 2006. The value shown for Mr.
Timken includes expense for 165,000 aggregate shares.
(3) The amounts shown in this column represent cash awards under (i) the Senior Executive
Management Performance Plan (annual incentive plan) for 2006, and (ii) performance units
under the Long-Term Incentive Plan covering the 2004-2006 performance cycle. Amounts
earned under the Senior Executive Management Performance Plan and performance units,
respectively, for each of the named executive officers was as follows: Mr. Griffith – $950,000
and $1,350,000; Mr. Timken – $750,000 and $432,000.
(4) The amounts shown in this column are derived as follows:
Mr. James W. Griffith:
$9,900 annual contribution by the Company to the Savings and Investment Pension Plan ("SIP Plan").
$97,875 annual contribution by the Company to the Post-Tax Savings Plan.
$2,308 reimbursement by the Company for financial planning expenses. The maximum annual
allowance is $10,000.
$458 related to charges for home security monitoring fees which the Company requires.
$6,904 annual life insurance premium paid by the Company.
$3,604 in tax gross ups related to financial planning allowance and spousal travel.
$2,027 related to reimbursement for spousal travel.
$968 related to personal use of the Company plane.
Mr. Ward J. Timken, Jr.:
$9,900 annual contribution by the Company to the SIP Plan.
$89,250 annual contribution by the Company to the Post-Tax Savings Plan.
$6,600 annual contribution by the Company to the core defined contribution retirement income
program.
$9,940 reimbursement by the Company for financial planning expenses. The maximum annual
allowance is $10,000.
$1,957 for reimbursement of expenses related to a Company mandated annual physical.
$379 related to charges for home security monitoring fees which the Company requires.
$6,568 annual life insurance premium paid by the Company.
$5,423 in tax gross ups related to financial planning allowance and spousal travel.
$7,058 related to reimbursement for spousal travel.
$555 in country club related fees reimbursed by the Company.
Termination Benefits for Employee Directors
Should Mr. James W. Griffith's and/or Mr. Ward J. Timken, Jr.'s employment with the Company
terminate, they will each receive a termination benefit in the amount of one week of their base salary
for each past year of service for the Company in accordance with the applicable Timken policy in
place for all associates (i.e., no specific rules apply for employee directors).
In addition, the Company has entered into change-in-control severance agreements with certain of its
executives. Under these agreements, when certain events occur, such as a reduction in the individual’s
responsibilities or termination of the individual’s employment, following a change in control of the
Company (as defined in the agreements), Mr. James W. Griffith and Mr. Ward J. Timken, Jr. would
be entitled to receive payment in an amount, grossed up for any excise taxes payable by the
individual, equal to three times the individual’s annual base salary and highest annual incentive
compensation during the past three years plus a lump sum amount representing a supplemental
pension benefit. The individual would also receive certain benefits under the SIP Plan and the Post-
71
Tax SIP Plan. The severance agreements also permit the individual to resign for any reason or without
a reason during the 30-day period immediately following the first anniversary of the first occurrence
of a change in control and receive the severance benefits. The amounts payable under these severance
agreements are secured by a trust arrangement.
4. Stock Options Granted to Employees
Under the Company’s stock option plans, shares of common stock have been made available to grant
at the discretion of the Compensation Committee (described below) to officers and key associates in
the form of stock options, stock appreciation rights, performance shares, performance units, restricted
shares and deferred shares. The options generally have a ten-year term and vest in 25% increments
annually beginning twelve months after the date of grant for associates and vest 100% twelve months
after the date of grant for Directors. The value of each type of long-term incentive grant is linked
directly to the performance of the Company or the price of common stock.
The Company offers a performance unit component to certain other, mostly executive, associates
under its Long-Term Incentive Plan. According to the rules of this plan, certain grants of performance
units are earned based on Company performance measured by several metrics over a three-year
performance period. The Compensation Committee can elect to make payments that become due in
the form of cash or shares of the Company's common stock.
For additional details, please see the description included in the financial statements for the fiscal year
ended December 31, 2006 (Notes to Consolidated Financial Statements, Section 9), pages 137 et seq.,
below.
5. Other Stock Purchase Plans for Timken Associates
In conjunction with the Company's global efforts to retain a productive workforce, the Company also
sponsors other equity compensation plans for its associates in the United States and in other countries.
These plans provide associates with the opportunity to purchase Company Stock and are similar in
form to TISOP.
6. Accrued Pension Benefits
As at December 31, 2006, the total amounts set aside by Timken in the balance sheet are $410.4
million for accrued pension cost and $682.9 million for accrued postretirement benefits cost.
7. Other Major Shareholders
The following table gives information known to the Company about each beneficial owner of more
than 5% of common stock of the Company:
72
Number of shares
Percentage of common
15
stock outstanding
Members of the Timken family (1)
11,386,896
12%
Participants in The Timken Company
Savings and Investment Pension Plan (2)
8,064,521
8.6%
Lord, Abbett & Co. LLC (3)
7,379,701
7.8%
5,361,728
5.7%
5,103,476
5.4%
Beneficial owner
Earnest Partners LLC
(4)
Barclays Global Investors, N.A. (5)
(1) Members of the Timken family, including John M. Timken, Jr.; Ward J. Timken; and Ward J.
Timken, Jr., have in the aggregate sole or shared voting power with respect to at least an
aggregate of 11,386,896 shares (12%) of common stock, which amount includes 538,750 shares
that members of the Timken family had the right to acquire on or before March 11, 2007. The
Timken Foundation of Canton, 200 Market Avenue, North, Suite 201, Canton, Ohio 44702,
holds 5,247,944 of these shares, representing 5.6% of the outstanding common stock. Ward J.
Timken; Joy A. Timken; Ward J. Timken, Jr.; and Nancy S. Knudsen are trustees of the
Foundation and share the voting and investment power with respect to such shares.
(2) Trustee of the plan is J. P. Morgan Retirement Plan Services LLC, P.O. Box 419784, Kansas
City, MO 64179-0654.
(3) A filing with the Securities and Exchange Commission dated February 12, 2007, by Lord, Abbett
& Co. LLC, 90 Hudson Street, Jersey City, New Jersey 07302, indicated that it has voting or
investment power over 7,379,701 shares (7.8%) of the Company’s outstanding common stock.
(4) A filing with the Securities and Exchange Commission dated February 14, 2007, by Earnest
Partners LLC, 1180 Peachtree Street, Atlanta, Georgia 30309, indicated that it has or shares
voting or investment power over 5,361,728 shares (5.7%) of the Company’s outstanding
common stock.
(5) A filing with the Securities and Exchange Commission dated January 31, 2007, by Barclays
Global Investors, N.A., 45 Fremont Street, San Francisco, California 94105, indicated that it has
or shares voting or investment power over 5,103,476 shares (5.4%) of the Company’s
outstanding common stock.
The shares of Company Stock held by any of these shareholders do not grant different voting rights
(see the description of the shares, Section VII. 1., above).
15
As at January 10, 2007.
73
8. Committees
Besides the Excecutive Committee of the Board (see above), the Board of Directors has instituted
other committees, including the Audit, Finance, Compensation, and Nominating and Corporate
Governance Committees.
Audit Committee
The Company has a standing Audit Committee of the Board of Directors, established in accordance
with the requirements of the US Securities Exchange Act of 1934. The Audit Committee has
oversight responsibility with respect to the Company’s independent auditors and the integrity of the
Company’s financial statements. The Audit Committee is composed of Frank C. Sullivan (Chairman),
Phillip R. Cox, Robert W. Mahoney, John P. Reilly, and John M. Timken, Jr. All members of the
Audit Committee are independent as defined in the listing standards of the New York Stock
Exchange. The Board of Directors of the Company has determined that the Company has at least one
audit committee financial expert serving on the Audit Committee, and has designated Frank C.
Sullivan as that expert.
Finance Committee
The Company has a standing Finance Committee. The Committee advises and consults with the
management and the Board of Directors regarding capital structure, dividend and investment policies
and other financial matters affecting the Company. Members of the Finance Committee are Phillip R.
Cox (Chairman), Frank C. Sullivan, John M. Timken, Jr. and Joseph F. Toot, Jr. All members of the
Finance Committee are independent as defined in the listing standards of the New York Stock
Exchange.
Compensation Committee
The Company has a standing Compensation Committee. The Compensation Committee establishes
and administers the Company’s policies, programs and procedures for compensating its senior
management and Board of Directors. Members of the Compensation Committee are John A. Luke, Jr.
(Chairman), Phillip R. Cox, Jerry J. Jasinowski, Joseph W. Ralston, John P. Reilly, and Jacqueline F.
Woods. All members of the Compensation Committee are independent as defined in the listing
standards of the New York Stock Exchange.
The Company, with the guidance and approval of the Compensation Committee of the Board of
Directors, has developed compensation programs for executive officers, including the Chief Executive
Officer, that are intended to provide a total compensation package that enables the Company to
attract, retain and motivate superior quality executive management, that reflects competitive market
practices based on comparative data from a relevant peer group of companies, and that links the
financial interests of executive management with those of shareholders, through short and long-term
incentive plans clearly tied to corporate, business unit and individual performance. The Compensation
Committee determines specific compensation elements for the Chief Executive Officer and considers
and acts upon recommendations made by the Chief Executive Officer regarding the other executive
officers.
The Compensation Committee has engaged Towers Perrin, a global professional services firm, to
conduct annual reviews of its total compensation programs for executive officers and from time-totime to review the total compensation of Directors. Towers Perrin also provides information to the
Compensation Committee on trends in executive compensation and other market data.
74
Nominating and Corporate Governance Committee
The Company has a standing Nominating and Corporate Governance Committee. The Nominating
and Corporate Governance Committee is responsible for, among other things, evaluating new Director
candidates and incumbent Directors, and recommending Directors to serve as members of the Board
Committees. Members of the Nominating and Corporate Governance Committee are Robert W.
Mahoney (Chairman), Jerry J. Jasinowski, John A. Luke, Jr., Joseph W. Ralston, Joseph F. Toot, Jr.,
and Jacqueline F. Woods. All members of the Committee are independent as defined in the listing
standards of the New York Stock Exchange.
Director candidates can be recommended by shareholders. In order for a shareholder to submit a
recommendation, the shareholder must deliver a communication by registered mail or in person to the
Nominating and Corporate Governance Committee, c/o The Timken Company, 1835 Dueber Avenue,
S.W., P.O. Box 6932, Canton, Ohio 44706-0932. Such communication should include the proposed
candidate’s qualifications, any relationship between the shareholder and the proposed candidate and
any other information that the shareholder would consider useful for the Nominating and Corporate
Governance Committee to consider in evaluating such candidate.
The general policies and procedures of the Board of Directors provide that general criteria for director
candidates include, but are not limited to, the highest integrity and ethical standards, the ability to
provide wise and informed guidance to management, a willingness to pursue thoughtful, objective
inquiry on important issues before the Company, and a range of experience and knowledge
commensurate with the Company’s needs as well as the expectations of knowledgeable investors. The
Nominating and Corporate Governance Committee is responsible for reviewing the qualifications of,
and making recommendations to the Board of Directors for director nominations submitted by
shareholders. All director nominees are evaluated in the same manner by the Nominating and
Corporate Governance Committee, without regard to the source of the nominee recommendation.
The Company’s code of business conduct and ethics called the "Standards of Business Ethics Policy"
and its corporate governance guidelines called the "Board of Directors General Policies and
Procedures" are reviewed annually by the Nominating and Corporate Governance Committee.
9. Compliance with Corporate Governance Standards
The Company complies with the corporate governance standards of the New York Stock Exchange.
75
IX.
FINANCIAL INFORMATION
1. Consolidated Financial Statements
The following part of this prospectus shows the audited annual consolidated financial statements
contained in the Company's Annual Reports to the shareholders for the fiscal years ending December
31, 2006, 2005 and 2004, respectively. The historical financial information such presented below
includes a description of the financial condition of the Company, its capital resources and
indebtedness and the consolidated financial statements, consisting of the consolidated balance sheet,
statement of income, statement of shareholders' equity, statement of cash flows and the notes to
consolidated financial statements for the period covering the Company's last three fiscal years.
The Company’s consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States.
2. Auditors
Ernst & Young LLP, 1300 Huntington Building, 925 Euclid Ave., Cleveland, Ohio 44115-1476,
USA, are certified public accountants and have audited the accounts of The Timken Company,
without qualification, in accordance with the standards of the Public Company Accounting Oversight
Board of the United States, for the financial periods ending December 31, 2006, 2005 and 2004,
respectively.
76
3. Annual Report to the Shareholders for the Fiscal Year Ended December 31, 2006
Introductory Note
The Annual Report to the shareholders for the Company's fiscal year ended December 31, 2006 (the
"2006 Annual Report") includes, as an integrated report, the annual report that was prepared on Form
10-K under the US Securities Exchange Act of 1934, and that was filed with the US Securities and
Exchange Commission on February 28, 2007. The following excerpts are extracted without
adjustment from the 2006 Annual Report. Since these excerpts contain text references to page
numbers in the 2006 Annual Report, the following pages also show the original page numbers printed
in the 2006 Annual Report in addition to the consecutive paging placed at the bottom right of each
page of this prospectus.
To facilitate the reader's access to the Company's 2006 Annual Report, the following selected items of
the 2006 Annual Report are referenced hereunder with their designated locations (pages):
Table of Contents
See page 78 of this prospectus.
Page 120.
Consolidated Balance Sheet
Page 121.
Page 122.
Consolidated Statement of Shareholders' Equity
Pages 123 et seq.
Notes to Consolidated Financial Statements
Pages 125 et seq.
Auditors' Reports
Pages 151 and 153.
77
THE TIMKEN COMPANY
INDEX TO FORM 10-K REPORT
PAGE
I.
PART I.
Item 1.
II.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Item 4A.
PART II.
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
III.
Item 9A.
Item 9B.
Part III.
Item 10.
Item 11.
Item 12.
Item 13.
IV.
Item 14.
Part IV.
Item 15.
Business
General
Products
Industry Segments
Competition
Joint Ventures
Backlog
Raw Materials
Research
Employment
Available Information
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Submission of Matters to a Vote of Security Holders
Executive Officers of the Registrant
Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial
Condition and Results of Operations
Quantitative and Qualitative Disclosures about Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
Controls and Procedures
Other Information
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Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and
Director Independence
Principal Accountant Fees and Services
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Exhibits and Financial Statement Schedules
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PART I.
Item 1. Business
General
As used herein, the term “Timken” or the “company” refers to The Timken Company and its subsidiaries unless the context
otherwise requires. Timken, an outgrowth of a business originally founded in 1899, was incorporated under the laws of the state of
Ohio in 1904.
Timken is a leading global manufacturer of highly engineered bearings, alloy and specialty steel and related components. The
company is the world’s largest manufacturer of tapered roller bearings and alloy seamless mechanical steel tubing and the largest
North American-based bearings manufacturer. Timken had facilities in 27 countries on six continents and employed approximately
25,000 people as of December 31, 2006.
Products
The Timken Company manufactures two basic product lines: anti-friction bearings and steel products. Differentiation in these two
product lines comes in two different ways: (1) differentiation by bearing type or steel type, and (2) differentiation in the applications
of bearings and steel.
Tapered Roller Bearings. In the bearing industry, Timken is best known for the tapered roller bearing, which was originally
patented by the company founder, Henry Timken. The tapered roller bearing is Timken’s principal product in the anti-friction
industry segment. It consists of four components: (1) the cone or inner race, (2) the cup or outer race, (3) the tapered rollers,
which roll between the cup and cone, and (4) the cage, which serves as a retainer and maintains proper spacing between the
rollers. Timken manufactures or purchases these four components and then sells them in a wide variety of configurations and
sizes.
The tapered rollers permit ready absorption of both radial and axial load combinations. For this reason, tapered roller bearings are
particularly well-adapted to reducing friction where shafts, gears or wheels are used. The uses for tapered roller bearings are
diverse and include applications on passenger cars, light and heavy trucks and trains, as well as a wide variety of industrial
applications, ranging from very small gear drives to bearings over two meters in diameter for wind energy machines. A number of
applications utilize bearings with sensors to measure parameters such as speed, load, temperature or overall bearing condition.
Matching bearings to the specific requirements of customers’ applications requires engineering and often sophisticated analytical
techniques. The design of Timken’s tapered roller bearing permits distribution of unit pressures over the full length of the roller.
This design, combined with high precision tolerances, proprietary internal geometry and premium quality material, provides
Timken bearings with high load-carrying capacity, excellent friction-reducing qualities and long life.
Precision Cylindrical and Ball Bearings. Timken’s aerospace and super precision facilities produce high-performance ball and
cylindrical bearings for ultra high-speed and/or high-accuracy applications in the aerospace, medical and dental, computer and
other industries. These bearings utilize ball and straight rolling elements and are in the super precision end of the general ball and
straight roller bearing product range in the bearing industry. A majority of Timken’s aerospace and super precision bearings
products are custom-designed bearings and spindle assemblies. They often involve specialized materials and coatings for use in
applications that subject the bearings to extreme operating conditions of speed and temperature.
Spherical and Cylindrical Bearings. Timken produces spherical and cylindrical roller bearings for large gear drives, rolling mills
and other process industry and infrastructure development applications. Timken’s cylindrical and spherical roller bearing capability
was significantly enhanced with the acquisition of Torrington’s broad range of spherical and heavy-duty cylindrical roller bearings
for standard industrial and specialized applications. These products are sold worldwide to original equipment manufacturers and
industrial distributors serving major industries, including construction and mining, natural resources, defense, pulp and paper
production, rolling mills and general industrial goods.
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Needle Bearings. With the acquisition of the Engineered Solutions business of Ingersol-Rand Company Limited (referred to as
“Torrington”) in February 2003, the company became a leading global manufacturer of highly engineered needle roller bearings.
Timken produces a broad range of radial and thrust needle roller bearings, as well as bearing assemblies, which are sold to
original equipment manufacturers and industrial distributors worldwide. Major applications include automotive, consumer,
construction, agriculture and general industrial.
Bearing Reconditioning. A small part of the business involves providing bearing reconditioning services for industrial and
railroad customers, both internationally and domestically. These services accounted for less than 5% of the company’s net sales
for the year ended December 31, 2006.
Aerospace Aftermarket Products and Services. Through strategic acquisitions and ongoing product development, Timken
continues to expand its portfolio of replacement parts and services for the aerospace aftermarket, where they are used in both civil
and military aircraft. In addition to a wide variety of power transmission and drive train components and modules, Timken supplies
comprehensive maintenance, repair and overhaul services for gas turbine engines, gearboxes and accessory systems in rotaryand fixed-wing aircraft. Specific parts in addition to bearings include airfoils (such as blades, vanes, rotors and diffusers), nozzles,
gears, and oil coolers. Services range from aerospace bearing repair and component reconditioning to the complete overhaul of
engines, transmissions and fuel controls.
Steel. Steel products include steels of low and intermediate alloy, as well as some carbon grades. These products are available in
a wide range of solid and tubular sections with a variety of lengths and finishes. These steel products are used in a wide array of
applications, including bearings, automotive transmissions, engine crankshafts, oil drilling components, aerospace parts and other
similarly demanding applications.
Timken also produces custom-made steel products, including steel components for automotive and industrial customers. This
steel components business has provided the company with the opportunity to further expand its market for tubing and capture
higher value-added steel sales. It also enables Timken’s traditional tubing customers in the automotive and bearing industries to
take advantage of higher-performing components that cost less than current alternative products. Customizing of products is an
important portion of the company’s steel business.
Geographic Financial Information
(Dollars in thousands)
United States
Europe
Other Countries
Consolidated
2006
Net sales
Non-current assets
$3,370,244
1,578,856
$849,915
285,840
$753,206
266,557
$4,973,365
2,131,253
2005
Net sales
Non-current assets
$3,295,171
1,413,575
$812,960
337,657
$715,036
177,988
$4,823,167
1,929,220
2004
Net sales
Non-current assets
$2,900,749
1,399,155
$779,478
398,925
$606,970
221,112
$4,287,197
2,019,192
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Industry Segments
The company has three reportable segments: Industrial Group, Automotive Group and Steel Group. Financial information for the
segments is discussed in Note 14 to the Consolidated Financial Statements.
Description of types of products and services from which each reportable segment derives its revenues
The company’s reportable segments are business units that target different industry segments or types of product. Each
reportable segment is managed separately because of the need to specifically address customer needs in these different
industries.
The Automotive Group includes sales of bearings and other products and services (other than steel) to automotive original
equipment manufacturers, or OEMs, for passenger cars, trucks and trailers. The Industrial Group includes sales of bearings and
other products and services (other than steel) to a diverse customer base, including industrial equipment, off-highway, rail and
aerospace and defense customers. The Industrial Group also includes aftermarket distribution operations, including automotive
applications, for products other than steel. The company’s bearing products are used in a variety of products and applications,
including passenger cars, trucks, locomotive and railroad cars, machine tools, rolling mills and farm and construction equipment,
aircraft, missile guidance systems, computer peripherals and medical instruments.
The Steel Group includes sales of low and intermediate alloy and carbon grade steel. These are available in a wide range of solid
and tubular sections with a variety of lengths and finishes. The company also manufactures custom-made steel products,
including precision steel components. Approximately 10% of the company’s steel is consumed in its bearing operations. In
addition, sales are made to other anti-friction bearing companies and to the automotive and truck, forging, construction, industrial
equipment, oil and gas drilling and aircraft industries and to steel service centers. In 2006, the company sold its Latrobe Steel
subsidiary. This business was part of the Steel Group for segment reporting purposes. This business has been treated as
discontinued operations for all periods presented.
Measurement of segment profit or loss and segment assets
The company evaluates performance and allocates resources based on return on capital and profitable growth. The primary
measurement used by management to measure the financial performance of each segment is adjusted EBIT (earnings before
interest and taxes, excluding special items such as impairment and restructuring charges, rationalization and integration costs,
one-time gains or losses on sales of assets, allocated receipts received or payments made under the Continued Dumping and
Subsidy Offset Act (CDSOA), loss on dissolution of subsidiary, acquisition-related currency exchange gains, and other items
similar in nature). The accounting policies of the reportable segments are the same as those described in the summary of
significant accounting policies. Intersegment sales and transfers are recorded at values based on market prices, which creates
intercompany profit on intersegment sales or transfers that is eliminated in consolidation.
Factors used by management to identify the enterprise’s reportable segments
The company reports net sales by geographic area in a manner that is more reflective of how the company operates its segments,
which is by the destination of net sales. Non-current assets by geographic area are reported by the location of the subsidiary.
Export sales from the U.S. and Canada are less than 10% of revenue. The company’s Automotive and Industrial Groups have
historically participated in the global bearing industry, while the Steel Group has concentrated primarily on U.S. customers.
Timken’s non-U.S. operations are subject to normal international business risks not generally applicable to domestic business.
These risks include currency fluctuation, changes in tariff restrictions, difficulties in establishing and maintaining relationships with
local distributors and dealers, import and export licensing requirements, difficulties in staffing and managing geographically
diverse operations, and restrictive regulations by foreign governments, including price and exchange controls.
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Timken’s products in the Automotive Group and Industrial Group are sold principally by their own internal sales organizations. A
portion of the Industrial Group’s sales are made through authorized distributors.
Traditionally, a main focus of the company’s sales strategy has consisted of collaborative projects with customers. For this reason,
the company’s sales forces are primarily located in close proximity to its customers rather than at production sites. In some
instances, the sales forces are located inside customer facilities. The company’s sales force is highly trained and knowledgeable
regarding all bearings products, and associates assist customers during the development and implementation phases and provide
ongoing support.
The company has a joint venture in North America focused on joint logistics and e-business services. This alliance is called
CoLinx, LLC and was founded by Timken, SKF, INA and Rockwell Automation. The e-business service was launched in
April 2001 and is focused on information and business services for authorized distributors in the Industrial Group. The company
also has another e-business joint venture which focuses on information and business services for authorized industrial distributors
in Europe, Latin America and Asia. This alliance, which Timken founded with SKF, Sandvik AB, INA and Reliance, is called
Endorsia.com International AB.
Timken’s steel products are sold principally by its own sales organization. Most orders are customized to satisfy customer-specific
applications and are shipped directly to customers from Timken’s steel manufacturing plants. Approximately 10% of Timken’s
Steel Group net sales are intersegment sales. In addition, sales are made to other anti-friction bearing companies and to the
automotive and truck, forging, construction, industrial equipment, oil and gas drilling and aircraft industries and to steel service
centers.
Timken has entered into individually negotiated contracts with some of its customers in its Automotive Group, Industrial Group and
Steel Group. These contracts may extend for one or more years and, if a price is fixed for any period extending beyond current
shipments, customarily include a commitment by the customer to purchase a designated percentage of its requirements from
Timken. Contracts extending beyond one year that are not subject to price adjustment provisions do not represent a material
portion of Timken’s sales. Timken does not believe that there is any significant loss of earnings risk associated with any given
contract.
Competition
The anti-friction bearing business is highly competitive in every country in which Timken sells products. Timken competes
primarily based on price, quality, timeliness of delivery, product design and the ability to provide engineering support and service
on a global basis. The company competes with domestic manufacturers and many foreign manufacturers of anti-friction bearings,
including SKF, INA, NTN Corporation, Koyo Seiko Co., Ltd. and NSK Ltd.
Competition within the steel industry, both domestically and globally, is intense and is expected to remain so. However, the recent
combination of a weakened U.S. dollar, worldwide rationalization of uncompetitive capacity, raw material cost increases and North
American and global market strength have allowed steel industry prices to increase and margins to improve. Timken’s worldwide
competitors for steel bar products include North American producers such as Republic, Mac Steel, Mittal, Steel Dynamics, Nucor
and a wide variety of offshore steel producers who export into North America. Competitors for seamless mechanical tubing include
Dofasco, Plymouth Tube, Michigan Seamless Tube, V & M Tube, Sanyo Special Steel, Ovako and Tenaris. Competitors in the
precision steel components sector include Formtec, Linamar, Jernberg and overseas companies such as Tenaris, Ovako,
Stackpole and FormFlo.
Maintaining high standards of product quality and reliability while keeping production costs competitive is essential to Timken’s
ability to compete with domestic and foreign manufacturers in both the anti-friction bearing and steel businesses.
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The U.S. government has six antidumping duty orders in effect covering ball bearings from five countries and tapered roller
bearings from China. The five countries covered by the ball bearing orders are France, Germany, Italy, Japan and the United
Kingdom. The company is a producer of these products in the United States. The U.S. government determined in August 2006
that each of these six antidumping duty orders should remain in effect for an additional five years.
The CDSOA provides for distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic
producers where the domestic producers have continued to invest in their technology, equipment and people. The company
reported CDSOA receipts, net of expenses, of $87.9 million, $77.1 million and $44.4 million in 2006, 2005 and 2004, respectively.
The amount for 2004 was net of the amount that Timken delivered to the seller of the Torrington business, pursuant to the terms
of the agreement under which the company purchased Torrington. In 2004, Timken delivered to the seller of the Torrington
business 80% of the CDSOA payments received in 2004 for Torrington’s bearing business.
In September 2002, the World Trade Organization (WTO) ruled that CDSOA payments are not consistent with international trade
rules. In February 2006, U.S. legislation was enacted that would end CDSOA distributions for imports covered by antidumping
duty orders entering the U.S. after September 30, 2007. Instead, any such antidumping duties collected would remain with the
U.S. Treasury. This legislation is not expected to have a significant effect on potential CDSOA distributions in 2007, but would be
expected to reduce likely distributions in years beyond 2007, with distributions eventually ceasing.
In separate cases in July and September 2006, the U.S. Court of International Trade (CIT) ruled that the procedure for
determining recipients eligible to receive CDSOA distributions is unconstitutional. The CIT has not ruled on other matters,
including any remedy as a result of its ruling. The company expects that these rulings of the CIT will be appealed. The company is
unable to determine, at this time, if these rulings will have a material adverse impact on the company’s financial results.
In addition to the CIT rulings, there are a number of factors that can affect whether the company receives any CDSOA
distributions and the amount of such distributions in any year. These factors include, among other things, potential additional
changes in the law, ongoing and potential additional legal challenges to the law and the administrative operation of the law.
Accordingly, the company cannot reasonably estimate the amount of CDSOA distributions it will receive in future years, if any. If
the company does receive CDSOA distributions in 2007, they likely will be received in the fourth quarter.
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Joint Ventures
The balances related to investments accounted for under the equity method are reported in other non-current assets on the
Consolidated Balance Sheet, which were approximately $12.1 million and $19.9 million at December 31, 2006 and 2005,
respectively.
During 2002, the company’s Automotive Group formed a joint venture, Advanced Green Components, LLC (AGC), with Sanyo
Special Steel Co., Ltd. (Sanyo) and Showa Seiko Co., Ltd. (Showa). AGC is engaged in the business of converting steel to
machined rings for tapered bearings and other related products. The company had been accounting for its investment in AGC
under the equity method since AGC’s inception. During the third quarter of 2006, AGC refinanced its long-term debt of $12.2
million. The company guaranteed half of this obligation. The company concluded the refinancing represented a reconsideration
event to evaluate whether AGC was a variable interest entity under FASB Interpretation No. 46 (revised December 2003). The
company concluded that AGC was a variable interest entity and the company was the primary beneficiary. Therefore, the
company consolidated AGC, effective September 30, 2006. As of September 30, 2006, the net assets of AGC were $9.0 million,
primarily consisting of the following: inventory of $5.7 million; property, plant and equipment of $27.2 million; goodwill of $9.6
milion; short-term and long-term debt of $20.3 million; and other non-current liabilities of $7.4 million. The $9.6 million of goodwill
was subsequently written-off as part of the annual test for impairment in accordance with Statement of Financial Accounting
Standards No. 142. All of AGC’s assets are collateral for its obligations. Except for AGC’s indebtedness for which the company is
a guarantor, AGC’s creditors have no recourse to the assets of the company.
Backlog
The backlog of orders of Timken’s domestic and overseas operations is estimated to have been $1.96 billion at December 31,
2006 and $1.98 billion at December 31, 2005. Actual shipments are dependent upon ever-changing production schedules of the
customer. Accordingly, Timken does not believe that its backlog data and comparisons thereof, as of different dates, are reliable
indicators of future sales or shipments.
Raw Materials
The principal raw materials used by Timken in its North American bearing plants to manufacture bearings are its own steel tubing
and bars, purchased strip steel and energy resources. Outside North America, the company purchases raw materials from local
sources with whom it has worked closely to ensure steel quality, according to its demanding specifications.
The principal raw materials used by Timken in steel manufacturing are scrap metal, nickel and other alloys. The availability and
prices of raw materials and energy resources are subject to curtailment or change due to, among other things, new laws or
regulations, changes in demand levels, suppliers’ allocations to other purchasers, interruptions in production by suppliers,
changes in exchange rates and prevailing price levels. For example, the weighted average price of scrap metal increased 87.1%
from 2003 to 2004, decreased 7.7% from 2004 to 2005 and increased 7.9% from 2005 to 2006. Prices for raw materials and
energy resources continue to remain high compared to historical levels.
The company continues to expect that it will be able to pass a significant portion of these increased costs through to customers in
the form of price increases or raw material surcharges.
Disruptions in the supply of raw materials or energy resources could temporarily impair the company’s ability to manufacture its
products for its customers or require the company to pay higher prices in order to obtain these raw materials or energy resources
from other sources, which could affect the company’s sales and profitability. Any increase in the prices for such raw materials or
energy resources could materially affect the company’s costs and its earnings.
Timken believes that the availability of raw materials and alloys is adequate for its needs, and, in general, it is not dependent on
any single source of supply.
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Research
Timken has developed a significant global footprint of technology centers.
The company operates four corporate innovation and development centers. The largest technical center is located in North
Canton, Ohio, near Timken’s world headquarters, and it supports innovation and know-how for friction management product lines,
such as tapered roller bearings and needle bearings. In 2006, Timken opened a new technical center in Greenville, South
Carolina, to support innovation and know–how for power transmission product lines. The company also supports related technical
capabilities with facilities in Bangalore, India and Brno, Czech Republic.
In addition, Timken’s business groups operate several technology centers for product excellence within the United States in Mesa,
Arizona, and Keene and Lebanon, New Hampshire. Within Europe, technology is developed in Ploiesti, Romania; Colmar, France;
and Halle-Westfallen, Germany.
The company’s technology commitment is to develop new and improved friction management and power transmission product
designs, such as tapered roller bearings and needle bearings, with a heavy influence in related steel materials and lean
manufacturing processes.
Expenditures for research, development and application amounted to approximately $67.9 million, $60.1 million, and $56.7 million
in 2006, 2005 and 2004, respectively. Of these amounts, $8.0 million, $7.2 million and $6.7 million, respectively, were funded by
others.
The company continues its efforts to protect the environment and comply with environmental protection laws. Additionally, it has
invested in pollution control equipment and updated plant operational practices. The company is committed to implementing a
documented environmental management system worldwide and to becoming certified under the ISO 14001 standard where
appropriate to meet or exceed customer requirements. By the end of 2006, 30 of the company’s plants had obtained ISO 14001
certification.
The company believes it has established adequate reserves to cover its environmental expenses and has a well-established
environmental compliance audit program, which includes a proactive approach to bringing its domestic and international units to
higher standards of environmental performance. This program measures performance against applicable laws, as well as
standards that have been established for all units worldwide. It is difficult to assess the possible effect of compliance with future
requirements that differ from existing ones. As previously reported, the company is unsure of the future financial impact to the
company that could result from the United States Environmental Protection Agency’s (EPA’s) final rules to tighten the National
Ambient Air Quality Standards for fine particulate and ozone. The company is also unsure of potential future financial impacts to
the company that could result from possible future legislation regulating emissions of greenhouse gases.
The company and certain U.S. subsidiaries have been designated as potentially responsible parties by the EPA for site
investigation and remediation at certain sites under the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA), known as the Superfund, or state laws similar to CERCLA. The claims for remediation have been asserted against
numerous other entities, which are believed to be financially solvent and are expected to fulfill their proportionate share of the
obligation.
Management believes any ultimate liability with respect to pending actions will not materially affect the company’s operations,
cash flows or consolidated financial position. The company is also conducting voluntary environmental investigations and/or
remediations at a number of current or former operating sites. Any liability with respect to such investigations and remediations, in
the aggregate, is not expected to be material to the operations or financial position of the company.
New laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown
contamination or the imposition of new clean-up requirements may require the company to incur costs or become the basis for
new or increased liabilities that could have a material adverse effect on Timken’s business, financial condition or results of
operations.
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Timken owns a number of U.S. and foreign patents, trademarks and licenses relating to certain products. While Timken regards
these as important, it does not deem its business as a whole, or any industry segment, to be materially dependent upon any one
item or group of items.
Employment
At December 31, 2006, Timken had 25,418 associates. Approximately 17% of Timken’s U.S. associates are covered under
collective bargaining agreements.
Timken’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available, free of charge,
on Timken’s website at www.timken.com as soon as reasonably practical after electronically filing or furnishing such material with
the SEC.
Item 1A: Risk Factors
The following are certain risk factors that could affect our business, financial condition and result of operations. The risks that are
highlighted below are not the only ones that we face. These risk factors should be considered in connection with evaluating
forward-looking statements contained in this Annual Report on Form 10-K because these factors could cause our actual results
and financial condition to differ materially from those projected in forward-looking statements. If any of the following risks actually
occur, our business, financial condition or results of operations could be negatively affected.
The bearing industry is highly competitive, and this competition results in significant pricing pressure for our products
that could affect our revenues and profitability.
The global bearing industry is highly competitive. We compete with domestic manufacturers and many foreign manufacturers of
anti-friction bearings, including SKF, INA, NTN, Koyo and NSK. The bearing industry is also capital-intensive and profitability is
dependent on factors such as labor compensation and productivity and inventory management, which are subject to risks that we
may not be able to control. Due to the competitiveness within the bearing industry, we may not be able to increase prices for our
products to cover increases in our costs and, in many cases, we may face pressure from our customers to reduce prices, which
could adversely affect our revenues and profitability.
Competition and consolidation in the steel industry, together with potential global overcapacity, could result in
significant pricing pressure for our products.
Competition within the steel industry, both domestically and worldwide, is intense and is expected to remain so. Global production
overcapacity has occurred in the past and may reoccur in the future, which, when combined with high levels of steel imports into
the United States, may exert downward pressure on domestic steel prices and result in, at times, a dramatic narrowing, or with
many companies the elimination, of gross margins. In addition, many of our competitors are continuously exploring and
implementing strategies, including acquisitions, which focus on manufacturing higher margin products that compete more directly
with our steel products. These factors could lead to significant downward pressure on prices for our steel products, which could
have a materially adverse effect on our revenues and profitability.
We may not be able to realize the anticipated benefits from, or successfully execute, Project O.N.E.
During 2005, we began implementing Project O.N.E., a multi-year program designed to improve business processes and systems
to deliver enhanced customer service and financial performance. During 2007, we expect the first major U.S. implementation of
Project O.N.E. We may not be able to realize the anticipated benefits from or successfully execute this program. Our future
success will depend, in part, on our ability to improve our business processes and systems. We may not be able to successfully
do so without substantial costs, delays or other difficulties. We may face significant challenges in improving our processes and
systems in a timely and efficient manner.
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Implementing Project O.N.E. will be complex and time-consuming, may be distracting to management and disruptive to our
businesses, and may cause an interruption of, or a loss of momentum in, our businesses as a result of a number of obstacles,
such as:
•
the loss of key associates or customers,
•
the failure to maintain the quality of customer service that we have historically provided;
•
the need to coordinate geographically diverse organizations; and
•
the resulting diversion of management’s attention from our day-to-day business and the need to dedicate additional
management personnel to address obstacles to the implementation of Project O.N.E.
If we are not successful in executing Project O.N.E., or if it fails to achieve the anticipated results, then our operations, margins,
sales and reputation could be adversely affected.
Any change in the operation of our raw material surcharge mechanisms or the availability or cost of raw materials and
energy resources could materially affect our earnings.
We require substantial amounts of raw materials, including scrap metal and alloys and natural gas to operate our business. Many
of our customer contracts contain surcharge pricing provisions. The surcharges are tied to a widely-available market index for that
specific raw material. Any change in the relationship between the market indices and our underlying costs could materially affect
our earnings.
Moreover, future disruptions in the supply of our raw materials or energy resources could impair our ability to manufacture our
products for our customers or require us to pay higher prices in order to obtain these raw materials or energy resources from other
sources, and could thereby affect our sales and profitability. Any increase in the prices for such raw materials or energy resources
could materially affect our costs and therefore our earnings.
Warranty, recall or product liability claims could materially adversely affect our earnings.
In our business, we are exposed to warranty and product liability claims. In addition, we may be required to participate in the recall
of a product. A successful warranty or product liability claim against us, or a requirement that we participate in a product recall,
could have a materially adverse effect on our earnings.
The failure to achieve the anticipated results of our Automotive Group initiatives could materially affect our earnings.
During 2005, we began restructuring our Automotive Group operations to address challenges in the automotive markets. We
expect that this restructuring will cost approximately $80 million to $90 million (pretax) and we are targeting annual pretax savings
of approximately $40 million by 2008. In response to reduced production demand from North American automotive manufacturers,
in September 2006, we announced further planned reductions in our Automotive Group workforce of approximately 700
associates. We expect that this workforce reduction will cost approximately $25 million (pretax) and we are targeting annual pretax
savings of approximately $35 million by 2008. The failure to achieve the anticipated results of our Automotive Group restructuring
and workforce reduction initiatives, including our targeted annual savings, could adversely affect our earnings.
The failure to achieve the anticipated results of our Canton bearing operation rationalization initiative could materially
adversely affect our earnings.
After reaching a new four-year agreement with the union representing employees in the Canton, Ohio bearing and steel plants in
2005, we refined our plans to rationalize our Canton bearing operations. We expect that this rationalization initiative will cost
approximately $35 million to $40 million (pretax) over the next three years and we are targeting annual pretax savings of
approximately $25 million. The failure to achieve the anticipated results of this initiative, including our targeted annual savings,
could adversely affect our earnings.
We may incur further impairment and restructuring charges that could materially affect our profitability.
We have taken approximately $82.6 million in impairment and restructuring charges for our Automotive Group restructuring and
workforce reduction and the rationalization of our Canton bearing operations during 2006 and 2005 and expect to take additional
charges in connection with these initiatives. Changes in business or economic conditions, or our business strategy may result in
additional restructuring programs and may require us to take additional charges in the future, which could have a materially
adverse effect on our earnings.
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Any reduction of CDSOA distributions in the future would reduce our earnings and cash flows.
In February 2006, U.S. legislation was enacted that would end CDSOA distributions for imports covered by antidumping duty
orders entering the United States after September 30, 2007. Instead, any such antidumping duties collected would remain with the
U.S. Treasury. This legislation is not expected to have a significant effect on potential CDSOA distributions in 2007, but would be
expected to reduce any distributions in years beyond 2007, with distributions eventually ceasing.
determining recipients eligible to receive CDSOA distributions is unconstitutional. The CIT has not finally ruled on other matters,
including any remedy as a result of its ruling. The company expects that the ruling of the CIT will be appealed. The company is
In addition to the CIT ruling, there are a number of other factors that can affect whether the company receives any CDSOA
changes in the law, other ongoing and potential additional legal challenges to the law, and the administrative operation of the law.
It is possible that CIT rulings might prevent us from receiving any CDSOA distributions in 2007. Any reduction of CDSOA
distributions would reduce our earnings and cash flow.
Weakness in any of the industries in which our customers operate, as well as the cyclical nature of our customers’
businesses generally, could adversely impact our revenues and profitability by reducing demand and margins.
Our revenues may be negatively affected by changes in customer demand, changes in the product mix and negative pricing
pressure in the industries in which we operate. Many of the industries in which our end customers operate are cyclical. Margins in
those industries are highly sensitive to demand cycles, and our customers in those industries historically have tended to delay
large capital projects, including expensive maintenance and upgrades, during economic downturns. As a result, our business is
also cyclical and our revenues and earnings are impacted by overall levels of industrial production.
Certain automotive industry companies have recently experienced significant financial downturns. In 2005, we increased our
reserve for accounts receivable relating to our automotive industry customers. If any of our automotive industry customers
becomes insolvent or files for bankruptcy, our ability to recover accounts receivable from that customer would be adversely
affected and any payment we received in the preference period prior to a bankruptcy filing may be potentially recoverable. In
addition, financial instability of certain companies that participate in the automotive industry supply chain could disrupt production
in the industry. A disruption of production in the automotive industry could have a materially adverse effect on our financial
condition and earnings.
Environmental regulations impose substantial costs and limitations on our operations and environmental compliance
may be more costly than we expect.
We are subject to the risk of substantial environmental liability and limitations on our operations due to environmental laws and
regulations. We are subject to various federal, state, local and foreign environmental, health and safety laws and regulations
concerning issues such as air emissions, wastewater discharges, solid and hazardous waste handling and disposal and the
investigation and remediation of contamination. The risks of substantial costs and liabilities related to compliance with these laws
and regulations are an inherent part of our business, and future conditions may develop, arise or be discovered that create
substantial environmental compliance or remediation liabilities and costs.
Compliance with environmental legislation and regulatory requirements may prove to be more limiting and costly than we
anticipate. New laws and regulations, including those which may relate to emissions of greenhouse gases, stricter enforcement of
existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean-up requirements
could require us to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our
business, financial condition or results of operations. We may also be subject from time to time to legal proceedings brought by
private parties or governmental authorities with respect to environmental matters, including matters involving alleged property
damage or personal injury.
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88
Unexpected equipment failures or other disruptions of our operations may increase our costs and reduce our sales and
earnings due to production curtailments or shutdowns.
Interruptions in production capabilities, especially in our Steel Group, would inevitably increase our production costs and reduce
sales and earnings for the affected period. In addition to equipment failures, our facilities are also subject to the risk of
catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions. Our manufacturing
processes are dependent upon critical pieces of equipment, such as furnaces, continuous casters and rolling equipment, as well
as electrical equipment, such as transformers, and this equipment may, on occasion, be out of service as a result of unanticipated
failures. In the future, we may experience material plant shutdowns or periods of reduced production as a result of these types of
equipment failures.
The global nature of our business exposes us to foreign currency fluctuations that may affect our asset values, results
of operations and competitiveness.
We are exposed to the risks of currency exchange rate fluctuations because a significant portion of our net sales, costs, assets
and liabilities, are denominated in currencies other than the U.S. dollar. These risks include a reduction in our asset values, net
sales, operating income and competitiveness.
For those countries outside the United States where we have significant sales, devaluation in the local currency would reduce the
value of our local inventory as presented in our Consolidated Financial Statements. In addition, a stronger U.S. dollar would result
in reduced revenue, operating profit and shareholders’ equity due to the impact of foreign exchange translation on our
Consolidated Financial Statements. Fluctuations in foreign currency exchange rates may make our products more expensive for
others to purchase or increase our operating costs, affecting our competitiveness and our profitability.
Changes in exchange rates between the U.S. dollar and other currencies and volatile economic, political and market conditions in
emerging market countries have in the past adversely affected our financial performance and may in the future adversely affect
the value of our assets located outside the United States, our gross profit and our results of operations.
Global political instability and other risks of international operations may adversely affect our operating costs, revenues
and the price of our products.
Our international operations expose us to risks not present in a purely domestic business, including primarily:
•
changes in tariff regulations, which may make our products more costly to export or import;
•
difficulties establishing and maintaining relationships with local OEMs, distributors and dealers;
•
import and export licensing requirements;
•
compliance with a variety of foreign laws and regulations, including unexpected changes in taxation and environmental
or other regulatory requirements, which could increase our operating and other expenses and limit our operations; and
•
difficulty in staffing and managing geographically diverse operations.
These and other risks may also increase the relative price of our products compared to those manufactured in other countries,
reducing the demand for our products in the markets in which we operate, which could have a materially adverse effect on our
revenues and earnings.
Underfunding of our defined benefit and other postretirement plans has caused and may continue to cause a significant
reduction in our shareholders’ equity.
As a result of recent accounting standards, the underfunded status of our pension fund assets and our postretirement health care
obligations, we were required to take a total net reduction of $276 million, net of income taxes, against our shareholders’ equity in
2006. We may be required to take further charges related to pension and other postretirement liabilities in the future and these
charges may be significant.
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89
The underfunded status of our pension fund assets will cause us to prepay the funding of our pension obligations which
may divert funds from other uses.
The increase in our defined benefit pension obligations, as well as our ongoing practice of managing our funding obligations over
time, have led us to prepay a portion of our funding obligations under our pension plans. We made cash contributions of
$243 million, $226 million and $185 million in 2006, 2005 and 2004, respectively, to our U.S.-based pension plans and currently
expect to make cash contributions of $80 million in 2007 to such plans. However, we cannot predict whether changing economic
conditions or other factors will lead us or require us to make contributions in excess of our current expectations, diverting funds we
would otherwise apply to other uses.
Work stoppages or similar difficulties could significantly disrupt our operations, reduce our revenues and materially
affect our earnings.
A work stoppage at one or more of our facilities could have a materially adverse effect on our business, financial condition and
results of operations. Also, if one or more of our customers were to experience a work stoppage, that customer would likely halt or
limit purchases of our products, which could have a materially adverse effect on our business, financial condition and results of
operations.
Item 1B. Unresolved Staff Comments
None.
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90
Item 2. Properties
Timken has Automotive Group, Industrial Group and Steel Group manufacturing facilities at multiple locations in the United States
and in a number of countries outside the United States. The aggregate floor area of these facilities worldwide is approximately
16,669,000 square feet, all of which, except for approximately 1,619,000 square feet, is owned in fee. The facilities not owned in
fee are leased. The buildings occupied by Timken are principally made of brick, steel, reinforced concrete and concrete block
construction. All buildings are in satisfactory operating condition in which to conduct business.
Timken’s Automotive and Industrial Groups’ manufacturing facilities in the United States are located in Bucyrus, Canton, New
Philadelphia, and Niles, Ohio; Altavista, Virginia; Randleman, Iron Station and Rutherfordton, North Carolina; Carlyle, Illinois;
South Bend, Indiana; Gaffney, Clinton, Union, Honea Path and Walhalla, South Carolina; Cairo, Norcross, Sylvania, Ball Ground
and Dahlonega, Georgia; Pulaski and Mascot, Tennessee; Keene and Lebanon, New Hampshire; Lenexa, Kansas; Ogden, Utah;
Mesa, Arizona; and Los Alamitos, California. These facilities, including the research facility in Canton, Ohio, and warehouses at
plant locations, have an aggregate floor area of approximately 7,193,000 square feet. The company’s Watertown, Connecticut
facility was sold on December 18, 2006.
Timken’s Automotive and Industrial Groups’ manufacturing plants outside the United States are located in Benoni, South Africa;
Brescia, Italy; Colmar, Vierzon, Maromme and Moult, France; Northampton and Wolverhampton, England; Medemblik, The
Netherlands; Bilbao, Spain; Halle-Westfallen, Germany; Olomouc, Czech Republic; Ploiesti, Romania; Mexico City, Mexico; Sao
Paulo, Brazil; Singapore, Singapore; Jamshedpur, India; Sosnowiec, Poland; St. Thomas and Bedford, Canada; and Yantai and
Wuxi, China. The facilities, including warehouses at plant locations, have an aggregate floor area of approximately 5,199,000
square feet. The company’s Nova Friburgo, Brazil facility was sold on December 18, 2006.
Timken’s Steel Group’s manufacturing facilities in the United States are located in Canton and Eaton, Ohio; and Columbus, North
Carolina. These facilities have an aggregate floor area of approximately 3,624,000 square feet. The company’s Wauseon and
Vienna, Ohio; Franklin and Latrobe, Pennsylvania; and White House, Tennessee facilities were sold on December 8, 2006.
Timken’s Steel Group’s manufacturing facilities outside the United States are located in Leicester and Sheffield, England. These
facilities have an aggregate floor area of approximately 653,000 square feet. The company’s Fougeres and Marnaz, France
facilities were sold on June 30, 2006.
In addition to the manufacturing and distribution facilities discussed above, Timken owns warehouses and steel distribution
facilities in the United States, United Kingdom, France, Singapore, Mexico, Argentina, Australia, Brazil, Germany and China, and
leases several relatively small warehouse facilities in cities throughout the world.
During 2006, the utilization by plant varied significantly due to decreasing demand across all automotive markets, and decreasing
demand in industrial sectors served by Automotive Group plants. The overall Automotive Group plant utilization was between
approximately 75% and 85%, lower than 2005. In 2006, as a result of the higher industrial global demand, Industrial Group plant
utilization was between 85% and 90%, which was the same as 2005. Also, in 2006, Steel Group plants operated at near capacity,
which was similar to 2005.
Item 3. Legal Proceedings
The company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters will not have a materially adverse effect on the company’s consolidated
financial position or results of operations.
In July 2006, the company entered into a settlement agreement with the State of Ohio concerning both a violation of Ohio air
pollution control laws, which was discovered by the company and voluntarily disclosed to the State of Ohio more than ten years
ago, as well as a failed grinder bag house stack test, which was corrected within three days. Pursuant to the terms of the
settlement agreement, the company has agreed to pay $200,000. The company will receive a credit of $22,500 of the total
settlement amount due to the company’s investments in approved supplemental environmental projects. Pursuant to the terms of
the settlement agreement, the company also conducted additional testing of certain equipment.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2006.
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Item 4A. Executive Officers of the Registrant
The executive officers are elected by the Board of Directors normally for a term of one year and until the election of their
successors. All executive officers, except for three, have been employed by Timken or by a subsidiary of the company during the
past five-year period. The executive officers of the company as of February 28, 2007 are as follows:
Name
Age
Current Position and Previous Positions During Last Five Years
Ward J. Timken, Jr.
39
2000
2002
2003
2005
Corporate Vice President — Office of the Chairman
Corporate Vice President — Office of the Chairman; Director
Executive Vice President and President — Steel Group; Director
Chairman of the Board
James W. Griffith
53
1999
2002
President and Chief Operating Officer; Director
President and Chief Executive Officer; Director
Michael C. Arnold
50
2000
President — Industrial Group
William R. Burkhart
41
2000
Senior Vice President and General Counsel
Alastair R. Deane
45
2000
Senior Vice President of Engineering, Automotive Driveline
Driveshaft business group of GKN Automotive, Incorporated, a global
supplier of driveline components and systems.
Senior Vice President — Technology, The Timken Company
2005
Jacqueline A. Dedo
45
2000
2004
Glenn A. Eisenberg
45
1999
2002
Vice President and General Manager Worldwide Market
Operations, Motorola, Inc., a global communications company
President — Automotive Group, The Timken Company
President and Chief Operating Officer, United Dominion
Industries, an international manufacturing, construction and
engineering firm
Executive Vice President — Finance and Administration,
The Timken Company
J. Ted Mihaila
52
2001
2006
Controller, Industrial Group
Senior Vice President and Controller
Salvatore J. Miraglia, Jr.
56
1999
2005
Senior Vice President — Technology
President — Steel Group
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The company’s common stock is traded on the New York Stock Exchange under the symbol “TKR.” The estimated number of
record holders of the company’s common stock at December 31, 2006 was approximately 6,697. The estimated number of
beneficial shareholders at December 31, 2006 was approximately 42,608.
The following table provides information about the high and low sales prices for the company’s common stock and dividends paid
for each quarter for the last two fiscal years.
2006
Stock prices
High
First quarter
Second quarter
Third quarter
Fourth quarter
$36.58
$36.25
$34.99
$31.89
2005
Dividends
per share
Low
$26.57
$27.68
$29.05
$27.60
$0.15
$0.15
$0.16
$0.16
Stock prices
High
$29.50
$27.68
$30.06
$32.84
Low
$22.73
$22.80
$22.90
$25.25
Dividends
per share
$0.15
$0.15
$0.15
$0.15
15
93
*
**
Total return assumes reinvestment of dividends.
Fiscal years ending December 31.
Assumes $100 invested on January 1, 2002, in Timken Company common stock, S&P 500 Index and Peer Index.
Timken Company
S&P 500
80% Bearing/20% Steel ***
***
2002
2003
2004
2005
2006
$121.35
77.90
99.31
$131.59
100.24
142.89
$174.59
111.15
182.83
$219.56
116.61
274.99
$204.14
135.02
366.39
Effective in 2003, the weighting of the peer index was revised from 70% Bearing/30% Steel to more accurately reflect
the company’s post-Torrington acquisition.
The line graph compares the cumulative total shareholder returns over five years for The Timken Company, the S&P 500 Stock
Index, and a peer index that proportionally reflects The Timken Company’s two businesses. The S&P Steel Index comprises the
steel portion of the peer index. This index was comprised of seven steel companies in 1996 and is now three (Allegheny
Technologies, Nucor and US Steel Corp.), as industry consolidation and bankruptcy have reduced the number of companies in
the index. The remaining portion of the peer index is a self-constructed bearing index that consists of six companies. These six
companies are Kaydon, FAG, JTETK (formerly Koyo Seiko), NSK, NTN and SKF. The last five are non-US bearing companies
that are based in Germany (FAG), Japan (JTETK, NSK, NTN), and Sweden (SKF). FAG was eliminated from the bearing index in
2003 when its minority interests were acquired and its shares delisted.
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94
Issuer Purchases of Common Stock:
The following table provides information about purchases by the company during the quarter ended December 31, 2006 of its
common stock.
Period
Total Number of Maximum Number of
Shares Purchased as Shares That May Yet
Total Number
Part of Publicly be Purchased Under
of Shares Average Price Paid Announced Plans or
the Plans or
per Share (2)
Programs (3)
Programs (3)
Purchased (1)
10/1/06 — 10/31/06
11/1/06 — 11/30/06
12/1/06 — 12/31/06
Total
(1)
(2)
(3)
—
1,942
6,850
8,792
$
—
30.77
30.71
$ 30.72
—
—
—
—
3,793,700
3,793,700
3,793,700
3,793,700
Consists solely of company repurchases of shares of its common stock that are owned and tendered by employees to satisfy
tax withholding obligations in connection with the vesting of restricted shares and the exercise of stock options.
The average price paid per share is calculated using the daily high and low sales prices of the company’s common stock as
quoted on the New York Stock Exchange at the time the employee tenders the shares.
Pursuant to the company’s 2000 common stock purchase plan, the company may purchase up to four million shares of
common stock at an amount not to exceed $180 million in the aggregate. The company was authorized to purchase shares
under its 2000 common stock purchase plan until December 31, 2006. The company did not purchase any shares under its
2000 common stock purchase plan during the periods listed above. On November 3, 2006, the company adopted its 2006
common stock purchase plan, effective as of January 1, 2007. Pursuant to the 2006 common stock purchase plan, the
company may purchase up to four million shares of common stock at an amount not to exceed $180 million, in the
aggregate, until December 31, 2012.
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95
Item 6. Selected Financial Data
2006
2005
2004
2003
2002
$2,072,495
1,573,034
1,327,836
4,973,365
$1,925,211
1,661,048
1,236,908
4,823,167
$1,709,770
1,582,226
995,201
4,287,197
$1,498,832
1,396,104
731,554
3,626,490
$ 971,534
752,763
659,780
2,384,077
1,005,844
677,342
44,881
64,271
219,350
79,666
299,016
49,387
176,439
999,957
646,904
26,093
—
326,960
67,726
394,686
51,585
233,656
824,376
575,910
13,538
—
234,928
12,100
247,028
50,834
134,046
632,082
511,053
19,154
—
101,875
9,903
111,778
48,401
38,940
462,749
345,240
31,852
—
85,657
36,326
121,983
31,540
55,385
46,088
$ 222,527
26,625
$ 260,281
1,610
$ 135,656
$
$ 952,310
1,601,559
4,031,533
$ 900,294
1,474,074
3,993,734
$ 799,717
1,508,598
3,942,909
$ 634,906
1,531,423
3,689,789
$ 425,003
1,142,056
2,748,356
—
40,217
10,236
547,390
597,843
—
63,437
95,842
561,747
721,026
—
157,417
1,273
620,634
779,324
—
114,469
6,725
613,446
734,640
8,999
78,354
23,781
350,085
461,219
(Dollars in thousands, except per share data)
Net Sales
Industrial
Automotive
Steel
Total net sales
Gross profit
Operating income
Other income (expense) — net
Earnings before interest and taxes (EBIT) (1)
Interest expense
income taxes
Net income
Balance Sheets
Inventories — net
Total assets
Total debt:
Commercial paper
Short-term debt
Long-term debt
Total debt:
Net debt:
Total debt
Net debt: (2)
Total liabilities
Capital:
Net debt
Income from continuing operations/Net sales
EBIT /Net sales
Capital expenditures /Net sales
Dividends per share
Earnings per share — assuming dilution (5)
Number of associates at year-end (6)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(2,459)
36,481
597,843
(101,072)
496,771
2,555,353
$1,476,180
721,026
(65,417)
655,609
2,496,667
$1,497,067
779,324
(50,967)
728,357
2,673,061
$1,269,848
734,640
(28,626)
706,014
2,600,162
$1,089,627
496,771
1,476,180
1,972,951
655,609
1,497,067
2,152,676
728,357
1,269,848
1,998,205
706,014
1,089,627
1,795,641
$
$
$
$
$
$
3.5%
6.0%
12.0%
191.5
296,093
196,592
6.0%
0.62
2.38
2.36
25.2%
25,418
42,608
$
$
$
$
$
$
4.8%
8.2%
15.6%
186.7
217,411
209,656
4.5%
0.60
2.84
2.81
30.5%
26,528
54,514
$
$
$
$
$
$
3.1%
5.8%
10.6%
170.0
143,781
201,173
3.4%
0.52
1.51
1.49
36.5%
25,128
42,484
$
$
$
$
$
$
1.1%
3.1%
3.6%
170.6
125,596
200,548
3.5%
0.52
0.44
0.44
39.3%
25,299
42,184
$
(16,636)
38,749
461,219
(82,050)
379,169
2,139,270
$ 609,086
379,169
609,086
988,255
$
$
$
$
$
$
2.3%
5.1%
9.1%
135.8
87,869
137,451
3.7%
0.52
0.63
0.62
38.4%
17,226
44,057
EBIT is defined as operating income plus other income (expense) — net.
The company presents net debt because it believes net debt is more representative of the company’s indicative financial
position due to temporary changes in cash and cash equivalents.
Return on equity is defined as income from continuing operations divided by ending shareholders’ equity.
Based on average number of shares outstanding during the year and includes discontinued operations for all periods
presented.
Adjusted to exclude Latrobe Steel for all periods.
Includes an estimated count of shareholders having common stock held for their accounts by banks, brokers and trustees for
benefit plans.
18
96
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Introduction
The Timken Company is a leading global manufacturer of highly engineered anti-friction bearings and alloy steels and a provider
of related products and services. Timken operates under three segments: Industrial Group, Automotive Group and Steel Group.
The Industrial and Automotive Groups design, manufacture and distribute a range of bearings and related products and services.
Industrial Group customers include both original equipment manufacturers and distributors for agriculture, construction, mining,
energy, mill, machine tool, aerospace and rail applications. Automotive Group customers include original equipment
manufacturers and suppliers for passenger cars, light trucks, and medium- to heavy-duty trucks. Steel Group products include
steels of low and intermediate alloy and carbon grades, in both solid and tubular sections, as well as custom-made steel products
for both industrial and automotive applications, including bearings.
Financial Overview
Overview:
2006
2005
$Change
% Change
(Dollars in millions, except earnings per share)
Net sales
Net income
$
4,973.4
176.4
46.1
222.5
$
1.87
0.49
$
2.36
94,294,716
$
$
4,823.2
233.7
26.6
260.3
$ 150.2
(57.3)
19.5
(37.8)
3.1%
(24.5)%
73.3%
(14.5)%
2.52
0.29
$
2.81
92,537,529
$ (0.65)
0.20
$ (0.45)
—
(25.8)%
69.0%
(16.0)%
1.9%
The Timken Company reported net sales for 2006 of approximately $5.0 billion, compared to $4.8 billion in 2005, an increase of
3.1%. Sales were higher across the Industrial and Steel Groups, offset by lower sales in the Automotive Group. In
December 2006, the company completed the divestiture of its Latrobe Steel subsidiary. Discontinued operations represent the
operating results and related gain on sale, net of tax, of this business. For 2006, earnings per diluted share were $2.36, compared
to $2.81 per diluted share for 2005. Income from continuing operations per diluted share was $1.87, compared to $2.52 per
diluted share for 2005.
The ongoing strength of global industrial markets drove the increase in Industrial and Steel Group sales, while the declines in
North American automotive demand during the second half of 2006 constrained results. The company’s growth initiatives, loss on
divestitures and restructuring the company’s operations, also constrained overall results. The company continued its focus on
increasing production capacity in targeted areas, including major capacity expansions for industrial products at several
manufacturing locations around the world. The company expects the strength in industrial markets will continue in 2007 and drive
year-over-year sales increases in both the Industrial and Steel Groups.
While global industrial markets are expected to remain strong, the improvements in the company’s operating performance will be
partially constrained by investments, including Project O.N.E. and Asian growth initiatives. Project O.N.E. is a program designed
to improve the company’s business processes and systems. In 2006, the company successfully completed a pilot program of
Project O.N.E. in Canada. The objective of Asian growth initiatives is to increase market share, influence major design centers
and expand the company’s network of sources of globally competitive friction management products.
The company’s strategy for the Industrial Group is to pursue growth in selected industrial markets and achieve a leadership
position in targeted Asian markets. In 2006, the company invested in three new plants in Asia to build the infrastructure to support
its Asian growth initiative. The company also expanded its capacity in aerospace products by investing in a new aerospace
aftermarket facility in Mesa, Arizona and through the acquisition of the assets of Turbo Engines, Inc. in December 2006. The new
facility in Mesa, which will include manufacturing and engineering functions, more than doubles the capacity of the company’s
previous aerospace aftermarket operations in Gilbert, Arizona. In addition, the company is increasing large-bore bearing capacity
in Romania, China and the United States to serve heavy industrial markets. The company is also expanding its line of industrial
seals to include large-bore seals to provide a more complete line of friction management products to distribution channels.
19
97
The company’s strategy for the Automotive Group is to make structural changes to its business to improve its financial
performance. In 2005, the company disclosed plans for its Automotive Group to restructure its business. These plans included the
closure of its automotive engineering center in Torrington, Connecticut and its manufacturing engineering center in Norcross,
Georgia. These facilities were consolidated into a new technology facility in Greenville, South Carolina. Additionally, the company
announced the closure of its manufacturing facility in Clinton, South Carolina. In February 2006, the company announced plans to
downsize its manufacturing facility in Vierzon, France.
In September 2006, the company announced further planned reductions in its Automotive Group workforce of approximately 700
associates. These plans are targeted to deliver annual pretax savings of approximately $35 million by 2008, with pretax costs of
approximately $25 million.
In December 2006, the company completed the divestiture of its Steering business located in Watertown, Connecticut and Nova
Friburgo, Brazil, resulting in a loss on divestiture of $54.3 million. The Steering business employed approximately 900 associates.
The company’s strategy for the Steel Group is to focus on opportunities where the company can offer differentiated capabilities
while driving profitable growth. In 2006, the company announced plans to invest in a new induction heat-treat line in Canton, Ohio,
which will increase capacity and the ability to provide differentiated product to more customers in its global energy markets. In
January 2007, the company announced plans to invest approximately $60 million to enable the company to competitively produce
steel bars down to 1-inch diameter for use in power transmission and friction management applications for a variety of customers,
including the rapidly growing automotive transplants. In 2006, the company also completed the divestiture of its Latrobe Steel
subsidiary and its Timken Precision Steel Components — Europe business. In addition, the company announced plans to exit its
seamless steel tube manufacturing operations located in Desford, England.
The Statement of Income
Sales by Segment:
2006
2005
$Change
$2,072.5
1,573.0
1,327.9
$4,973.4
$1,925.2
1,661.1
1,236.9
$4,823.2
$ 147.3
(88.1)
91.0
$ 150.2
% Change
(Dollars in millions, and exclude intersegment sales)
Industrial Group
Automotive Group
Steel Group
Total Company
7.7%
(5.3)%
7.4%
3.1%
The Industrial Group’s net sales in 2006 increased from 2005 primarily due to higher demand across most end markets, with the
highest growth in aerospace, heavy industry and industrial distribution. The Automotive Group’s net sales in 2006 decreased from
2005 primarily due to significantly lower volume, driven by reductions in vehicle production by North American original equipment
manufacturers, partially offset by improved pricing. The Steel Group’s net sales in 2006 increased from 2005 primarily due to
increased pricing and surcharges to recover high raw material and energy costs, as well as strong demand in industrial and
energy market sectors, partially offset by lower sales to automotive customers.
Gross Profit:
2006
2005
$Change
Change
(Dollars in millions)
Gross profit
Gross profit % to net sales
Rationalization expenses included in cost of products sold
$1,005.8
20.2%
$ 18.5
$1,000.0
20.7%
$ 14.5
$
$
5.8
—
4.0
0.6%
(50)bps
27.6%
Gross profit margin decreased in 2006 compared to 2005, primarily due to the impact of lower volume in the Automotive Group,
driven by reductions in vehicle production by North American original equipment manufacturers, leading to underutilization of
manufacturing capacity, as well as an increase in product warranty reserves. The impact of lower volumes and the increase in
product warranty reserves in the Automotive Group more than offset favorable sales volume from the Industrial and Steel
businesses, price increases, and increased productivity in the company’s other businesses.
In 2006, rationalization expenses included in cost of products sold related to the company’s Canton, Ohio Industrial Group bearing
facilities, certain Automotive Group domestic manufacturing facilities, certain facilities in Torrington, Connecticut and the closure of
the company’s seamless steel tube manufacturing operations located in Desford, England. In 2005, rationalization expenses
included in cost of products sold related to the rationalization of the company’s Canton, Ohio bearing facilities and costs for certain
facilities in Torrington, Connecticut.
20
98
Selling, Administrative and General Expenses:
2006
2005
$Change
$677.3
13.6%
$646.9
13.4%
$30.4
—
$
$
$ 3.1
Change
Selling, administrative and general expenses % to net sales
Rationalization expenses included in selling, administrative and
general expenses
5.9
2.8
4.7%
20bps
110.7%
The increase in selling, administrative and general expenses in 2006 compared to 2005 was primarily due to higher costs
associated with investments in the Asian growth initiative and Project O.N.E. and higher rationalization expenses, partially offset
by lower bad debt expense.
In 2006, the rationalization expenses included in selling, administrative and general expenses primarily related to Automotive
Group manufacturing and engineering facilities. In 2005, the rationalization expenses included in selling, administrative and
general expenses primarily related to the company’s Canton, Ohio bearing facilities and costs associated with the Torrington
acquisition.
Impairment and Restructuring Charges:
2006
2005
$15.3
25.8
3.8
$44.9
$ 0.8
20.3
5.0
$26.1
$Change
Impairment charges
Severance and related benefit costs
Exit costs
Total
$14.5
5.5
(1.2)
$18.8
Industrial
In May 2004, the company announced plans to rationalize the company’s three bearing plants in Canton, Ohio within the Industrial
Group. On September 15, 2005, the company reached a new four-year agreement with the United Steelworkers of America, which
went into effect on September 26, 2005, when the prior contract expired. This rationalization initiative is expected to deliver annual
pretax savings of approximately $25 million through streamlining operations and workforce reductions, with pretax costs of
approximately $35 to $40 million over the next three years.
In 2006, the company recorded $1.0 million of impairment charges and $0.6 million of exit costs associated with the Industrial
Group’s rationalization plans. In 2005, the company recorded $0.8 million of impairment charges and environmental exit costs of
$2.2 million associated with the Industrial Group’s rationalization plans.
In November 2006, the company announced plans to vacate its Torrington, Connecticut office complex. In 2006, the company
recorded $1.5 million of severance and related benefit costs and $0.1 million of impairment charges associated with the Industrial
Group vacating the Torrington complex.
In addition, the company recorded $1.4 million of environmental exit costs in 2006 related to a former plant in Columbus, Ohio and
$0.1 million of severance and related benefit costs related to other company initiatives.
Automotive
In 2005, the company disclosed detailed plans for its Automotive Group to restructure its business and improve performance.
These plans included the closure of a manufacturing facility in Clinton, South Carolina and engineering facilities in Torrington,
Connecticut and Norcross, Georgia. In February 2006, the company announced additional plans to rationalize production capacity
at its Vierzon, France bearing manufacturing facility in response to changes in customer demand for its products. These
restructuring efforts, along with other future actions, are targeted to deliver annual pretax savings of approximately $40 million by
2008, with expected net workforce reductions of approximately 400 to 500 positions and pretax costs of approximately $80 million
to $90 million.
In September 2006, the company announced further planned reductions in its workforce of approximately 700 associates. These
additional plans are targeted to deliver annual pretax savings of approximately $35 million by 2008, with expected pretax costs of
approximately $25 million.
In 2006, the company recorded $16.5 million of severance and related benefit costs, $1.5 million of exit costs and $1.6 million of
impairment charges associated with the Automotive Group’s restructuring plans. In 2005, the company recorded approximately
$20.3 million of severance and related benefit costs and $2.8 million of exit costs as a result of environmental charges related to
the closure of a manufacturing facility in Clinton, South Carolina, and administrative facilities in Torrington, Connecticut and
Norcross, Georgia.
21
99
In 2006, the company recorded an additional $0.7 million of severance and related benefit costs and $0.3 million of impairment
charges for the Automotive Group related to the announced plans to vacate its Torrington campus office complex and $0.1 million
of severance and related benefit costs related to other company initiatives.
In addition, the company recorded impairment charges of $11.9 million in 2006 representing the write-off of goodwill associated
with the Automotive Group in accordance with Statement of Financial Accounting Standards No. 142 (SFAS No. 142), “Goodwill
and Other Intangible Assets.” Refer to Note 8 — Goodwill and Other Intangible Assets in the Notes to Consolidated Financial
Statements for additional discussion.
Steel
In October 2006, the company announced its intention to exit during 2007 its European seamless steel tube manufacturing
operations located in Desford, England. The company recorded approximately $6.9 million of severance and related benefit costs
in 2006 related to this action. In addition, the company recorded an impairment charge and removal costs of $0.6 million related to
the write-down of property, plant and equipment at one of the Steel Group’s facilities.
Rollforward of Restructuring Accruals:
2006
2005
$ 18.1
29.6
(15.7)
$ 32.0
$ 4.1
17.5
(3.5)
$18.1
Beginning balance, January 1
Expense
Payments
Ending balance, December 31
The restructuring accrual for 2006 and 2005 was included in accounts payable and other liabilities in the Consolidated Balance
Sheet. The restructuring accrual at December 31, 2005 excludes costs related to curtailment of pension and postretirement
benefit plans.
Loss on Divestitures
2006
2005
$Change
$—
$(64.3)
(Loss) on Divestitures
$(64.3)
In June 2006, the company completed the divestiture of its Timken Precision Steel Components — Europe business and recorded
a loss on disposal of $10.0 million. In December 2006, the company completed the divestiture of the Automotive Group’s steering
business located in Watertown, Connecticut and Nova Friburgo, Brazil and recorded a loss on disposal of $54.3 million.
Interest Expense and Income:
2006
2005
$49.4
$ 4.6
$51.6
$ 3.4
$Change
% Change
Interest expense
Interest income
$(2.2)
$ 1.2
(4.3)%
35.3%
Interest expense for 2006 decreased slightly compared to 2005 due to lower average debt outstanding in 2006 compared to 2005,
partially offset by higher interest rates. Interest income increased for 2006 compared to 2005 due to higher invested cash
balances and higher interest rates.
22
100
Other Income and Expense:
2006
2005
$Change
% Change
CDSOA receipts, net of expenses
Other expense — net:
Gain on sale of non-strategic assets
Gain (loss) on dissolution of subsidiaries
Other
$ 87.9
$ 77.1
$10.8
14.0%
$ 7.1
0.9
(16.2)
$ (8.2)
$ 8.9
(0.6)
(17.7)
$ (9.4)
$ (1.8)
1.5
1.5
$ 1.2
(20.2)%
NM
8.5%
12.8%
The U.S. Continued Dumping and Subsidy Offset Act (CDSOA) receipts are reported net of applicable expenses. CDSOA
provides for distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic producers where the
domestic producers have continued to invest in their technology, equipment and people. In 2006, the company received CDSOA
receipts, net of expenses, of $87.9 million. In 2005, the company received CDSOA receipts, net of expenses, of $77.1 million. In
September 2002, the World Trade Organization (WTO) ruled that such payments are inconsistent with international trade rules. In
February 2006, U.S. legislation was signed into law that would end CDSOA distributions for imports covered by antidumping duty
orders entering the U.S. after September 30, 2007. Instead, any such antidumping duties collected would remain with the U.S.
Treasury. This legislation by itself is not expected to have a significant effect on potential CDSOA distributions in 2007, but would
be expected to reduce any distributions in years beyond 2007, with distributions eventually ceasing altogether. There are a
number of factors that can affect whether the company receives any CDSOA distributions and the amount of such distributions in
any year. These factors include, among other things, potential additional changes in the law, ongoing and potential additional legal
challenges to the law, the administrative operation of the law and the status of the underlying antidumping orders. Accordingly, the
company cannot reasonably estimate the amount of CDSOA distributions it will receive in future years, if any. If the company does
receive CDSOA distributions in 2007, they will most likely be received in the fourth quarter.
In 2006, the gain on sale of non-strategic assets primarily related to the sale of assets of PEL Technologies (PEL). In 2000, the
company’s Steel Group invested in PEL, a joint venture to commercialize a proprietary technology that converted iron units into
engineered iron oxide for use in pigments, coatings and abrasives. The company consolidated PEL effective March 31, 2004 in
accordance with Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46). In 2006, the company liquidated
the joint venture. Refer to Note 12 — Equity Investments in the Notes to Consolidated Financial Statements for additional
discussion.
In 2005, the gain on sale of non-strategic assets of $8.9 million related to the sale of certain non-strategic assets, including NRB
Bearings, a joint venture based in India, and the Industrial Group’s Linear Motion Systems business, based in Europe.
For 2006, other expense primarily included losses from equity investments, donations, minority interests, and losses on the
disposal of assets. For 2005, other expense primarily included losses on the disposal of assets, losses from equity investments,
donations, minority interests and foreign currency exchange losses.
23
101
Income Tax Expense:
2006
2005
$Change
$77.8
30.6%
$112.9
32.6%
$(35.1)
—
% Change
Income tax expense
Effective tax rate
(31.1)%
(200)bps
The effective tax rate for 2006 was less than the U.S. federal statutory tax rate due to the favorable impact of taxes on foreign
income, including earnings of certain foreign subsidiaries being taxed at a rate less than 35%, the extraterritorial income exclusion
on U.S. exports, and tax holidays in China and the Czech Republic. In addition, the effective tax rate was favorably impacted by
certain U.S. tax benefits, including a net reduction in our tax reserves related primarily to the settlement of certain prior year tax
matters with the Internal Revenue Service during the year, accrual of the tax-free Medicare prescription drug subsidy, deductible
dividends paid to the company’s Employee Stock Ownership Plan (ESOP), and the U.S. domestic manufacturing deduction
provided by the American Jobs Creation Act of 2004 (the AJCA). These benefits were offset partially by the inability to record tax
benefits for losses at certain foreign subsidiaries, taxes on foreign remittances, the impairment of non-deductible goodwill
recorded in the fourth quarter of 2006, U.S. state and local income taxes, and the aggregate impact of other U.S. tax items.
The effective tax rate for 2005 was less than the U.S. statutory tax rate due to tax benefits on foreign income, including the
extraterritorial income exclusion on U.S. exports, tax holidays in China and the Czech Republic, and earnings of certain foreign
subsidiaries being taxed at a rate less than 35%, as well as the aggregate tax benefit of other U.S. tax items. These benefits were
offset partially by taxes incurred on foreign remittances, including a remittance during the fourth quarter of 2005 pursuant to the
AJCA, U.S. state and local income taxes and the inability to record a tax benefit for losses at certain foreign subsidiaries.
In October 2004, the AJCA was signed into law. The AJCA contains a provision that eliminates the benefits of the extraterritorial
income exclusion for U.S. exports after 2006. The company recognized tax benefits of $5.3 million related to the extraterritorial
income exclusion in 2006. Additionally, the AJCA contains a provision that enables companies to deduct a percentage (3% in
2005 and 2006; 6% in 2007 through 2009; and 9% in 2010 and later years) of taxable income derived from qualified domestic
manufacturing operations. The company recognized tax benefits of approximately $1.6 million related to the manufacturing
deduction in 2006.
In December 2006, the Tax Relief and Health Care Act of 2006 (the TRHCA) was signed into law. The TRHCA extends the U.S.
federal income tax credit for qualified research and development activities (the R&D credit), which had expired on December 31,
2005, through December 31, 2007. The TRHCA also provides an alternative simplified method for calculating the R&D credit for
2007. The company expects the alternative simplified method to result in an increased R&D credit for 2007, versus prior years.
2006
2005
$33.2
12.9
$46.1
$26.6
—
$26.6
$Change
% Change
Operating results, net of tax
Gain on disposal, net of tax
Total
$ 6.6
12.9
$19.5
24.8%
NM
73.3%
In December 2006, the company completed the divestiture of its Latrobe Steel subsidiary. Latrobe Steel is a global producer and
distributor of high-quality, vacuum melted specialty steels and alloys. Discontinued operations represent the operating results and
related gain on sale, net of tax, of this business. Refer to Note 2 — Acquisitions and Divestitures in the Notes to Consolidated
Financial Statements for additional discussion.
24
102
Business Segments:
The primary measurement used by management to measure the financial performance of each segment is adjusted EBIT
(earnings before interest and taxes, excluding the effect of amounts related to certain items that management considers not
representative of ongoing operations such as impairment and restructuring, rationalization and integration charges, one-time gains
or losses on sales of non-strategic assets, allocated receipts received or payments made under the CDSOA and loss on the
dissolution of subsidiary). Refer to Note 14 — Segment Information in the Notes to Consolidated Financial Statements for the
reconciliation of adjusted EBIT by Group to consolidated income before income taxes.
Industrial Group:
2006
2005
$2,074.5
$ 201.3
9.7%
$1,927.1
$ 199.9
10.4%
$Change
Change
$147.4
$ 1.4
—
7.6%
0.7%
(70)bps
Net sales, including intersegment sales
Adjusted EBIT
Adjusted EBIT margin
Sales by the Industrial Group include global sales of bearings and other products and services (other than steel) to a diverse
customer base, including: industrial equipment; construction and agriculture; rail; and aerospace and defense customers. The
Industrial Group also includes aftermarket distribution operations, including automotive applications, for products other than steel.
The Industrial Group’s net sales for 2006 compared to 2005 increased primarily due to higher demand across most end markets,
particularly aerospace, heavy industry and industrial distribution markets. While sales increased in 2006, adjusted EBIT margin
was lower compared to 2005 primarily due to higher manufacturing costs associated with ramping up new facilities to meet
customer demand and investments in the Asian growth initiative and Project O.N.E., mostly offset by higher volume and increased
pricing. The company expects the Industrial Group to benefit from continued strength in most industrial segments in 2007. The
Industrial Group is also expected to benefit from additional supply capacity in constrained products throughout 2007.
Automotive Group:
2006
2005
$Change
Change
$1,573.0
$ (73.7)
(4.7)%
$1,661.1
$ (19.9)
(1.2)%
$(88.1)
$(53.8)
—
(5.3)%
NM
(350)bps
Adjusted EBIT (loss)
Adjusted EBIT (loss) margin
The Automotive Group includes sales of bearings and other products and services (other than steel) to automotive original
equipment manufacturers and suppliers. The Automotive Group’s net sales in 2006 compared to 2005 decreased primarily due to
lower volume, driven by reductions in vehicle production by North American original equipment manufacturers, partially offset by
improved pricing. Profitability for 2006 compared to 2005 decreased primarily due to lower volume, leading to the underutilization
of manufacturing capacity, and an increase of $18.8 million in warranty reserves, partially offset by improved pricing and a
decrease in allowances for automotive industry credit exposure. The Automotive Group’s sales are expected to stabilize in 2007
compared to the second half of 2006, and the Automotive Group is expected to deliver improved margins due to its restructuring
initiatives.
During 2006, the company recorded $16.5 million of severance and related benefit costs, $1.5 million of exit costs and $1.6 million
of impairment charges associated with the Automotive Group’s restructuring plans. In 2005, the company recorded approximately
$20.3 million of severance and related benefit costs and $2.8 million of exit costs as a result of environmental charges related to
the closure of a manufacturing facility in Clinton, South Carolina, and administrative facilities in Torrington, Connecticut and
Norcross, Georgia. The Automotive Group’s adjusted EBIT (loss) excludes these restructuring costs, as they are not
representative of ongoing operations.
25
103
Steel Group:
2006
2005
$1,472.3
$ 206.7
14.0%
$1,415.1
$ 175.8
12.4%
$Change
% Change
Adjusted EBIT
$57.2
$30.9
—
4.0%
17.6%
160bps
The Steel Group sells steel of low and intermediate alloy and carbon grades in both solid and tubular sections, as well as custommade steel products for both automotive and industrial applications, including bearings.
In December 2006, the company completed the sale of its Latrobe Steel subsidiary. Sales and Adjusted EBIT from these
operations are included in discontinued operations. Previously reported amounts for the Steel Group have been adjusted to
remove the Latrobe Steel operations. The Steel Group’s 2006 net sales increased over 2005 primarily due to increased pricing
and surcharges to recover high raw material and energy costs, as well as strong demand in industrial and energy market sectors,
partially offset by lower automotive demand. The increase in the Steel Group’s profitability in 2006 compared to 2005 was
primarily due to a favorable sales mix, improved manufacturing productivity and increased pricing. The company expects the Steel
Group to continue to benefit from strong demand in industrial and energy market sectors. The company also expects the Steel
Group’s Adjusted EBIT to be slightly higher in 2007 primarily due to price increases and higher manufacturing productivity. Scrap
costs are expected to decline from their current level, while alloy and energy costs are expected to remain at high levels.
However, these costs are expected to be recovered through surcharges and price increases.
26
104
Overview:
2005
2004
$Change
% Change
4,287.2
134.1
1.6
135.7
$536.0
99.6
25.0
124.6
12.5%
74.3%
NM
91.8%
1.48
0.01
$
1.49
90,759,571
$ 1.04
0.28
$ 1.32
—
70.3%
NM
88.6%
2.0%
$Change
% Change
Net sales
Income from discontinuted operations
Net income
$
4,823.2
233.7
26.6
260.3
$
2.52
0.29
$
2.81
92,537,529
$
$
Sales by Segment:
2005
2004
Industrial Group
Automotive Group
Steel Group
Total Company
$1,925.2
1,661.1
1,236.9
$4,823.2
$1,709.8
1,582.2
995.2
$4,287.2
$215.4
78.9
241.7
$536.0
12.6%
5.0%
24.3%
12.5%
The Industrial Group’s net sales increased from 2004 to 2005 due to higher volume and improved product mix. Many end markets
were strong, especially mining, metals, rail, aerospace and oil and gas, which also drove strong distribution sales. The Automotive
Group’s net sales increased from 2004 to 2005 due to improved pricing and growth in medium- and heavy-truck markets. The
Steel Group’s net sales increased from 2004 to 2005 due to strong industrial, aerospace and energy sector demand, as well as
increased pricing and surcharges to recover high raw material and energy costs.
Gross Profit:
2005
2004
$Change
Change
$1,000.0
20.7%
$824.4
19.2%
$175.6
—
21.3%
150bps
$
$
$ 10.0
Gross profit
Rationalization and integration charges included in cost of
products sold
14.5
4.5
NM
Gross profit benefited from price increases and surcharges, favorable sales volume and mix. In 2005, manufacturing
rationalization and integration charges related to the rationalization of the company’s Canton, Ohio bearing facilities and costs for
certain facilities in Torrington, Connecticut. In 2004, manufacturing rationalization and integration charges related primarily to
expenses associated with the integration of Torrington.
27
105
2005
2004
$Change
$646.9
13.4%
$575.9
13.4%
$ 71.0
—
$
$ 22.5
$(19.7)
Change
Rationalization expenses included in selling, administrative and
general expenses
2.8
12.3%
0bps
(87.6)%
The increase in selling, administrative and general expenses in 2005 compared to 2004 was primarily due to higher costs
associated with performance-based compensation and growth initiatives, partially offset by lower rationalization and integration
charges. Growth initiatives included investments in Project O.N.E., as well as targeted geographic growth in Asia.
In 2005, the rationalization and integration charges primarily related to the rationalization of the company’s Canton, Ohio bearing
facilities and costs associated with the Torrington acquisition. In 2004, the manufacturing rationalization and integration charges
related primarily to expenses associated with the integration of Torrington, mostly for information technology and purchasing
initiatives.
2005
2004
$ 0.8
20.3
5.0
$26.1
$ 8.5
4.3
0.7
$13.5
$Change
Impairment charges
Exit costs
Total
$ (7.7)
16.0
4.3
$12.6
In 2005, the company recorded approximately $20.3 million of severance and related benefit costs and $2.8 million of exit costs
as a result of environmental charges related to the closure of manufacturing facilities in Clinton, South Carolina, and administrative
facilities in Torrington, Connecticut and Norcross, Georgia. These closures are part of the restructuring plans for the Automotive
Group announced in July 2005.
Asset impairment charges of $0.8 million and exit costs of $2.2 million related to environmental charges were recorded in 2005 as
a result of the rationalization of the company’s three bearing plants in Canton, Ohio within the Industrial Group.
In 2004, the impairment charges related primarily to the write-down of property, plant and equipment at one of the Steel Group’s
facilities, based on the company’s estimate of its fair value. The severance and related benefit costs related to associates who
exited the company as a result of the integration of Torrington. The exit costs related primarily to domestic facilities.
28
106
2005
2004
$51.6
$ 3.4
$50.8
$ 1.4
$Change
% Change
Interest expense
Interest income
$0.8
$2.0
1.6%
142.9%
Interest expense in 2005 compared to 2004 increased slightly due to higher effective interest rates. Interest income increased due
to higher cash balances and interest rates.
2005
2004
$Change
% Change
$ 77.1
$ 44.4
$32.7
73.6%
Other expense — net:
Gain on divestitures of non-strategic assets
Loss on dissolution of subsidiary
Other
$ 8.9
(0.6)
(17.7)
$ (9.4)
$ 16.4
(16.2)
(32.5)
$(32.3)
$ (7.5)
15.6
14.8
$22.9
(45.7)%
96.3%
45.5%
70.9%
CDSOA receipts are reported net of applicable expenses. In 2005, the company received CDSOA receipts, net of expenses, of
$77.1 million. In 2004, the CDSOA receipts of $44.4 million were net of the amounts that Timken delivered to the seller of the
Torrington business, pursuant to the terms of the agreement under which the company purchased Torrington. In 2004, Timken
delivered to the seller of the Torrington business 80% of the CDSOA payments received for Torrington’s bearing business.
In 2005, the gain on divestitures of non-strategic assets of $8.9 million related to the sale of certain non-strategic assets, which
included NRB Bearings, a joint venture based in India, and the Industrial Group’s Linear Motion Systems business, based in
Europe. In 2004, the $16.4 million gain included the sale of real estate at a facility in Duston, England, which ceased operations in
2002, offset by a loss on the sale of the company’s Kilian bearing business, which was acquired in the Torrington acquisition.
In 2004, the company began the process of liquidating one of its inactive subsidiaries, British Timken Ltd., located in Duston,
England. The company recorded non-cash charges on dissolution of $0.6 million and $16.2 million in 2005 and 2004, respectively,
which related primarily to the transfer of cumulative foreign currency translation losses to the Statement of Income.
For 2005, other expense included losses on the disposal of assets, losses from equity investments, donations, minority interests
and foreign currency exchange losses. For 2004, other expense included losses from equity investments, losses on the disposal
of assets, foreign currency exchange losses, donations, minority interests, and a non-cash charge for the adoption of FASB
Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51” (FIN
46). During 2004, the company consolidated its investment in its joint venture, PEL, in accordance with FIN 46. The company
previously accounted for its investment in PEL using the equity method. Refer to Note 12 — Equity Investments in the Notes to
Consolidated Financial Statements for additional discussion.
29
107
Income Tax Expense:
2005
2004
$112.9
32.6%
$63.5
32.2%
$Change
% Change
Income tax expense
Effective tax rate
$49.4
—
77.8%
40bps
The effective tax rate for 2005 was less than the U.S. statutory tax rate due to tax benefits on foreign income, including the
extraterritorial income exclusion on U.S. exports, tax holidays in China and the Czech Republic, and earnings of certain foreign
subsidiaries being taxed at a rate less than 35%, as well as the aggregate tax benefit of other U.S. tax items. These benefits were
offset partially by taxes incurred on foreign remittances, including a remittance during the fourth quarter of 2005 pursuant to the
AJCA, U.S. state and local income taxes and the inability to record a tax benefit for losses at certain foreign subsidiaries.
The effective tax rate for 2004 was less than the U.S. statutory tax rate due to benefits from the settlement of prior years’ liabilities,
the changes in the tax status of certain foreign subsidiaries, benefits of tax holidays in China and the Czech Republic, earnings of
certain subsidiaries being taxed at a rate less than 35% and the aggregate impact of certain other items. These benefits were
partially offset by the establishment of a valuation allowance against certain deferred tax assets associated with loss
carryforwards attributable to a subsidiary that was in the process of liquidation, U.S. state and local income taxes, taxes incurred
on foreign remittances and the inability to record a tax benefit for losses at certain foreign subsidiaries.
Discontinued Operations:
2005
2004
$26.6
$1.6
$Change
% Change
Operating results, net of tax
$25.0
NM
In December 2006, the company completed the divestiture of its Latrobe Steel subsidiary. Discontinued operations represent the
operating results, net of tax, of this business in 2005 and 2004.
30
108
Business Segments:
Industrial Group:
2005
2004
$1,927.1
$ 199.9
10.4%
$1,711.2
$ 177.9
10.4%
$Change
Change
$215.9
$ 22.0
—
12.6%
12.4%
0bps
Adjusted EBIT
The Industrial Group’s net sales increased in 2005 due to higher volume and improved product mix. Many end markets were
strong, especially mining, metals, rail, aerospace and oil and gas, which also drove strong distribution sales. While sales
increased in 2005, adjusted EBIT margin was comparable to 2004, as volume growth and pricing were partially offset by higher
manufacturing costs associated with ramping up of capacity to meet customer demand, investments in the Asia growth initiative
and Project O.N.E., and write-offs of obsolete and slow-moving inventory. During 2005, operations were expanded in Wuxi, China
to serve industrial customers. The company also increased capacity at two large-bore bearings operations located in Ploiesti,
Romania and Randleman (Asheboro), North Carolina.
Automotive Group:
2005
2004
$Change
Change
$1,661.1
$ (19.9)
(1.2)%
$1,582.2
$ 15.9
1.0%
$ 78.9
$(35.8)
—
5.0%
NM
(220)bps
The Automotive Group’s net sales increased in 2005 due to improved pricing and increased demand for heavy truck products,
partially offset by reduced volume for light vehicle products. While the Automotive Group’s improved sales favorably impacted
profitability, it was more than offset by the higher manufacturing costs associated with ramping up plants serving industrial
customers and from reduced unit volume from light vehicle customers. Automotive results were also impacted by investments in
Project O.N.E. and an increase in the accounts receivable reserve.
During 2005, the company announced a restructuring plan as part of its effort to improve Automotive Group performance and
address challenges in the automotive markets. The company recorded approximately $20.3 million of severance and related
benefit costs and $2.8 million of exit costs as a result of environmental and curtailment charges related to the closure of
manufacturing facilities in Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross, Georgia.
Steel Group:
2005
2004
$1,415.1
$ 175.8
12.4%
$1,157.1
$ 52.7
4.6%
$Change
Change
$258.0
$123.1
—
22.3%
NM
780bps
Adjusted EBIT
The Steel Group’s 2005 net sales increased over 2004 due to strong demand in industrial and energy market sectors, as well as
increased pricing and surcharges to recover high raw material and energy costs. The Steel Group’s improved profitability reflected
price increases and surcharges to recover high raw material costs, improved volume and mix, as well as continued high labor
productivity.
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109
The Balance Sheet
Total assets, as shown on the Consolidated Balance Sheet at December 31, 2006, increased by $37.8 million from December 31,
2005. This increase was primarily due to increased property, plant and equipment — net, and working capital from continuing
operations required to support higher sales, partially offset by the decrease in assets of discontinued operations that were part of
the sale of Latrobe Steel.
Current Assets:
12/31/2006
12/31/2005
$Change
% Change
Accounts receivable, net
Inventories, net
Total current assets
$ 101.1
673.4
952.3
85.6
11.1
—
76.8
$1,900.3
$
65.4
657.3
900.3
97.7
17.9
162.2
82.5
$1,983.3
$ 35.7
16.1
52.0
(12.1)
(6.8)
(162.2)
(5.7)
$ (83.0)
54.6%
2.4%
5.8%
(12.4)%
(38.0)%
(100.0)%
(6.9)%
(4.2)%
The increase in cash and cash equivalents in 2006 was primarily due to proceeds from the sale of Latrobe Steel, offset by the
payment of debt. Refer to the Consolidated Statement of Cash Flows for further explanation. Net accounts receivable increased
primarily due to the impact of foreign currency translation and higher sales in the fourth quarter of 2006 as compared to 2005. The
increase in inventories was primarily due to the impact of foreign currency translation, higher volume and increased raw material
costs. The decrease in deferred income taxes was the result of the utilization of certain loss carryforwards and tax credits in 2006.
Current assets of discontinued operations at December 31, 2005 reflect the total current assets of Latrobe Steel.
Property, Plant and Equipment — Net:
12/31/2006
12/31/2005
$Change
$ 3,664.8
(2,063.3)
$ 1,601.5
$ 3,441.6
(1,967.5)
$ 1,474.1
$223.2
(95.8)
$127.4
% Change
Property, plant and equipment
Less: allowances for depreciation
6.5%
4.9%
8.6%
The increase in property, plant and equipment — net was primarily due to capital expenditures exceeding depreciation expense
and the impact of foreign currency translation.
Other Assets:
12/31/2006
12/31/2005
$Change
$201.9
104.1
169.4
—
54.3
$529.7
$204.1
179.0
1.9
81.2
70.1
$536.3
$ (2.2)
(74.9)
167.5
(81.2)
(15.8)
$ (6.6)
% Change
Goodwill
Total other assets
(1.1)%
(41.8)%
NM
(100.0)%
(22.5)%
(1.2)%
The decrease in goodwill in 2006 was primarily due to the impairment loss recorded on Automotive Group goodwill of
$11.9 million in accordance with SFAS No. 142, mostly offset by acquisitions. Other intangible assets decreased primarily due to
adoption of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment
of FASB Statements No. 87, 88, 106 and 132(R),” which eliminates the pension intangible asset. The increase in deferred income
taxes was primarily due to deferred tax assets recorded in conjunction with the adoption of SFAS No. 158. Non-current assets of
discontinued operations at December 31, 2005 reflect the total non-current assets, including property, plant and equipment, of
Latrobe Steel.
32
110
Current Liabilities:
12/31/2006
12/31/2005
$ 40.2
506.3
225.4
52.8
0.6
—
10.2
$835.5
$
$Change
% Change
Short-term debt
Total current liabilities
63.4
471.0
364.0
30.5
4.9
41.7
95.8
$1,071.3
$ (23.2) (36.6)%
35.3
7.5%
(138.6) (38.1)%
22.3
73.1%
(4.3) (87.8)%
(41.7) (100.0)%
(85.6) (89.4)%
$(235.8) (22.0)%
The decrease in short-term debt was the result of the repayment of debt held by PEL, an equity investment of the company. The
increase in accounts payable and other liabilities was primarily due to an increase in severance accruals and foreign currency
translation. The decrease in salaries, wages and benefits was primarily due to a decrease in the current portion of accrued
pension cost. At December 31, 2006, the current portion of accrued pension costs and accrued postretirement costs relate to
unfunded plans and represent the actuarial present value of expected payments related to these plans to be made over the next
twelve months pursuant to SFAS No. 158. At December 31, 2005, the current portion of accrued pension costs was based upon
the company’s estimate of contributions to its pension plans in the next twelve months. The increase in income taxes payable was
primarily due to the full utilization of U.S. tax loss carryforwards and the impact of a tax audit settlement in 2006. The current
liabilities of discontinued operations at December 31, 2005 reflect the total current liabilities of Latrobe Steel. The current portion
of long-term debt decreased primarily due to the payment of debt, partially offset by the reclassification of debt maturing within the
next twelve months to current.
Non-Current Liabilities:
12/31/2006
12/31/2005
$Change % Change
$ 547.4
410.4
682.9
6.7
—
72.4
$1,719.8
$ 561.7
242.4
488.5
36.6
35.9
60.2
$1,425.3
$ (14.3)
(2.5)%
168.0
69.3%
194.4
39.8%
(29.9) (81.7)%
(35.9) (100.0)%
12.2
20.3%
$294.5
20.7%
Long-term debt
Total non-current liabilities
The decrease in long-term debt was primarily due to the reclassification of long-term debt to current for debt maturing within the
next twelve months, partially offset by debt assumed in the consolidation of a joint venture. The increase in accrued pension cost
and accrued postretirement benefits cost increase as a result of the adoption of SFAS No. 158. The amounts at December 31,
2006 for both accrued pension cost and accrued postretirement benefits cost reflect the funded status of the company’s defined
benefit pension and postretirement benefit plans. In 2005, the net unrecognized actuarial losses, unrecognized prior service costs
and unrecognized transition obligation remaining from the initial adoption of SFAS No. 87 and SFAS No. 106 were netted against
the funded status. Refer to Note 13 — Retirement and Postretirement Benefit Plans in the Notes to Consolidated Financial
Statements. The non-current liabilities of discontinued operations at December 31, 2005 reflect the total non-current liabilities of
Latrobe Steel. The decrease in deferred income taxes was primarily due to an adjustment to reflect a tax audit settlement in 2006
and the classification of the year-end net asset balance to non-current deferred tax assets.
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111
Shareholders’ Equity:
12/31/2006
12/31/2005
$Change % Change
$ 806.2
1,217.2
(544.6)
(2.6)
$1,476.2
$ 772.1
1,052.9
(323.5)
(4.4)
$1,497.1
$ 34.1
4.4%
164.3 15.6%
(221.1) 68.3%
1.8 (40.9)%
$ (20.9) (1.4)%
Common stock
Treasury shares
Total shareholders’ equity
The increase in common stock in 2006 related to stock option exercises by employees and the related income tax benefits.
Earnings invested in the business were increased in 2006 by net income, partially reduced by dividends declared. The increase in
accumulated other comprehensive loss was primarily due to the amounts recorded in conjunction with the adoption of SFAS
No. 158, partially offset by the increase in the foreign currency translation adjustment. The increase in the foreign currency
translation adjustment was due to weakening of the U.S. dollar relative to other currencies, such as the Romanian lei, the Brazilian
real and the Euro. For discussion regarding the impact of foreign currency translation, refer to Item 7A. Quantitative and
Qualitative Disclosures About Market Risk.
Cash Flows:
12/31/2006
12/31/2005
$Change
$ 336.9
(130.9)
(176.7)
6.3
$ 35.6
$ 318.7
(242.8)
(56.3)
(5.2)
$ 14.4
$ 18.2
111.9
(120.4)
11.5
$ 21.2
Net cash provided by operating activities
Net cash used by investing activities
Net cash used by financing activities
Increase in cash and cash equivalents
The net cash provided by operating activities of $336.9 million for 2006 increased from 2005 with operating cash flows from
discontinued operations increasing $42.6 million, partially offset by operating cash flows from continuing operations decreasing
$24.4 million. The decrease in net cash provided by operating activities from continuing operations was primarily the result of
lower income from continuing operations of $176.4 million, adjusted for non-cash items of $266.5 million in 2006, compared to
income from continuing operations of $233.7 million, adjusted for non-cash items of $301.3 million, in 2005. The decrease in noncash items was driven by a deferred tax benefit in 2006 compared to expense in 2005, partially offset by higher impairment and
restructuring charges and losses on the sale of non-strategic assets. The lower net income from continuing operations, adjusted
for non-cash items, was partially offset by the reduction in the use of cash for working capital requirements, primarily inventories,
partially offset by accounts payable and accrued expenses. Inventory was a use of cash of $6.7 million in 2006 compared to a use
of cash of $137.3 million in 2005. Excluding cash contributions to the company’s U.S.-based pension plans, accounts payable and
accrued expenses were a source of cash of $120.3 million in 2006, compared to a source of cash of $175.7 million in 2005. The
company made cash contributions to its U.S.-based pension plans in 2006 of $242.6 million, compared to $226.2 million in 2005.
The increase in operating cash flows from discontinued operations was primarily due to working capital items, primarily inventory.
The decrease in net cash used by investing activities in 2006 compared to 2005 was primarily due to higher cash proceeds from
divestitures and lower acquisition activity, partially offset by higher capital expenditures. The cash proceeds from divestitures
increased $181.5 million primarily due to the sale of the company’s Latrobe Steel subsidiary. Capital expenditures increased
$78.7 million in 2006 compared to 2005 primarily to fund Industrial Group growth initiatives and Project O.N.E. In addition, cash
used by investing activities of discontinued operations increased $18.3 million in 2006 primarily due to the buyout of a rolling mill
operating lease in conjunction with the sale of Latrobe Steel.
The increase in net cash used by financing activities was primarily due to the company decreasing its net borrowings
$141.4 million in 2006 after decreasing its net borrowings $40.9 million in 2005. In addition, proceeds from the exercise of stock
options decreased during 2006 compared to 2005.
34
112
Liquidity and Capital Resources
Total debt was $597.8 million at December 31, 2006 compared to $720.9 million at December 31, 2005. Net debt was
$496.7 million at December 31, 2006 compared to $655.5 million at December 31, 2005. The net debt to capital ratio was 25.2%
at December 31, 2006 compared to 30.5% at December 31, 2005.
Reconciliation of total debt to net debt and the ratio of net debt to capital:
Net Debt:
12/31/2006
12/31/2005
$ 40.2
10.2
547.4
597.8
(101.1)
$ 496.7
$ 63.4
95.8
561.7
720.9
(65.4)
$655.5
12/31/2006
12/31/2005
$ 496.7
1,476.2
$ 1,972.9
25.2%
$ 655.5
1,497.1
$ 2,152.6
30.5%
Short-term debt
Long-term debt
Total debt
Net debt
Net debt
The company presents net debt because it believes net debt is more representative of the company’s indicative financial position.
At December 31, 2006, the company had no outstanding borrowings under its $500 million Amended and Restated Credit
Agreement (Senior Credit Facility), and letters of credit outstanding totaling $33.8 million, which reduced the availability under the
Senior Credit Facility to $466.2 million. The Senior Credit Facility matures on June 30, 2010. Under the Senior Credit Facility, the
company has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. At December 31,
2006, the company was in full compliance with the covenants under the Senior Credit Facility and its other debt agreements.
Refer to Note 5 — Financing Arrangements in the Notes to Consolidated Financial Statements for further discussion.
At December 31, 2006, the company had no outstanding borrowings under the company’s Asset Securitization, which provides for
borrowings up to $200 million, limited to certain borrowing base calculations, and is secured by certain domestic trade receivables
of the company. As of December 31, 2006, there were letters of credit outstanding totaling $16.7 million, which reduced the
availability under the Asset Securitization to $183.3 million.
The company expects that any cash requirements in excess of cash generated from operating activities will be met by the
availability under its Asset Securitization and Senior Credit Facility. The company believes it has sufficient liquidity to meet its
obligations through 2010.
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113
Financing Obligations and Other Commitments
The company’s contractual debt obligations and contractual commitments outstanding as of December 31, 2006 are as follows:
Payments due by Period:
Contractual Obligations
Interest payments
Long-term debt, including current portion
Short-term debt
Operating leases
Total
Total
$ 336.6
557.6
40.2
133.8
$1,068.2
Less than
1 Year
1–3 Years
3–5 Years
More than
5 Years
$ 33.9
10.2
40.2
28.7
$113.0
$ 62.0
34.0
—
38.9
$134.9
$ 35.8
299.9
—
24.1
$359.8
$204.9
213.5
—
42.1
$460.5
The interest payments are primarily related to medium-term notes that mature over the next twenty-eight years.
The company expects to make cash contributions of $100.0 million to its global defined benefit pension plans in 2007. Refer to
Note 13 — Retirement and Postretirement Benefit Plans in the Notes to Consolidated Financial Statements.
During 2006, the company did not purchase any shares of its common stock as authorized under the company’s 2000 common
stock purchase plan. This plan authorized 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, and authorized
purchases up to an aggregate of $180 million. This plan expired on December 31, 2006. On November 3, 2006 the company
adopted its 2006 common stock purchase plan, effective January 1, 2007. The 2006 common stock purchase plan authorizes the
company to buy in the open market or in privately negotiated transactions up to four million shares of common stock. This plan
authorizes purchases up to an aggregate of $180 million. The company may exercise this authorization until December 31, 2012.
The company does not expect to be active in repurchasing its shares under the plan in the near-term.
The company does not have any off-balance sheet arrangements with unconsolidated entities or other persons.
Recently Adopted Accounting Pronouncements:
In December 2004, the FASB issued SFAS No. 123 (revised 2004), (SFAS No. 123(R)) “Share-Based Payment,” which requires
the measurement and recognition of compensation expense based on estimated fair value for all share-based payment awards
including grants of employee stock options. The company adopted the provisions of SFAS No. 123(R) using the modified
prospective transition method beginning January 1, 2006. Prior to the adoption of SFAS No. 123(R), the company previously
accounted for stock-based payment awards in accordance with Accounting Principles Board Opinion No. 25 (APB 25),
“Accounting for Stock Issued to Employees.” In accordance with the transition method, the company did not restate prior periods
for the effect of compensation expense calculated under SFAS No. 123(R). The company selected the Black-Scholes optionpricing model as the most appropriate method for determining the estimated fair value of all of its awards. The adoption of SFAS
No. 123(R) reduced income before income taxes for 2006 by $6.0 million and reduced net income for 2006 by $3.8 million ($0.04
per diluted share). The adoption of SFAS No. 123(R) had no material effect on the Consolidated Statement of Cash Flows for
2006. See Note 9 — Stock-Based Compensation in the Notes to the Consolidated Financial Statements for more information on
the impact of this new standard.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which changes the accounting for
and reporting of a change in accounting principle. This statement also carries forward the guidance from APB No. 20 regarding
the correction of an error and changes in accounting estimates. This statement requires retrospective application to prior period
financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific or
cumulative effects of the change. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after
December 15, 2005. The adoption of this standard did not have an impact on the company’s results of operations or financial
condition.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other
Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132(R).” SFAS No. 158 requires a company to
(a) recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under funded
status, (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year,
and (c) recognize changes in the funded status of a defined postretirement plan in the year in which the changes occur (reported
in comprehensive income). The requirement to recognize the funded status of a benefit plan and the disclosure requirements
were adopted by the company effective December 31, 2006 and reduced stockholders’ equity by $332.4 million. Refer to Note 13
— Retirement and Postretirement Benefit Plans for additional discussion on the impact of adopting SFAS No. 158.
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114
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB) 108, “Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 requires that public companies
utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an
income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 was adopted by the
company effective December 31, 2006, and the guidance did not have a material effect on the company’s results of operations
and financial condition.
Recently Issued Accounting Pronouncements:
In July 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes.” This interpretation clarifies the accounting
for uncertain tax positions recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income
Taxes.” FIN 48 prescribes requirements and other guidance for financial statement recognition and measurement of positions
taken or expected to be taken on tax returns. This interpretation is effective for fiscal years beginning after December 15, 2006.
The cumulative effect of adopting FIN 48 is recorded as an adjustment to the opening balance of retained earnings in the period of
adoption. The company will adopt FIN 48 as of January 1, 2007. Management is currently in the process of evaluating the impact
of FIN 48 on the company’s Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a framework for
measuring fair value that is based on the assumptions market participants would use when pricing an asset or liability and
establishes a fair value hierarchy that prioritizes the information to develop those assumptions. Additionally, the standard expands
the disclosures about fair value measurements to include separately disclosing the fair value measurements of assets or liabilities
within each level of the fair value hierarchy. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The
company is currently evaluating the impact of adopting SFAS No. 157 on the company’s results of operations and financial
condition.
Critical Accounting Policies and Estimates:
The company’s financial statements are prepared in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the periods presented. The following paragraphs include a discussion of some critical areas that require a higher
degree of judgment, estimates and complexity.
Revenue recognition:
The company’s revenue recognition policy is to recognize revenue when title passes to the customer. This occurs at the shipping
point, except for certain exported goods and certain foreign entities, for which it occurs when the goods reach their destination.
Selling prices are fixed based on purchase orders or contractual arrangements.
Goodwill:
SFAS No. 142 requires that goodwill and indefinite-lived intangible assets be tested for impairment at least annually. Furthermore,
goodwill is reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be
recoverable. The company engages an independent valuation firm and performs its annual impairment test during the fourth
quarter after the annual forecasting process is completed. In 2006, the carrying value of the company’s Automotive reporting units
exceeded their fair value. As a result, an impairment loss of $11.9 million was recognized. Refer to Note 8 — Goodwill and Other
Intangible Assets in the Notes to Consolidated Financial Statements. In 2005 and 2004, the fair values of the company’s reporting
units exceeded their carrying values, and no impairment losses were recognized.
Restructuring costs:
The company’s policy is to recognize restructuring costs in accordance with SFAS No. 146, “Accounting for Costs Associated with
Exit or Disposal Activities” and SFAS No. 112, “Employers’ Accounting for Postemployment Benefits—an amendment of FASB
Statements No. 5 and 43.” Detailed contemporaneous documentation is maintained and updated to ensure that accruals are
properly supported. If management determines that there is a change in estimate, the accruals are adjusted to reflect this change.
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115
Benefit plans:
The company sponsors a number of defined benefit pension plans, which cover eligible associates. The company also sponsors
several unfunded postretirement plans that provide health care and life insurance benefits for eligible retirees and dependents.
The measurement of liabilities related to these plans is based on management’s assumptions related to future events, including
discount rate, return on pension plan assets, rate of compensation increases and health care cost trend rates. The discount rate is
determined using a model that matches corporate bond securities against projected future pension and postretirement
disbursements. Actual pension plan asset performance either reduces or increases net actuarial gains or losses in the current
year, which ultimately affects net income in subsequent years.
For expense purposes in 2006 and 2005, the company applied a discount rate of 5.875% and an expected rate of return of 8.75%
for the company’s pension plan assets. The assumption for expected rate of return on plan assets was not changed from 8.75%
for 2007. A 0.25 percentage point reduction in the discount rate would increase pension expense by approximately $5.0 million for
2007. A 0.25 percentage point reduction in the expected rate of return would increase pension expense by approximately
$4.7 million for 2007.
For measurement purposes for postretirement benefits, the company assumed a weighted-average annual rate of increase in the
per capita cost (health care cost trend rate) for medical benefits of 8.0% for 2007, declining gradually to 5.0% in 2010 and
thereafter; and 11.25% for 2007, declining gradually to 5.0% in 2014 and thereafter for prescription drug benefits. 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 2006 total service and interest components by $1.2 million and
would have increased the postretirement obligation by $20.9 million. A one percentage point decrease would provide
corresponding reductions of $1.2 million and $20.0 million, respectively.
The U.S. Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Medicare Act) was signed into law on
December 8, 2003. The Medicare Act provides for prescription drug benefits under Medicare Part D and contains a subsidy to
plan sponsors who provide “actuarially equivalent” prescription plans. In May 2004, the FASB issued FASB Staff Position No. FAS
106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act
of 2003” (FSP 106-2). During 2005, the company’s actuary determined that the prescription drug benefit provided by the
company’s postretirement plan is considered to be actuarially equivalent to the benefit provided under the Medicare Act. The
effects of the Medicare Act are reductions to the accumulated postretirement benefit obligation and net periodic postretirement
benefit cost of $53.3 million and $7.8 million, respectively. The 2006 expected Medicare subsidy was $3.1 million, of which
$1.0 million was received in 2006.
Income taxes:
Deferred income taxes are provided for the temporary differences between the financial reporting basis and tax basis of the
company’s assets and liabilities. SFAS No. 109, “Accounting for Income Taxes,” requires that a valuation allowance be
established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. The company estimates
current tax due and temporary differences, resulting from the different treatment of items for tax and financial reporting purposes.
These differences result in deferred tax assets and liabilities that are included within the Consolidated Balance Sheet. Based on
known and projected earnings information and prudent tax planning strategies, the company then assesses the likelihood that
deferred tax assets will be realized. If the company determines it is more likely than not that a deferred tax asset will not be
realized, a charge is recorded to establish a valuation allowance against it, which increases income tax expense in the period in
which such determination is made. In the event that the company later determines that realization of the deferred tax asset is
more likely than not, a reduction in the valuation allowance is recorded, which reduces income tax expense in the period in which
such determination is made. Net deferred tax assets relate primarily to pension and postretirement benefits, which the company
believes are more likely than not to result in future tax benefits. Significant management judgment is required in determining the
provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against deferred tax assets.
Historically, actual results have not differed significantly from those used in determining the estimates described above.
Other loss reserves:
The company has a number of loss exposures incurred in the ordinary course of business such as environmental claims, product
liability, product warranty, litigation and accounts receivable reserves. Establishing loss reserves for these matters requires
management’s estimate and judgment with regards to 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.
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116
Other Matters:
ISO 14001
The company continues its efforts to protect the environment and comply with environmental protection laws. Additionally, it has
invested in pollution control equipment and updated plant operational practices. The company is committed to implementing a
documented environmental management system worldwide and to becoming certified under the ISO 14001 standard to meet or
exceed customer requirements. As of the end of 2006, 30 of the company’s plants had ISO 14001 certification. The company
believes it has established adequate reserves to cover its environmental expenses and has a well-established environmental
compliance audit program, which includes a proactive approach to bringing its domestic and international units to higher
standards of environmental performance. This program measures performance against local laws, as well as standards that have
been established for all units worldwide. It is difficult to assess the possible effect of compliance with future requirements that
differ from existing ones. As previously reported, the company is unsure of the future financial impact to the company that could
result from the United States Environmental Protection Agency’s (EPA’s) final rules to tighten the National Ambient Air Quality
Standards for fine particulate and ozone.
The company and certain of its U.S. subsidiaries have been designated as potentially responsible parties by the EPA for site
(Superfund). The claims for remediation have been asserted against numerous other entities, which are believed to be financially
solvent and are expected to fulfill their proportionate share of the obligation. Management believes any ultimate liability with
respect to all pending actions will not materially affect the company’s results of operations, cash flows or financial position.
The U.S. government previously had eight antidumping duty orders in effect covering ball bearings from France, Germany, Italy,
Japan, Singapore and the United Kingdom, tapered roller bearings from China and spherical plain bearings from France. The
company is a producer of all of these products in the United States. The U.S. government conducted five-year sunset reviews on
each of these eight antidumping duty orders in order to determine whether or not each should remain in effect. On August 3,
2006, the U.S. International Trade Commission continued six of the eight antidumping orders under review. Two antidumping
orders, relating to spherical plain bearings from France and ball bearings from Singapore, are no longer in effect. The other six
orders, covering ball bearings from France, Germany, Italy, Japan and the United Kingdom and tapered roller bearings from
China, will remain in effect for an additional five years, when another sunset review process will take place. The non-renewal of
the two antidumping orders is not expected to have a material adverse impact on the company’s revenues or profitability.
In September 2002, the WTO ruled that such payments are not consistent with international trade rules. In February 2006, U.S.
legislation was enacted that would end CDSOA distributions for imports covered by antidumping duty orders entering the U.S.
after September 30, 2007. Instead, any such antidumping duties collected would remain with the U.S. Treasury. This legislation is
not expected to have a significant effect on potential CDSOA distributions in 2007, but would be expected to reduce any
distributions in years beyond 2007, with distributions eventually ceasing.
determining recipients eligible to receive CDSOA distributions is unconstitutional. The CIT has not ruled on other matters,
including any remedy as a result of its ruling. The company expects that these rulings of the CIT will be appealed. The company is
In addition to the CIT rulings, there are a number of other factors that can affect whether the company receives any CDSOA
changes in the law, ongoing and potential additional legal challenges to the law and the administrative operation of the law.
Accordingly, the company cannot reasonably estimate the amount of CDSOA distributions it will receive in future years, if any.
Quarterly Dividend
On February 6, 2007, the company’s Board of Directors declared a quarterly cash dividend of $0.16 per share. The dividend will
be paid on March 2, 2007 to shareholders of record as of February 16, 2007. This will be the 339th consecutive dividend paid on
the common stock of the company.
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Forward — Looking Statements
Certain statements set forth in this document and in the company’s 2006 Annual Report to Shareholders (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. In particular, Management’s Discussion and Analysis on pages 19 through 39
contain numerous forward-looking statements. 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 important factors,
such as:
a) 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;
b) 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 the rapid changes in customer demand, 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;
c) 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;
d) 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; higher cost and availability of raw materials and
energy; the company’s ability to mitigate the impact of fluctuations in raw materials and energy costs and the operation of the
company’s surcharge mechanism; changes in the expected costs associated with product warranty claims; changes resulting
from inventory management and cost reduction initiatives and different levels of customer demands; the effects of unplanned
work stoppages; and changes in the cost of labor and benefits;
e) the success of the company’s operating plans, including its ability to achieve the benefits from its ongoing continuous
improvement and rationalization programs; the ability of acquired companies to achieve satisfactory operating results; and the
company’s ability to maintain appropriate relations with unions that represent company associates in certain locations in order
to avoid disruptions of business;
f) 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;
g) 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; and
h) those items identified under Item 1A. Risk Factors on pages 8 through 12.
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 forwardlooking statement, whether as a result of new information, future events or otherwise.
40
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Changes in short-term interest rates related to several separate funding sources impact the company’s earnings. These sources
are borrowings under an Asset Securitization, borrowings under the $500 million Senior Credit Facility, floating rate tax-exempt
U.S. municipal bonds with a weekly reset mode and short-term bank borrowings at international subsidiaries. The company is also
sensitive to market risk for changes in interest rates, as they influence $80 million of debt that is subject to interest rate swaps.
The company has interest rate swaps with a total notional value of $80 million to hedge a portion of its fixed-rate debt. Under the
terms of the interest rate swaps, the company receives interest at fixed rates and pays interest at variable rates. The maturity
dates of the interest rate swaps are January 15, 2008 and February 15, 2010. If the market rates for short-term borrowings
increased by one-percentage-point around the globe, the impact would be an increase in interest expense of $2.3 million with a
corresponding decrease in income before income taxes of the same amount. The amount was determined by considering the
impact of hypothetical interest rates on the company’s borrowing cost, year-end debt balances by category and an estimated
impact on the tax-exempt municipal bonds’ interest rates.
Fluctuations in the value of the U.S. dollar compared to foreign currencies, predominately in European countries, also impact the
company’s earnings. The greatest risk relates to products shipped between the company’s European operations and the United
States. Foreign currency forward contracts are used to hedge these intercompany transactions. Additionally, hedges are used to
cover third-party purchases of product and equipment. As of December 31, 2006, there were $247.6 million of hedges in place. A
uniform 10% weakening of the U.S. dollar against all currencies would have resulted in a charge of $20.4 million for these hedges.
In addition to the direct impact of the hedged amounts, changes in exchange rates also affect the volume of sales or foreign
currency sales price as competitors’ products become more or less attractive.
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119
Item 8. Financial Statements and Supplementary Data
2006
2005
2004
Net sales
Gross Profit
$4,973,365
3,967,521
1,005,844
$4,823,167
3,823,210
999,957
$4,287,197
3,462,821
824,376
Operating Income
677,342
44,881
64,271
219,350
646,904
26,093
—
326,960
575,910
13,538
—
234,928
Interest expense
Interest income
Receipt of Continued Dumping & Subsidy Offset Act (CDSOA) payment, net of
expenses
Income from discontinued operations, net of income taxes
Net Income
(49,387)
4,605
(51,585)
3,437
(50,834)
1,397
87,907
(8,241)
$ 254,234
77,795
$ 176,439
46,088
$ 222,527
77,069
(9,343)
$ 346,538
112,882
$ 233,656
26,625
$ 260,281
44,429
(32,329)
$ 197,591
63,545
$ 134,046
1,610
$ 135,656
$
1.89
0.49
2.38
$
2.55
0.29
2.84
$
1.87
0.49
2.36
$
2.52
0.29
2.81
$
Earnings Per Share:
$
$
$
$
$
$
$
1.49
0.02
1.51
1.48
0.01
1.49
See accompanying Notes to Consolidated Financial Statements.
42
120
December 31,
2006
2005
(Dollars in thousands)
ASSETS
Current Assets
Accounts receivable, less allowances: 2006 - $36,673; 2005 - $37,473
Inventories, net
$ 101,072
673,428
952,310
85,576
11,083
—
76,811
1,900,280
Other Assets
Goodwill
Total Other Assets
Total Assets
Current Liabilities
Short-term debt
Long-term debt
Authorized - 10,000,000 shares each class, none issued
Authorized - 200,000,000 shares Issued (including shares in treasury) (2006 - 94,244,407
shares; 2005 - 93,160,285 shares)
Stated capital
Treasury shares at cost (2006 - 80,005 shares; 2005 - 154,374 shares)
$
65,417
657,237
900,294
97,712
17,926
162,237
82,486
1,983,309
1,601,559
1,474,074
201,899
104,070
169,417
—
54,308
529,694
$4,031,533
204,129
179,043
1,918
81,205
70,056
536,351
$3,993,734
$
$
40,217
506,301
225,409
52,768
638
—
10,236
835,569
63,437
470,966
364,028
30,497
4,880
41,676
95,842
1,071,326
547,390
410,438
682,934
6,659
—
72,363
1,719,784
561,747
242,414
488,506
36,556
35,878
60,240
1,425,341
—
—
53,064
753,095
1,217,167
(544,562)
(2,584)
1,476,180
$4,031,533
53,064
719,001
1,052,871
(323,449)
(4,420)
1,497,067
$3,993,734
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121
2006
2005
$ 222,527
(46,088)
$ 260,281
(26,625)
$ 135,656
(1,610)
196,592
15,267
65,405
(26,395)
15,594
209,656
770
211
81,393
9,293
201,173
10,154
6,062
56,859
2,775
(5,987)
(6,743)
4,098
(122,326)
(19,319)
292,625
(12,399)
(137,329)
(22,888)
(50,533)
5,157
316,987
(102,848)
(116,332)
7,107
(59,201)
2,690
142,485
44,303
336,928
1,714
318,701
(21,956)
120,529
(296,093)
9,207
203,316
(17,953)
(2,922)
(104,445)
(26,423)
(130,868)
(217,411)
5,271
21,838
(48,996)
4,622
(234,676)
(8,126)
(242,802)
(143,781)
5,223
50,690
(9,359)
(7,626)
(104,853)
(3,728)
(108,581)
(58,231)
22,963
170,000
(170,000)
272,549
(392,100)
(21,891)
(176,710)
6,305
35,655
65,417
$ 101,072
(55,148)
39,793
231,500
(231,500)
346,454
(308,233)
(79,160)
(56,294)
(5,155)
14,450
50,967
$ 65,417
(46,767)
17,628
198,000
(198,000)
335,068
(328,651)
20,860
(1,862)
12,255
22,341
28,626
$ 50,967
2004
(Dollars in Thousands)
Net income
Net (income) from discontinued operations
Adjustments to reconcile income from continuing operations to net cash
provided by operating activities:
Loss on sale of assets
Deferred income tax (benefit) provision
Accounts receivable
Inventories
Other assets
Foreign currency translation (gain) loss
Net Cash Provided by Operating Activities — Continuing Operations
Net Cash Provided (Used) by Operating Activities — Discontinued
Operations
Proceeds from disposals of property, plant and equipment
Divestitures
Acquisitions
Other
Net Cash Used by Investing Activities — Continuing Operations
Net Cash Used by Investing Activities — Discontinued Operations
Net proceeds from common share activity
Accounts receivable securitization financing borrowings
Accounts receivable securitization financing payments
Short-term debt activity — net
Net Cash Used by Financing Activities
Increase In Cash and Cash Equivalents
Cash and cash equivalents at beginning of year
44
122
Total
Common Stock
Other
Stated
Paid-In
Capital
Capital
Earnings
Invested
In the
Business
Accumulated
Other
Comprehensive
Loss
Treasury
Stock
$53,064
$758,849
135,656
$(358,382)
$(176)
(Dollars in thousands, except per share
data)
Net income
adjustments (net of income
tax of $18,766)
Minimum pension liability
Adjustment (net income
tax of $18,391)
Change in fair value of
derivative financial
instruments, net of
reclassifications
Tax benefit from stock
compensation
Issuance (net) of 3,100 shares
from treasury(1)
Issuance of 1,435,719 shares
From authorized(1)
Net income
adjustments (net of income
tax of $1,720)
adjustment (net of income
tax of $24,716)
instruments, net of
reclassifications
compensation
Issuance (net) of 146,873
shares from treasury(1)
from authorized(1)
$1,089,627
135,656
$636,272
105,736
(36,468)
(36,468)
(372)
204,552
(46,767)
(372)
(46,767)
3,068
3,068
(1,067)
(1,045)
20,435
$1,269,848
$53,064
20,435
$658,730
260,281
(22)
847,738
$(289,486)
260,281
(49,940)
(49,940)
13,395
13,395
2,582
226,318
(55,148)
2,582
(55,148)
8,151
8,151
(5,831)
(1,609)
53,729
$1,497,067
$(198)
$53,064
53,729
$719,002
(4,222)
$1,052,871
$(323,449)
$(4,420)
123
Total
Net Income
adjustments (net of
income tax of $386)
adjustment (net of income
tax of $24,716)
instruments, net of
reclassifications
Adjustment recognized upon
adoption of SFAS No. 158
(net of income tax of
$184,453)
Compensation
Issuance (net) of 74,369
shares from treasury(1)
from authorized (1)
Common Stock
Other
Stated
Paid-In
Capital
Capital
Earnings
Invested
In the
Business
222,527
Accumulated
Other
Comprehensive
Loss
222,527
56,293
56,293
56,411
56,411
(1,451)
333,780
(1,451)
(332,366)
(58,231)
(332,366)
(58,231)
4,526
4,526
1,829
29,575
$1,476,180
Treasury
Stock
(7)
$53,064
29,575
$753,095
1,836
$1,217,167
$(544,562)
$(2,584)
(1)
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1 Significant Accounting Policies
Principles of Consolidation: The consolidated financial statements include the accounts and operations of The Timken Company
and its subsidiaries (the “company”). All significant intercompany accounts and transactions are eliminated upon consolidation.
Investments in affiliated companies are accounted for by the equity method, except when they qualify as variable interest entities
in which case the investments are consolidated in accordance with FASB Interpretation No. 46 (revised December 2003) (FIN 46),
“Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51.”
Revenue Recognition: The company recognizes revenue when title passes to the customer. This is FOB shipping point except for
certain exported goods and certain foreign entities, which are FOB destination. Selling prices are fixed based on purchase orders
or contractual arrangements. Shipping and handling costs are included in cost of products sold in the Consolidated Statement of
Income.
Cash Equivalents: The company considers all highly liquid investments with a maturity of three months or less when purchased to
be cash equivalents.
Allowance for Doubtful Accounts: The company has recorded an allowance for doubtful accounts, which represents an estimate of
the losses expected from the accounts receivable portfolio, to reduce accounts receivable to their net realizable value. The
allowance was based upon historical trends in collections and write-offs, management’s judgment of the probability of collecting
accounts and management’s evaluation of business risk. The company extends credit to customers satisfying pre-defined credit
criteria. The company believes it has limited concentration of credit risk due to the diversity of its customer base.
Inventories: Inventories are valued at the lower of cost or market, with 45% valued by the last-in, first-out (LIFO) method and the
remaining 55% valued by first-in, first-out (FIFO) method. If all inventories had been valued at FIFO, inventories would have been
$200,900 and $189,000 greater at December 31, 2006 and 2005, respectively. The components of inventories are as follows:
December 31,
2006
Inventories:
Manufacturing supplies
Work in process and raw materials
Finished products
Total Inventories
$ 84,398
390,133
477,779
$952,310
2005
$ 71,840
395,306
433,148
$900,294
The company has elected to change its method of inventory valuation for certain domestic inventories effective January 1, 2007
from FIFO to LIFO. As a result, all domestic inventories will be valued using the LIFO valuation method beginning in 2007.
46
125
Property, Plant and Equipment: Property, plant and equipment is valued at cost less accumulated depreciation. Maintenance and
repairs are charged to expense as incurred. Provision for depreciation is computed principally by the straight-line method based
upon the estimated useful lives of the assets. The useful lives are approximately 30 years for buildings, five to seven years for
computer software and three to 20 years for machinery and equipment. Depreciation expense was $185,896, $199,902 and
$191,172 in 2006, 2005 and 2004, respectively. The components of property, plant and equipment are as follows:
December 31,
2006
Property, Plant and Equipment:
Land and buildings
Machinery and equipment
Subtotal
Less allowances for depreciation
Property, Plant and Equipment — net
$
628,542
3,036,266
3,664,808
(2,063,249)
$ 1,601,559
2005
$
613,326
2,828,267
3,441,593
(1,967,519)
$ 1,474,074
Impairment of long-lived assets is recognized when events or changes in circumstances indicate that the carrying amount of the
asset or related group of assets may not be recoverable. If the expected future undiscounted cash flows are less than the carrying
amount of the asset, an impairment loss is recognized at that time to reduce the asset to the lower of its fair value or its net book
value in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.”
Goodwill: The company tests goodwill and indefinite-lived intangible assets for impairment at least annually. The company
engages an independent valuation firm and performs its annual impairment test during the fourth quarter, after the annual
forecasting process is completed. Furthermore, goodwill is reviewed for impairment whenever events or changes in circumstances
indicate that the carrying value may not be recoverable in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.”
Income Taxes: Deferred income taxes are provided for the temporary differences between the financial reporting basis and tax
basis of the company’s assets and liabilities. Valuation allowances are recorded when and to the extent the company determines
it is more likely than not that all or a portion of its deferred tax assets will not be realized.
Foreign Currency Translation: Assets and liabilities of subsidiaries, other than those located in highly inflationary countries, 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 year. The related translation adjustments are reflected as a separate component of accumulated
other comprehensive loss. Gains and losses resulting from foreign currency transactions and the translation of financial
statements of subsidiaries in highly inflationary countries are included in the Consolidated Statement of Income. The company
recorded a foreign currency exchange loss of $5,354 in 2006, a gain of $7,031 in 2005 and a loss of $7,739 in 2004. During 2004,
the American Institute of Certified Public Accountants SEC Regulations Committee’s International Practices Task Force concluded
that Romania should come off highly inflationary status no later than October 1, 2004. Effective October 1, 2004, the company no
longer accounted for Timken Romania as being in a highly inflationary country.
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126
Stock-Based Compensation: On January 1, 2006, the company adopted the provisions of SFAS No. 123(R), “Share-Based
Payment,” and elected to use the modified prospective transition method. The modified prospective transition method requires that
compensation cost be recognized in the financial statements for all stock option awards granted after the date of adoption and for
all unvested stock option awards granted prior to the date of adoption. In accordance with SFAS No. 123(R), prior period amounts
were not restated. Prior to the adoption of SFAS No. 123(R), the company utilized the intrinsic-value based method of accounting
under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, and adopted the disclosure
requirements of SFAS No. 123, “Accounting for Stock-Based Compensation.”
The effect on net income and earnings per share as if the company had applied the fair value recognition provisions of SFAS
No. 123 to all outstanding and nonvested stock option awards is as follows for the years ended December 31:
2005
2004
Net income, as reported
Add: Stock-based employee compensation expense, net of related taxes
Deduct: Stock-based employee compensation expense determined under fair value based
methods for all awards, net of related taxes
Pro forma net income
$260,281
5,955
$135,656
1,884
(10,042)
$256,194
(6,751)
$130,789
Earnings per share:
Basic — as reported
Basic — pro forma
Diluted — as reported
Diluted — pro forma
$
$
$
$
$
$
$
$
2.84
2.80
2.81
2.77
1.51
1.46
1.49
1.44
Earnings Per Share: Earnings per share are computed by dividing net income by the weighted-average number of common
shares outstanding during the year. Earnings per share - assuming dilution are computed by dividing net income by the weightedaverage number of common shares outstanding, adjusted for the dilutive impact of potential common shares for share-based
compensation.
Derivative Instruments: The company accounts for its derivative instruments in accordance with SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” as amended. The company recognizes all derivatives on the balance sheet at fair
value. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. If the derivative is
designated and qualifies as a hedge, depending on the nature of the hedge, changes in the fair value of the derivatives are either
offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in
other comprehensive loss until the hedged item is recognized in earnings. The company’s holdings of forward foreign exchange
contracts have been deemed derivatives pursuant to the criteria established in SFAS No. 133, of which the company has
designated certain of those derivatives as hedges. The critical terms, such as the notional amount and timing of the forward
contract and forecasted transaction, coincide, resulting in no significant hedge ineffectiveness. In 2004, the company entered into
interest rate swaps to hedge a portion of its fixed-rate debt. The critical terms, such as principal and notional amounts and debt
maturity and swap termination dates, coincide, resulting in no hedge ineffectiveness. These instruments qualify as fair value
hedges. Accordingly, the gain or loss on both the hedging instrument and the hedged item attributable to the hedged risk are
recognized currently in earnings.
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127
Recently Adopted Accounting Pronouncements:
In May 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154, “Accounting Changes and Error
Corrections,” which changes the accounting for and reporting of a change in accounting principle. This statement also carries
forward the guidance from APB No. 20 regarding the correction of an error and changes in accounting estimates. This statement
requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impractical to
determine either the period-specific or cumulative effects of the change. SFAS No. 154 is effective for accounting changes made
in fiscal years beginning after December 15, 2005. The company adopted the provisions of SFAS No. 154 effective January 1,
2006. The adoption of SFAS No. 154 did not have an impact on the company’s results of operations or financial condition.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other
Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132(R).” SFAS No. 158 requires a company to
(a) recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under funded
status, (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year,
and (c) recognize changes in the funded status of a defined postretirement plan in the year in which the changes occur (reported
in comprehensive income). The requirement to recognize the funded status of a benefit plan and the disclosure requirements
were adopted by the company effective December 31, 2006 and reduced shareholders’ equity by $332,366. Refer to Note 13 —
Retirement and Postretirement Benefit Plans for additional discussion on the impact of adopting SFAS No. 158.
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB) 108, “Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 requires that public companies
utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an
income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 was adopted by the
company effective December 31, 2006, and the guidance did not have a material effect on the company’s results of operations or
financial condition.
Recently Issued Accounting Pronouncements:
In July 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertain
tax positions recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN
48 prescribes requirements and other guidance for financial statement recognition and measurement of positions taken or
expected to be taken on income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The
cumulative effect of adopting FIN 48 will be recorded as an adjustment to the opening balance of retained earnings in the period
of adoption. The company will adopt FIN 48 as of January 1, 2007. Management is currently in the process of evaluating the
impact of FIN 48 on the company’s Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a framework for
measuring fair value that is based on the assumptions market participants would use when pricing an asset or liability and
establishes a fair value hierarchy that prioritizes the information to develop those assumptions. Additionally, the standard expands
the disclosures about fair value measurements to include separately disclosing the fair value measurements of assets or liabilities
within each level of the fair value hierarchy. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The
company is currently evaluating the impact of adopting SFAS No. 157 on the company’s results of operations and financial
condition.
Use of Estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles
requires management to make estimates and assumptions that affect the amounts reported in the financial statements and
accompanying notes. These estimates and assumptions are reviewed and updated regularly to reflect recent experience.
Reclassifications: Certain amounts reported in the 2005 and 2004 Consolidated Financial Statements have been reclassified to
conform to the 2006 presentation.
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2 Acquisitions and Divestitures
Acquisitions
The company purchased the assets of Turbo Engines, Inc., a provider of aircraft engine overhaul and repair services, in
December 2006 for $13,500, including acquisition costs. The company has preliminarily allocated the purchase price to assets of
$14,983, including $4,487 of amortizable intangible assets and liabilities of $1,483. The excess of the purchase price over the fair
value of the net assets acquired was recorded as goodwill in the amount of $1,923. The company also purchased the assets of
Turbo Technologies, Inc., a provider of aircraft engine overhaul and repair services, in July 2006 for $4,453, including acquisition
costs. The company acquired net assets of $4,300, including $1,288 of amortizable intangible assets. The company assumed no
liabilities. The excess of the purchase price over the fair value of the net assets acquired was recorded as goodwill in the amount
of $153. The results of the operations of Turbo Engines and Turbo Technologies are included in the company’s Consolidated
Statement of Income for the periods subsequent to the effective date of acquisition. Pro forma results of the operations are not
presented because the effect of the acquisitions are not significant.
The company purchased the stock of Bearing Inspection, Inc. (Bii), a provider of bearing inspection, reconditioning and
engineering services during October 2005 for $42,367, including acquisition costs. The company acquired net assets of $36,399,
including $27,150 of amortizable intangible assets. The company also assumed liabilities with a fair value of $9,315. The excess
of the purchase price over the fair value of the net assets acquired was recorded as goodwill in the amount of $15,283. The
results of the operations of Bii are included in the company’s Consolidated Statement of Income for the periods subsequent to the
effective date of the acquisition. Pro forma results of the operations are not presented because the effect of the acquisition was
not significant.
During 2004, the company finalized several acquisitions. The total cost of these acquisitions amounted to $8,425. The purchase
price was allocated to the assets and liabilities acquired, based on their fair values at the dates of acquisition. The fair value of the
assets acquired was $5,513 in 2004 and the fair value of the liabilities assumed was $815. The excess of the purchase price over
the fair value of the net assets acquired was allocated to goodwill. The company’s Consolidated Statement of Income includes the
results of operations of the acquired businesses for the periods subsequent to the effective date of the acquisitions. Pro forma
results of the operations have not been presented because the effect of these acquisitions was not significant.
Divestitures
In December 2006, the company completed the divestiture of its subsidiary, Latrobe Steel. Latrobe Steel is a leading global
producer and distributor of high-quality, vacuum melted specialty steels and alloys. This business was part of the Steel Group for
segment reporting purposes. The following results of operations for this business have been treated as discontinued operations
for all periods presented.
2006
Net sales
Earnings before income taxes
Net income
Gain on divestiture, net of tax
$328,181
53,510
33,239
12,849
2005
$345,267
44,008
26,625
—
2004
$226,474
2,188
1,610
—
The gain on divestiture in 2006 was net of tax of $8,355. As of December 31, 2006, there were no assets or liabilities remaining
from the divestiture of Latrobe Steel. The assets of discontinued operations as of December 31, 2005 primarily consisted of
$54,546 of accounts receivable, net, $98,074 of inventory and $72,970 of property, plant and equipment, net. The liabilities of
discontinued operations as of December 31, 2005 primarily consisted of $30,458 of accounts payable and other liabilities, $11,236
of salaries, wages and benefits and $29,543 of accrued pension and postretirement benefit costs. Refer to Note 13 — Retirement
and Postretirement Benefit Plans for discussion of pension and postretirement benefit obligations that were retained by Latrobe
Steel and those that are the responsibility of the company after the sale.
In December 2006, the company completed the divestiture of its automotive steering business. This business was part of the
Automotive Group. The divestiture of the automotive steering business did not qualify for discontinued operations because it was
not a component of an entity as defined by SFAS No. 144. The company recognized a pretax loss on divestiture of $54,300, and
the loss is reflected in Loss on divestitures in the Consolidated Statement of Income. In June 2006, the company completed the
divestiture of its Timken Precision Components — Europe business. This business was part of the Steel Group. The company
recognized a pretax loss on divestiture of $9,971, and the loss was reflected in Loss on divestitures in the Consolidated Statement
of Income. The results of operations and net assets of the divested businesses were immaterial to the consolidated results of
operations and financial position of the company.
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3 Earnings Per Share
The following table sets forth the reconciliation of the numerator and the denominator of basic earnings per share and diluted
earnings per share for the years ended December 31:
2006
Numerator:
Income from continuing operations for basic earnings per share and diluted
earnings per share
Denominator:
Weighted-average number of shares outstanding — basic
Effect of dilutive securities:
Stock options and awards — based on the treasury stock method
Weighted-average number of shares outstanding, assuming dilution of stock
options and awards
Basic earnings per share from continuing operations
Diluted earnings per share from continuing operations
$
176,439
2005
$
233,656
2004
$
134,046
93,325,729
91,533,242
89,875,650
968,987
1,004,287
883,921
94,294,716
$
1.89
$
1.87
92,537,529
$
2.55
$
2.52
90,759,571
$
1.49
$
1.48
The exercise prices for certain stock options that the company has awarded exceed the average market price of the company’s
common stock. Such stock options are antidilutive and were not included in the computation of diluted earnings per share. The
antidilutive stock options outstanding were 737,122, 1,327,056 and 2,464,025 during 2006, 2005 and 2004, respectively.
Under the performance unit component of the company’s long-term incentive plan, the Compensation Committee of the Board of
Directors can elect to make payments that become due in the form of cash or shares of the company’s common stock. Refer to
Note 9 — Stock Compensation Plans for additional discussion. Performance units granted, if fully earned, would represent
394,068 shares of the company’s common stock at December 31, 2006. These performance units have not been included in the
calculation of dilutive securities.
4 Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consists of the following for the years ended December 31:
Foreign currency translation adjustments, net of tax
Pension and postretirement benefits adjustments, net of tax
Fair value of open foreign currency cash flow hedges, net of tax
Accumulated Other Comprehensive Loss
2006
2005
2004
$ 106,631
(650,310)
(883)
$(544,562)
$ 50,338
(374,355)
568
$(323,449)
$ 100,278
(387,750)
(2,014)
$(289,486)
In 2006, the company recorded non-cash credits of $5,293 on dissolution of inactive subsidiaries, which related primarily to the
transfer of cumulative foreign currency translation losses to the Consolidated Statement of Income, which were included in other
expense — net.
In 2004, the company recorded a non-cash charge of $16,186 on dissolution that related primarily to the transfer of cumulative
foreign currency translation losses to the Consolidated Statement of Income, which was included in other expense — net.
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5 Financing Arrangements
Short-term debt at December 31, 2006 and 2005 was as follows:
2006
Variable-rate lines of credit for certain of the company’s European and Asian subsidiaries with
various banks with interest rates ranging from 3.32% to 11.5% and 2.65% to 7.70% at
December 31, 2006 and 2005, respectively
Variable-rate Ohio Water Development Authority revenue bonds for PEL (3.59% at
December 31, 2005)
Fixed-rate mortgage for PEL with an interest rate of 9.00%
Fixed-rate short-term loans of an Asian subsidiary with interest rates ranging from 6.76% to
6.84% at December 31, 2006
Other
Short-term debt
2005
$27,000
$23,884
—
—
23,000
11,491
10,005
3,212
$40,217
—
5,062
$63,437
In January 2006, the company repaid, in full, the $23,000 balance outstanding of the revenue bonds held by PEL Technologies
LLC (PEL), an equity investment of the company. In June 2006, the company continued to liquidate the remaining assets of PEL
with land and buildings exchanged for the fixed-rate mortgage. Refer to Note 12 — Equity Investments for a further discussion of
PEL.
The lines of credit for certain of the company’s European and Asian subsidiaries provide for borrowings up to $217,109. At
December 31, 2006, the company had borrowings outstanding of $27,000, which reduced the availability under these facilities to
$190,109.
On December 30, 2005, the company entered into a new $200,000 Accounts Receivable Securitization Financing Agreement
(2005 Asset Securitization), replacing the $125,000 Asset Securitization Financing Agreement that had been in place since 2002.
The 2005 Asset Securitization provided for borrowings up to $200,000, limited to certain borrowing base calculations, and was
secured by certain domestic trade receivables of the company. On December 30, 2006, the company entered into a $200,000
Accounts Receivable Securitization Financing Agreement (2006 Asset Securitization) replacing the 2005 Asset Securitization.
Under the terms of the 2006 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. Under the 2006 Asset
Securitization, the company also has the ability to issue letters of credit. As of December 31, 2006, 2005 and 2004, there were no
amounts outstanding under the receivables securitization facility. As of December 31, 2006, the company had issued letters of
credit totaling $16,658, which reduced the availability under the 2006 Asset Securitization to $183,342. Any amounts outstanding
under this facility would be reported on the company’s Consolidated Balance Sheet in short-term debt. 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 Statement of Income. This rate was 5.84%, 4.59% and 2.57%, at December 31, 2006, 2005 and
2004, respectively.
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Long-term debt at December 31, 2006 and 2005 was as follows:
2006
Fixed-rate Medium-Term Notes, Series A, due at various dates through May 2028, with interest
rates ranging from 6.20% to 7.76%
Variable-rate State of Ohio Air Quality and Water Development Revenue Refunding Bonds,
maturing on November 1, 2025 (3.63% at December 31, 2006)
Variable-rate State of Ohio Pollution Control Revenue Refunding Bonds, maturing on June 1,
2033 (3.63% at December 31, 2006)
Variable-rate State of Ohio Water Development Revenue Refunding Bonds, maturing on May 1,
2007 (3.63% at December 31, 2006)
Variable-rate State of Ohio Water Development Authority Solid Waste Revenue Bonds, maturing
on July 1, 2032
Variable-rate Unsecured Canadian Note, Maturing on December 22, 2010 (5.98% at
December 31, 2006)
Fixed-rate Unsecured Notes, maturing on February 15, 2010 with an interest rate of 5.75%
Variable-rate credit facility with US Bank for Advanced Green Components, LLC, maturing on
July 18, 2008 (6.28% at December 31, 2006)
Other
Less current maturities
Long-term debt
2005
$191,601
$286,474
21,700
21,700
17,000
17,000
8,000
8,000
—
24,000
49,593
247,773
49,759
247,651
12,240
9,719
557,626
10,236
$547,390
—
3,005
657,589
95,842
$561,747
The maturities of long-term debt for the five years subsequent to December 31, 2006 are as follows: 2007—$10,236; 2008—
$32,467; 2009—$1,483; 2010—$298,652; and 2011—$1,272.
Interest paid was approximately $51,600 in 2006, $52,000 in 2005 and $52,000 in 2004. This differs from interest expense due to
timing of payments and interest capitalized of $3,281 in 2006, $620 in 2005 and $541 in 2004. The weighted-average interest rate
on short-term debt during the year was 4.6% in 2006, 3.9% in 2005 and 3.1% in 2004. The weighted-average interest rate on
short-term debt outstanding at December 31, 2006 and 2005 was 5.8% and 4.9%, respectively.
The company has a $500,000 Amended and Restated Credit Agreement (Senior Credit Facility) that matures on June 30, 2010.
At December 31, 2006, the company had no outstanding borrowings under the $500,000 Senior Credit Facility and had issued
letters of credit under this facility totaling $33,788, which reduced the availability under the Senior Credit Facility to $466,212.
Under the Senior Credit Facility, the company has two financial covenants: a consolidated leverage ratio and a consolidated
interest coverage ratio. At December 31, 2006, the company was in full compliance with the covenants under the Senior Credit
Facility and its other debt agreements.
In December 2005, the company entered into a 57,800 Canadian Dollar unsecured loan in Canada. The principal balance of the
loan is payable in full on December 22, 2010. The interest rate is variable based on the Canadian LIBOR rate and interest
payments are due quarterly.
In August 2006, the company repaid, in full, the $24,000 balance outstanding under the variable-rate State of Ohio Water
Development Authority Solid Waste Revenue Bonds.
Advanced Green Components, LLC (AGC) is a joint venture of the company formerly accounted for using the equity method. The
company is the guarantor of $6,120 of AGC’s credit facility. Effective September 30, 2006, the company consolidated AGC and its
outstanding debt. Refer to Note 12 — Equity Investments for additional discussion.
The company and its subsidiaries lease a variety of real property and equipment. Rent expense under operating leases amounted
to $31,027, $22,799 and $17,486 in 2006, 2005 and 2004, respectively. At December 31, 2006, future minimum lease payments
for noncancelable operating leases totaled $133,823 and are payable as follows: 2007—$28,664; 2008—$22,086; 2009—
$16,851; 2010—$13,301; 2011—$10,803; and $42,118 thereafter.
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6 Impairment and Restructuring Charges
Impairment and restructuring charges are comprised of the following for the years ended December 31:
2006
Impairment charges
Severance expense and related benefit costs
Exit costs
Total
$15,267
25,837
3,777
$44,881
2005
$
770
20,284
5,039
$26,093
2004
$ 8,454
4,369
715
$13,538
Industrial
In May 2004, the company announced plans to rationalize the company’s three bearing plants in Canton, Ohio within the Industrial
Group. On September 15, 2005, the company reached a new four-year agreement with the United Steelworkers of America, which
went into effect on September 26, 2005, when the prior contract expired. This rationalization initiative is expected to deliver annual
pretax savings of approximately $25,000 through streamlining operations and workforce reductions, with pretax costs of
approximately $35,000 to $40,000 over the next three years.
In 2006, the company recorded $971 of impairment charges and $571 of exit costs associated with the Industrial Group’s
rationalization plans. In 2005, the company recorded $770 of impairment charges and environmental exit costs of $2,239
associated with the Industrial Group’s rationalization plans. Including rationalization costs recorded in cost of products sold and
selling, administrative and general expenses, the Industrial Group has incurred cumulative pretax costs of approximately $22,026
as of December 31, 2006 for these restructuring plans.
In November 2006, the company announced plans to vacate its Torrington, Connecticut office complex. In 2006, the company
recorded $1,501 of severance and related benefit costs and $160 of impairment charges associated with the Industrial Group.
In addition, the company recorded $1,356 in environmental exit costs in 2006 related to a former plant in Columbus, Ohio and
another $147 in severance and related benefits related to other company initiatives.
Automotive
In July 2005, the company disclosed plans for its Automotive Group to restructure its business and improve performance. These
plans included the closure of a manufacturing facility in Clinton, South Carolina and engineering facilities in Torrington,
Connecticut and Norcross, Georgia. In February 2006, the company announced additional plans to rationalize production capacity
at its Vierzon, France bearing manufacturing facility in response to changes in customer demand. These restructuring efforts are
targeted to deliver annual pretax savings of approximately $40,000 by 2008, with expected net workforce reductions of
approximately 400 to 500 positions and pretax costs of approximately $80,000 to $90,000.
In September 2006, the company announced further planned reductions in its workforce of approximately 700 associates. These
additional plans are targeted to deliver annual pretax savings of approximately $35,000 by 2008, with expected pretax costs of
approximately $25,000.
In 2006, the company recorded $16,502 of severance and related benefit costs, $1,558 of exit costs and $1,620 of impairment
charges associated with the Automotive Group’s restructuring plans. In 2005, the company recorded approximately $20,319 of
severance and related benefit costs and $2,800 of exit costs as a result of environmental charges related to the closure of a
manufacturing facility in Clinton, South Carolina, and administrative facilities in Torrington, Connecticut and Norcross, Georgia.
Including rationalization expenses recorded in cost of products sold and selling, administrative and general expenses, the
Automotive Group has incurred cumulative pretax costs of approximately $60,558 as of December 31, 2006 for these restructuring
plans.
In 2006, the company recorded an additional $654 of severance and related benefit costs and $241 of impairment charges for the
Automotive Group related to the announced plans to vacate its Torrington campus office complex and another $143 of severance
and related benefit costs related to other company initiatives.
In addition, the company recorded impairment charges of $11,915 in 2006 representing the write-off of goodwill for the Automotive
Group in accordance with SFAS No. 142. Refer to Note 8 — Goodwill and Other Intangible Assets for a further discussion of
goodwill impairment charges.
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Steel
In October 2006, the company announced its intention to exit during 2007 its European seamless steel tube manufacturing
operations located in Desford, England. The company recorded approximately $6,890 of severance and related benefit costs in
2006 related to this action. In addition, the company recorded an impairment charge and removal costs of $652 related to the
write-down of property, plant and equipment at one of the Steel Group’s facilities.
Impairment and restructuring charges by segment are as follows:
Year ended December 31, 2006:
Impairment charges
Exit costs
Total
Industrial
Automotive
$1,131
1,648
1,927
$4,706
$13,776
17,299
1,558
$32,633
Steel
Total
$ 360
6,890
292
$7,542
$15,267
25,837
3,777
$44,881
Total
Impairment charges
Exit costs
Total
Industrial
Automotive
Steel
$ 770
—
2,239
$3,009
$
—
20,284
2,800
$23,084
$—
—
—
$—
Industrial
Automotive
Steel
$
$
$
770
20,284
5,039
$26,093
Impairment charges
Exit costs
Total
—
2,652
715
$3,367
—
1,717
—
$1,717
$8,454
—
—
$8,454
Total
$ 8,454
4,369
715
$13,538
The rollforward of restructuring accruals is as follows for the years ended December 31:
Expense
Payments
2006
2005
2004
$ 18,143
29,614
(15,772)
$ 31,985
$ 4,116
17,538
(3,511)
$18,143
$ 4,358
5,084
(5,326)
$ 4,116
The restructuring accrual for 2006, 2005 and 2004 was included in accounts payable and other liabilities in the Consolidated
Balance Sheet. The restructuring accrual at December 31, 2005 excludes costs related to curtailment of pension and
postretirement benefit plans. The majority of the restructuring accrual at December 31, 2006 will be paid by the end of 2007.
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7 Contingencies
The company and certain of its U.S. subsidiaries have been designated as potentially responsible parties (PRPs) by the United
States Environmental Protection Agency for site investigation and remediation under the Comprehensive Environmental
Response, Compensation and Liability Act (Superfund) with respect to certain sites. The claims for remediation have been
asserted against numerous other entities, which are believed to be financially solvent and are expected to fulfill their proportionate
share of the obligation. In addition, the company is subject to various lawsuits, claims and proceedings, which arise in the ordinary
course of its business. The company accrues costs associated with environmental and legal matters when they become probable
and reasonably estimable. Accruals are established based on the estimated undiscounted cash flows to settle the obligations and
are not reduced by any potential recoveries from insurance or other indemnification claims. Management believes that any
ultimate liability with respect to these actions, in excess of amounts provided, will not materially affect the company’s Consolidated
Financial Statements.
The company is also the guarantor of debt for AGC, an equity investment of the company. The company guarantees $6,120 of
AGC’s outstanding long-term debt of $12,240 with US Bank. In case of default by AGC, the company has agreed to pay the
outstanding balance, pursuant to the guarantee, due as of the date of default. The debt matures on July 18, 2008. Refer to Note
12 — Equity Investments for additional discussion.
Product Warranties
The company provides warranty policies on certain of its products. The company accrues liabilities under warranty policies based
upon specific claims and a review of historical warranty claim experience in accordance with SFAS No. 5. The company records
and accounts for its warranty reserve based on specific claim incidents. Should the company become aware of a specific potential
warranty claim, a specific charge is recorded and accounted for accordingly. Adjustments are made quarterly to the reserves as
claim data and historical experience change. The following is a rollforward of the warranty reserves for 2006 and 2005:
Expense
Payments
2006
2005
910
20,024
(911)
$20,023
$ 4,688
707
(4,485)
$ 910
$
The product warranty charge for 2006 related primarily to a single production line at an individual plant that occurred during a
limited period. The product warranty accrual for 2006 and 2005 was included in accounts payable and other liabilities in the
Consolidated Balance Sheet.
8 Goodwill and Other Intangible Assets
SFAS No. 142 requires that goodwill and indefinite-lived intangible assets be tested for impairment at least annually. The
company engages an independent valuation firm and performs its annual impairment test during the fourth quarter after the
annual forecasting process is completed. In 2006, the company concluded that the entire amount of goodwill for its Automotive
Group was impaired. The company recorded a pretax impairment loss of $11,915, which was reported in impairment and
restructuring charges. The company has determined that there were no further impairments as of December 31, 2006. There was
no impairment in 2005 or 2004.
Changes in the carrying value of goodwill are as follows:
Beginning
Balance
Goodwill:
Industrial
Automotive
Total
Acquisitions
$202,058
2,071
$204,129
$2,076
—
$2,076
Impairment
$
—
(11,915)
$(11,915)
Other
$(2,235)
9,844
$ 7,609
Ending Balance
$201,899
—
$201,899
“Other” for 2006 includes $9,612 of goodwill related to the consolidation of AGC, an equity investment of the company. Refer to
Note 12 — Equity Investments for additional discussion. The remaining portion of “Other” primarily includes foreign currency
translation adjustments. The purchase price allocations are preliminary for acquisitions completed in 2006, because the company
is waiting for final valuation reports, and may be subsequently adjusted.
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Beginning
Balance
Goodwill:
Industrial
Automotive
Total
Acquisitions
$187,066
2,233
$189,299
$16,689
—
$16,689
Impairment
$—
—
$—
Other
Ending Balance
$(1,697)
(162)
$(1,859)
$202,058
2,071
$204,129
“Other” for 2005 primarily includes foreign currency translation adjustments.
The following table displays intangible assets as of December 31:
2006
Gross
Carrying
Amount
2005
Accumulated
Amortization
Net
Carrying
Amount
Gross
Carrying
Amount
Accumulated
Amortization
Net
Carrying
Amount
Intangible assets subject to
amortization:
Industrial:
Customer relationships
Engineering drawings
Know-how transfer
Patents
Technology use
Trademarks
Unpatented technology
PMA licenses
Automotive:
Land use rights
Patents
Technology use
Trademarks
Steel trademarks
Intangible assets not subject to
amortization:
Goodwill
Intangible pension asset
Automotive land use rights
Industrial license agreements
Total intangible assets
$ 31,773
2,000
1,162
1,742
5,373
1,734
7,370
3,500
$ 3,762
1,667
544
765
1,430
1,346
2,903
337
$ 28,011
333
618
977
3,943
388
4,467
3,163
$ 27,339
2,000
1,065
1,328
4,823
1,729
7,370
2,212
$ 2,333
1,349
412
467
787
931
2,127
168
$ 25,006
651
653
861
4,036
798
5,243
2,044
21,960
3,000
7,122
19,513
5,717
2,178
11,055
864
$126,063
4,255
2,500
1,996
7,973
1,521
1,655
4,355
313
$37,322
17,705
500
5,126
11,540
4,196
523
6,700
551
$ 88,741
21,960
3,000
6,762
18,997
5,736
2,225
11,055
894
$118,495
3,157
2,024
1,611
5,771
936
1,280
3,190
233
$26,776
18,803
976
5,151
13,226
4,800
945
7,865
661
$ 91,719
$201,899
—
148
15,181
$217,228
$343,291
$
$201,899
—
148
15,181
$217,228
$305,969
$204,129
72,015
133
15,176
$291,453
$409,948
$
$204,129
72,015
133
15,176
$291,453
$383,172
—
—
—
—
$
—
$37,322
—
—
—
—
$
—
$26,776
Amortization expense for intangible assets was approximately $10,600 and $9,800 for the years ended December 31, 2006 and
2005, respectively, and is estimated to be approximately $9,200 annually for the next five years. The intangible assets subject to
amortization have useful lives ranging from 2 to 20 years with a weighted-average useful life of 12 years. The intangible assets
subject to amortization acquired in 2006 have not been finalized, because the company is waiting for final valuation reports.
Preliminarily, $5,775 has been allocated to intangible assets, subject to amortization, for acquisitions completed in 2006.
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9 Stock Compensation Plans
Under the company’s long-term incentive plan, shares of common stock have been made available to grant at the discretion of the
Compensation Committee of the Board of Directors to officers and key associates in the form of stock option awards. Stock option
awards typically have a ten-year term and generally vest in 25% increments annually beginning on the first anniversary of the date
of grant. In addition to stock option awards, the company has granted restricted shares under the long-term incentive plan.
Restricted shares typically vest in 25% increments annually beginning on the first year anniversary of the date of grant and have
historically been expensed over the vesting period.
On January 1, 2006, the company adopted the provisions of SFAS No. 123(R) and elected to use the modified prospective
transition method. The modified prospective transition method requires that compensation cost be recognized in the financial
statements for all stock option awards granted after the date of adoption and for all unvested stock option awards granted prior to
the date of adoption. In accordance with SFAS No. 123(R), prior period amounts were not restated. Additionally, the company
elected to calculate its initial pool of excess tax benefits using the simplified alternative approach described in FASB Staff Position
No. FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” Prior to the
adoption of SFAS No. 123(R), the company utilized the intrinsic-value based method of accounting under APB Opinion No. 25,
“Accounting for Stock Issued to Employees,” and related interpretations, and adopted the disclosure requirements of SFAS
No. 123, “Accounting for Stock-Based Compensation.”
Prior to January 1, 2006, no stock-based compensation expense was recognized for stock option awards under the intrinsic-value
based method. The adoption of SFAS No. 123(R) reduced operating income before income taxes for 2006 by $6,000, and
reduced net income for 2006 by $3,800 ($.04 per basic and diluted share). The effect on net income and earnings per share as if
the company had applied the fair value recognition provisions of SFAS 123(R) to prior years is included in Note 1 — Significant
Accounting Policies.
The fair value of significant stock option awards granted during 2006 and 2005 was estimated at the date of grant using a BlackScholes option-pricing method with the following assumptions:
Assumptions:
Weighted average fair value per option
Risk-free interest rate
Dividend yield
Expected stock volatility
Expected life — years
2006
2005
$ 9.59
4.53%
2.14%
0.348
5
$ 7.97
4.12%
3.28%
0.360
8
Historical information was the primary basis for the selection of the expected dividend yield, expected volatility and the expected
lives of the options. The dividend yield was revised in 2006 from five years’ quarterly dividends to the last dividend prior to the
grant compared to the trailing 12 months’ daily stock prices. The risk-free interest rate was based upon yields of U.S. zero coupon
issues and U.S. Treasury issues, with a term equal to the expected life of the option being valued, for 2006 and 2005,
respectively. Effective January 1, 2006, forfeitures were estimated at 2%.
A summary of option activity as of December 31, 2006 and changes during the year then ended is presented below:
Number of
Shares
Weighted
Average
Weighted
Remaining
Contractual
Average
Exercise Price
Term
Aggregate
Intrinsic Value
(000’s)
Outstanding — beginning of year
Granted
Exercised
Canceled or expired
Outstanding — end of year
5,439,913
817,150
(906,259)
(81,696)
5,269,108
$22.78
30.94
21.12
30.45
$24.21
6 years
$31,755
Options exercisable
3,410,233
$23.07
5 years
$24,479
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The company has also issued performance-based nonqualified stock options that vest contingent upon the company’s common
shares reaching specified fair market values. No performance-based nonqualified stock options were awarded in 2006 and 2005,
respectively. The number of performance-based nonqualified stock options awarded in 2004 was 25,000. Compensation expense
under these plans was zero, $3,500 and zero in 2006, 2005 and 2004, respectively.
Exercise prices for options outstanding as of December 31, 2006 range from $15.02 to $19.56, $21.99 to $26.44 and $28.30 to
$33.75. The number of options outstanding at December 31, 2006, which correspond with these ranges, are 1,736,016, 2,226,055
and 1,307,037, respectively. The number of options exercisable at December 31, 2006, which correspond to these ranges are
1,449,005, 1,448,629 and 512,599, respectively. The weighted-average remaining contractual life of these options is six years.
As of December 31, 2006, a total of 895,898 deferred shares, deferred dividend credits, restricted shares and director common
shares have been awarded and are not vested. The company distributed 261,877, 146,250 and 73,025 shares in 2006, 2005 and
2004, respectively, as a result of these awards. The shares awarded in 2006, 2005 and 2004 totaled 433,861, 413,267, and
371,650, respectively.
The company offers a performance unit component under its long-term incentive plan to certain employees in which awards are
earned based on company performance measured by two metrics over a three-year performance period. The Compensation
Committee of the Board of Directors can elect to make payments that become due in the form of cash or shares of the company’s
common stock. A total of 47,153, 38,788 and 34,398 performance units were granted in 2006, 2005 and 2004, respectively. Since
the inception of the plan, 30,824 performance units were cancelled. Each performance unit has a cash value of $100.
The number of shares available for future grants for all plans at December 31, 2006 is 3,299,542.
The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 was $11,000, $22,600
and $8,700, respectively. Net cash proceeds from the exercise of stock options were $18,700, $39,800 and $17,600, respectively.
Income tax benefits were $3,900, $8,200 and $3,100 for the years ended December 31, 2006, 2005 and 2004, respectively.
A summary of restricted share and deferred share activity for the year ended December 31, 2006 is as follows:
Number of Shares
Outstanding — beginning of year
Granted
Vested
Canceled or expired
Outstanding — end of year
755,290
433,861
(261,877)
(31,376)
895,898
Weighted Average
Grant Date Fair
Value
$24.46
31.19
25.49
27.38
$27.32
The company recognized compensation expense of $9,600, $5,800 and $2,900 for the years ended December 31, 2006, 2005
and 2004, respectively, relating to restricted shares and deferred shares.
As of December 31, 2006, the company had unrecognized compensation expense of $23,200, before taxes, related to stock
option awards, restricted shares and deferred shares. The unrecognized compensation expense is expected to be recognized
over a total weighted average period of two years.
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138
10 Financial Instruments
As a result of its worldwide operating activities, the company is exposed to changes in foreign currency exchange rates, which
affect its results of operations and financial condition. The company and certain subsidiaries enter into forward exchange
contracts to manage exposure to currency rate fluctuations, primarily related to anticipated purchases of inventory and equipment.
At December 31, 2006 and 2005, the company had forward foreign exchange contracts, all having maturities of less than eighteen
months, with notional amounts of $247,586 and $238,378, respectively, and fair values of a $4,099 liability and a $2,691 asset,
respectively. The forward foreign exchange contracts were entered into primarily by the company’s domestic entity to manage
Euro exposures relative to the U.S. dollar and by its European subsidiaries to manage U.S. dollar exposures. For derivative
instruments that qualify for hedge accounting, unrealized gains and losses are deferred and included in accumulated other
comprehensive income. These deferred gains and losses are reclassified from accumulated other comprehensive loss and
recognized in earnings when the future transactions occur. For derivative instruments that do not qualify for hedge accounting,
gains and losses are recognized immediately in earnings.
During 2004, the company entered into interest rate swaps with a total notional value of $80,000 to hedge a portion of its fixedrate debt. Under the terms of the interest rate swaps, the company receives interest at fixed rates and pays interest at variable
rates. The maturity dates of the interest rate swaps are January 15, 2008 and February 15, 2010. The fair value of these swaps
was $2,626 and $2,875 at December 31, 2006 and 2005, respectively, and was included in other non-current liabilities. The
critical terms, such as principal and notional amounts and debt maturity and swap termination dates, coincide resulting in no
hedge ineffectiveness. These instruments are designated and qualify as fair value hedges. Accordingly, the gain or loss on both
the hedging instrument and the hedged item attributable to the hedged risk are recognized currently in earnings.
The carrying value of cash and cash equivalents, accounts receivable, commercial paper, short-term borrowings and accounts
payable are a reasonable estimate of their fair value due to the short-term nature of these instruments. The fair value of the
company’s long-term fixed-rate debt, based on quoted market prices, was $440,700 and $525,000 at December 31, 2006 and
2005, respectively. The carrying value of this debt at such dates was $450,200 and $538,000, respectively.
11 Research and Development
The company performs research and development under company-funded programs and under contracts with the federal
government and others. Expenditures committed to research and development amounted to $67,900, $60,100 and $56,700 for
2006, 2005 and 2004, respectively. Of these amounts, $8,000, $7,200 and $6,700, respectively, were funded by others.
Expenditures may fluctuate from year to year depending on special projects and needs.
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139
12 Equity Investments
Consolidated Balance Sheet, which were approximately $12,144 and $19,900 at December 31, 2006 and 2005, respectively. In
2006, the company sold a portion of CoLinx, LLC due to the addition of another company to the joint venture. In 2005, the
company sold a joint venture, NRB Bearings, based in India.
Equity investments are reviewed for impairment when circumstances (such as lower-than-expected financial performance or
change in strategic direction) indicate that the carrying value of the investment may not be recoverable. If impairment does exist,
the equity investment is written down to its fair value with a corresponding charge to the Consolidated Statement of Income. No
impairments were recorded during 2006 relating to the company’s equity investments.
PEL
During 2000, the company’s Steel Group invested in a joint venture, PEL, to commercialize a proprietary technology that converts
iron units into engineered iron oxides for use in pigments, coatings and abrasives. In the fourth quarter of 2003, the company
concluded its investment in PEL was impaired due to the following indicators of impairment: history of negative cash flow and
losses; 2004 operating plan with continued losses and negative cash flow; and the continued required support from the company
or another party. In the fourth quarter of 2003, the company recorded a non-cash impairment loss of $45,700, which was reported
in other expense — net on the Consolidated Statement of Income.
The company concluded that PEL was a variable interest entity and that the company was the primary beneficiary. In accordance
with FIN 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51,” the company
consolidated PEL effective March 31, 2004. The adoption of FIN 46 resulted in a charge, representing the cumulative effect of
change in accounting principle, of $948, which was reported in other expense — net on the Consolidated Statement of Income. In
addition, the adoption of FIN 46 increased the Consolidated Balance Sheet as follows: current assets by $1,659; property, plant
and equipment by $11,333; short-term debt by $11,561; accounts payable and other liabilities by $659; and other non-current
liabilities by $1,720. All of PEL’s assets were collateral for its obligations. Except for PEL’s indebtedness for which the company
was a guarantor, PEL’s creditors had no recourse to the general credit of the company.
In the first quarter of 2006, plans were finalized to liquidate the assets of PEL, and the company recorded a related gain of
approximately $3,549. In January 2006, the company repaid, in full, the $23,000 balance outstanding of the revenue bonds held
by PEL. In June 2006, the company continued to liquidate PEL, with land and buildings exchanged and the buyer’s assumption of
the fixed-rate mortgage, which resulted in a gain of $2,787.
Advanced Green Components
During 2002, the company’s Automotive Group formed a joint venture, AGC, with Sanyo Special Steel Co., Ltd. (Sanyo) and
Showa Seiko Co., Ltd. (Showa). AGC is engaged in the business of converting steel to machined rings for tapered bearings and
other related products. The company has been accounting for its investment in AGC under the equity method since AGC’s
inception. During the third quarter of 2006, AGC refinanced its long-term debt of $12,240. The company guaranteed half of this
obligation. The company concluded the refinancing represented a reconsideration event to evaluate whether AGC was a variable
interest entity under FIN 46 (revised December 2003). The company concluded that AGC was a variable interest entity and the
company was the primary beneficiary. Therefore, the company consolidated AGC, effective September 30, 2006. As of
September 30, 2006, the net assets of AGC were $9,011, primarily consisting of the following: inventory of $5,697; property, plant
and equipment of $27,199; goodwill of $9,612; short-term and long-term debt of $20,271; and other non-current liabilities of
$7,365. The $9,612 of goodwill was subsequently written-off as part of the annual test for impairment in accordance with SFAS
No. 142. All of AGC’s assets are collateral for its obligations. Except for AGC’s indebtedness for which the company is a
guarantor, AGC’s creditors have no recourse to the general credit of the company.
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13 Retirement and Postretirement Benefit Plans
The company sponsors defined contribution retirement and savings plans covering substantially all associates in the United
States and certain salaried associates at non-U.S. locations. The company contributes shares of the company’s common stock to
certain plans based on formulas established in the respective plan agreements. At December 31, 2006, the plans had 11,129,438
shares of the company’s common stock with a fair value of $324,757. Company contributions to the plans, including performance
sharing, amounted to $28,074, in 2006, $25,801 in 2005 and $22,801 in 2004. The company paid dividends totaling $6,947 in
2006, $7,224 in 2005 and $6,467 in 2004, to plans holding shares of the company’s common stock.
The company and its subsidiaries sponsor several unfunded postretirement plans that provide health care and life insurance
benefits for eligible retirees and dependents. Depending on retirement date and associate classification, certain health care plans
contain contributions and cost-sharing features such as deductibles and coinsurance. The remaining health care and life
insurance plans are noncontributory.
The company and its subsidiaries sponsor a number of defined benefit pension plans, which cover eligible associates. The cash
contributions for the company’s defined benefit pension plans were $264,756 and $238,089 in 2006 and 2005, respectively.
On December 31, 2006, the company adopted the recognition and disclosure provisions of SFAS No. 158. SFAS No. 158
required the company to recognize the funded status (i.e., the difference between the company’s fair value of plan assets and the
projected benefit obligations) of its defined benefit pension and postretirement benefit plans (collectively, the postretirement
benefit plans) in the December 31, 2006 Consolidated Balance Sheet, with a corresponding adjustment to accumulated other
comprehensive income, net of tax. The adjustment to accumulated other comprehensive income at adoption represents the net
unrecognized actuarial losses, unrecognized prior service costs and unrecognized transition obligation remaining from the initial
adoption of SFAS No. 87 and SFAS No. 106, all of which were previously netted against the plans’ funded status in the
company’s Consolidated Balance Sheet in accordance with the provisions of SFAS No. 87 and SFAS No. 106. These amounts
will be subsequently recognized as net periodic benefit cost in accordance with the company’s historical accounting policy for
amortizing these amounts. In addition, actuarial gains and losses that arise in subsequent periods and are not recognized as net
periodic benefit cost in the same periods will be recognized as a component of other comprehensive income. Those amounts will
be subsequently recognized as a component of net periodic benefit cost on the same basis as the amounts recognized in
accumulated other comprehensive income at adoption of SFAS No. 158.
The incremental effects of adopting the provisions of SFAS No. 158 on the company’s Consolidated Balance Sheet at
December 31, 2006 are presented in the following table. The adoption of SFAS No. 158 had no effect on the company’s
Consolidated Statement of Income for the year ended December 31, 2006 and 2005, respectively, and it will not effect the
company’s operating results in subsequent periods.
At December 31, 2006
Prior to
Effect of
Adopting
Adopting
SFAS No. 158
SFAS No. 158
Pension and Postretirement Benefit Plans
Assets:
Total assets
Liabilities and Shareholders’ Equity:
Pension and postretirement benefit liabilities
Accumulated other comprehensive income
Total liabilities and shareholders’ equity
$ 166,642
50,579
70,540
3,905,923
860,805
(212,196)
3,905,923
$ (62,572)
3,729
184,453
125,610
457,976
(332,366)
125,610
As Reported
at December
31, 2006
$ 104,070
54,308
254,993
4,031,533
1,318,781
(544,562)
4,031,533
In the table presented above, deferred income taxes represent current and non-current deferred income tax assets on the
Consolidated Balance Sheet as of December 31, 2006. In addition, pension and postretirement benefit liabilities represent
salaries, wages and benefits, accrued pension cost and accrued postretirement benefits costs on the Consolidated Balance Sheet
as of December 31, 2006.
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141
The following tables set forth the change in benefit obligation, change in plan assets, funded status and amounts recognized in
the Consolidated Balance Sheet of the defined benefit pension and postretirement benefits as of December 31, 2006 and 2005:
Defined Benefit
Pension Plans
2006
2005
Change in benefit obligation
Benefit obligation at beginning of year
Service cost
Interest cost
Amendments
Actuarial losses (gains)
Associate contributions
International plan exchange rate change
Acquisition (divestitures)
Curtailment (gain) loss
Benefits paid
Settlements
Benefit obligation at end of year
Change in plan assets (1)
Fair value of plan assets at beginning of year
Actual return on plan assets
Company contributions
Benefits paid
Settlements
Fair value of plan assets at end of year
Funded status at end of year
Unrecognized net actuarial loss
Unrecognized net asset at transition dates, net of amortization
Unrecognized prior service cost (benefit)
Net amounts recognized
Amounts recognized in the Consolidated Balance Sheet
Noncurrent assets
Current liabilities
Noncurrent liabilities
(3)
$2,586,146
40,049
152,265
4,730
188,962
993
(38,588)
—
729
(163,613)
—
$2,771,673
$2,104,175
255,290
1,010
264,756
32,385
(166,552)
(101,679)
$2,389,385
$ (412,097)
$1,840,866
210,234
993
238,089
(24,216)
(161,791)
—
$2,104,175
$ (667,498)
812,353
(500)
88,059
$ 232,414
$
$
3,729
(5,388)
(410,438)
—
$ (412,097)
Amounts recognized in accumulated other comprehensive
income
Net actuarial loss
Net prior service cost (credit)
Net transition obligation (asset)
(1)
(2)
$2,771,673
45,414
154,992
879
53,405
1,010
48,607
(503)
(740)
(166,552)
(106,703)
$2,801,482
$ 730,234
72,157
(333)
$ 802,058
Postretirement Plans
2006
2005
$ 821,246
5,277
44,099
—
(44,285)
—
(11)
—
—
(51,653)
(34,442)
$ 740,231
$ 820,595
5,501
45,847
25,717
(32,662)
—
117
—
8,141
(52,010)
—
$ 821,246
$
—
$(740,231)
$
—
$(821,246)
254,307
—
(2,361)
$(569,300)
77,595 (2) $
—
(160,183) (2)
(57,297)
(246,692) (2) (682,934)
561,694 (2)
—
$ 232,414
$(740,231)
N/A
N/A
N/A
N/A
(3)
(3)
(3)
(3)
$ 188,742
(420)
—
$ 188,322
$
— (2)
(55,529) (2)
(513,771) (2)
— (2)
$(569,300)
N/A
N/A
N/A
N/A
(3)
(3)
(3)
(3)
Plan assets are primarily invested in listed stocks and bonds and cash equivalents.
Effective November 30, 2006, the company sold its Latrobe Steel subsidiary. As part of the sale, Latrobe Steel retained
responsibility for the pension and postretirement benefit obligations with respect to current and retired employees covered by
collective bargaining agreements. Amounts in 2005 for defined benefit pension plans and postretirement plans include
$5,580 of non-current assets, $3,521 of current liabilities and $29,543 of non-current liabilities related to Latrobe Steel, which
are included in discontinued operations on their respective line of the Consolidated Balance Sheet. In addition, accumulated
other comprehensive income includes $9,964 related to these plans retained by Latrobe Steel.
These disclosures are not applicable to 2005 defined benefit pension plans and postretirement plans due to SFAS No. 158
being effective for the year ended December 31, 2006.
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142
Defined benefit pension plans in the United States represent 84% of the benefit obligation and 86% of the fair value of plan assets
as of December 31, 2006.
Certain of the company’s international postretirement benefit plans have an overfunded status as of December 31, 2006. As a
result, these amounts are included in other non-current assets on the Consolidated Balance Sheet. The current portion of accrued
pension cost, which is included in salaries, wages and benefits on the Consolidated Balance Sheet, was $5,388 and $160,200 at
December 31, 2006 and 2005, respectively. The current portion of accrued postretirement benefit cost, which is included in
salaries, wages and benefits on the Consolidated Balance Sheet, was $57,297 and $55,500 at December 31, 2006 and 2005,
respectively. In 2006, the current portion of accrued pension cost and accrued postretirement benefit cost relates to unfunded
plans and represents the actuarial present value of expected payments related to the plans to be made over the next 12 months.
In 2006, investment performance and company contributions increased the company’s pension fund asset values.
The accumulated benefit obligations at December 31, 2006 exceeded the market value of plan assets for the majority of the
company’s plans. For these plans, the projected benefit obligation was $2,209,000; the accumulated benefit obligation was
$2,108,000; and the fair value of plan assets was $1,840,000 at December 31, 2006.
For 2007 expense, the company’s discount rate will be 5.875%, the same discount rate used for calculating 2006 expense.
As of December 31, 2006 and 2005, the company’s defined benefit pension plans did not hold a material amount of shares of the
company’s common stock.
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The following table summarizes the assumptions used by the consulting actuary and the related benefit cost information for the
years ended December 31:
2006
Assumptions
Discount rate
Future compensation assumption
Expected long-term return on plan
assets
Components of net periodic
benefit cost
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized net actuarial loss
Cost of SFAS 88 events
Amortization of transition asset
Net periodic benefit cost
Other changes in plan assets
and benefit obligations
recognized in other
comprehensive income (4)
AOCI at December 31, 2005
Net loss/(gain)
Recognition of prior service cost/
(credit)
Recognition of loss/(gain)
Decrease prior to adoption of
SFAS No. 158
Increase due to adoption of
SFAS No. 158
Total recognized in other
comprehensive income at
December 31, 2006
(4)
Pension Benefits
2005
2004
5.875%
3% to 4%
5.875%
3% to 4%
6.00%
3% to 4%
8.75%
8.75%
8.75%
$ 45,414
154,992
(173,437)
12,399
56,779
9,473
(171)
$ 105,449
$ 40,049
152,265
(153,493)
12,513
49,902
900
(118)
$ 102,018
$ 37,112
145,880
(146,199)
15,137
33,075
—
(106)
$ 84,899
$ 561,694
—
N/A
N/A
N/A
N/A
—
N/A
(88,133)
2006
Postretirement Benefits
2005
5.875%
$
5,277
44,099
—
(1,941)
12,238
(25,400)
—
$ 34,273
$
2004
5.875%
$ 5,501
45,847
—
(4,446)
16,275
7,649
—
$70,826
6.00%
$ 5,751
48,807
—
(4,683)
17,628
—
—
$67,503
—
—
N/A
N/A
N/A
N/A
N/A
—
N/A
N/A
N/A
N/A
—
N/A
N/A
328,497
N/A
N/A
188,322
N/A
N/A
$ 802,058
N/A
N/A
$188,322
N/A
N/A
These disclosures are not applicable to 2005 and 2004 defined benefit pension plans and postretirement plans due to the
SFAS No. 158 being effective for the year ended December 31, 2006.
The net periodic benefit cost includes $4,272, $3,521 and $4,471 in 2006, 2005 and 2004, respectively, for defined benefit
pension and postretirement plans retained by Latrobe Steel classified as discontinued operations.
The estimated net loss, prior service cost and net transition (asset)/obligation for the defined benefit pension plans that will be
amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $47,988,
$11,301 and $(162), respectively.
The estimated net loss and prior service credit for the postretirement plans that will be amortized from accumulated other
comprehensive income into net periodic benefit cost over the next fiscal year are $10,306 and $(1,877), respectively.
As a result of the company’s sale of its Latrobe Steel subsidiary, Latrobe Steel retained responsibility for the pension and
postretirement benefit obligations with respect to current and retired employees covered by collective bargaining agreements. As
a result, the company recognized a total settlement and curtailment pretax loss of $9,383 for the pension benefit obligations. In
addition, the company recognized a curtailment gain of $34,442 less a portion of an unrecognized loss of $9,042, resulting in onetime income of $25,400 associated with the postretirement benefit obligations retained by Latrobe Steel. Pension and
postretirement benefit obligations for the Latrobe Steel salaried associates and retirees will continue to be the company’s
responsibility.
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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 8.0% for 2007, declining gradually to 5.0% in 2010 and thereafter; and 11.25% for 2007,
declining gradually to 5.0% in 2014 and thereafter for prescription drug benefits.
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 increase the 2006 total service and interest cost components by $1,222 and
would increase the postretirement benefit obligation by $20,876. A one percentage point decrease would provide corresponding
reductions of $1,179 and $19,971, respectively.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Medicare Act) was signed into law on
December 8, 2003. The Medicare Act provides for prescription drug benefits under Medicare Part D and contains a subsidy to
plan sponsors who provide “actuarially equivalent” prescription plans. In May 2004, the FASB issued FASB Staff Position No. FAS
106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act
of 2003” (FSP 106-2). During 2005, the company’s actuary determined that the prescription drug benefit provided by the
company’s postretirement plan is considered to be actuarially equivalent to the benefit provided under the Medicare Act. In
accordance with FSP 106-2, all measures of the accumulated postretirement benefit obligation or net periodic postretirement
benefit cost in the financial statements or accompanying notes reflect the effects of the Medicare Act on the plan for the entire
fiscal year.
The effect on the accumulated postretirement benefit obligation attributed to past service as of January 1, 2006 is a reduction of
$53,273 and the effect on the amortization of actuarial losses, service cost, and interest cost components of net periodic benefit
cost is a reduction of $7,790. The 2006 expected subsidy was $3,100, of which $975 was received prior to December 31, 2006.
Plan Assets:
The company’s pension asset allocation at December 31, 2006 and 2005 and target allocation are as follows:
Asset Category
Current Target
Allocation
2007
Percentage of Pension
Plan Assets at
December 31
2006
2005
Equity securities
Debt securities
Total
60% to 70%
30% to 40%
100%
67%
33%
100%
67%
33%
100%
The company recognizes its overall responsibility to ensure that the assets of its various pension plans are managed effectively
and prudently and in compliance with its policy guidelines and all applicable laws. Preservation of capital is important, however,
the company also recognizes that appropriate levels of risk are necessary to allow its investment managers to achieve satisfactory
long-term results consistent with the objectives and the fiduciary character of the pension funds. Asset allocation is established in
a manner consistent with projected plan liabilities, benefit payments and expected rates of return for various asset classes. The
expected rate of return for the investment portfolio is based on expected rates of return for various asset classes as well as
historical asset class and fund performance.
Cash Flows:
Employer Contributions to Defined Benefit Plans
2005
2006
2007 (planned)
$238,089
$264,756
$100,078
Future benefit payments are expected to be as follows:
Benefit Payments
Pension Benefits
Gross
2007
2008
2009
2010
2011
2012-2016
$164,083
$167,800
$172,012
$173,210
$175,529
$936,643
$ 62,193
$ 64,962
$ 67,529
$ 68,828
$ 69,166
$323,300
Expected
Net Including
Medicare
Medicare
Subsidies
Subsidies
$ 3,213
$ 3,677
$ 3,495
$ 3,851
$ 4,249
$28,268
$ 58,980
$ 61,285
$ 64,034
$ 64,977
$ 64,917
$295,032
The pension accumulated benefit obligation was $2,642,405 and $2,638,920 at December 31, 2006 and 2005, respectively.
66
145
14 Segment Information
The company’s reportable segments are business units that target different industry segments. Each reportable segment is
managed separately because of the need to specifically address customer needs in these different industries. The company has
three reportable segments: Industrial Group, Automotive Group and Steel Group.
The Industrial Group includes sales of bearings and other products and services (other than steel) to a diverse customer base,
including: industrial equipment, off-highway, rail, and aerospace and defense customers. The Industrial Group also includes
aftermarket distribution operations, including automotive applications, for products other than steel. The Automotive Group
includes sales of bearings and other products and services (other than steel) to automotive original equipment manufacturers for
passenger cars, trucks and trailers. The company’s bearing products are used in a variety of products and applications including
passenger cars, trucks, locomotive and railroad cars, machine tools, rolling mills, farm and construction equipment, aircraft,
missile guidance systems, computer peripherals and medical instruments.
The Steel Group includes sales of low and intermediate alloy and carbon grade steel in a wide range of solid and tubular sections
with a variety of finishes. The company also manufactures custom-made steel products, including precision steel components.
Approximately 10% of the company’s steel is consumed in its bearing operations. In addition, sales are made to other anti-friction
bearing companies and to aircraft, automotive, forging, tooling, oil and gas drilling industries and steel service centers. In 2006,
the company sold the Latrobe Steel subsidiary. This business was part of the Steel Group for segment reporting purposes. This
business has been treated as discontinued operations for all periods presented.
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 charges, rationalization and integration costs,
one-time gains or losses on sales of assets, allocated receipts or payments made under the CDSOA, loss on dissolution of
subsidiary, acquisition-related currency exchange gains, and other items similar in nature). The accounting policies of the
reportable segments are the same as those described in the summary of significant accounting policies. Intersegment sales and
transfers are recorded at values based on market prices, which creates intercompany profit on intersegment sales or transfers that
is eliminated in consolidation.
The company reports net sales by geographic area in a manner that is more reflective of how the company operates its segments,
which is by the destination of net sales. Non-current assets by geographic area are reported by the location of the subsidiary.
United States
Europe
Other Countries
Consolidated
2006
Net sales
Non-current assets
$3,370,244
1,578,856
$849,915
285,840
$753,206
266,557
$4,973,365
2,131,253
2005
Net sales
Non-current assets
$3,295,171
1,413,575
$812,960
337,657
$715,036
177,988
$4,823,167
1,929,220
2004
Net sales
Non-current assets
$2,900,749
1,399,155
$779,478
398,925
$606,970
221,112
$4,287,197
2,019,192
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146
Segment Financial Information
2006
2005
2004
Industrial Group
Net sales to external customers
Intersegment sales
EBIT, as adjusted
Assets employed at year-end
$2,072,495
1,998
74,005
201,334
132,815
1,954,589
$1,925,211
1,847
73,278
199,936
87,932
1,748,619
$1,709,770
1,437
71,352
177,913
49,721
1,735,692
Automotive Group
EBIT (loss) as adjusted
$1,573,034
81,091
(73,696)
111,079
1,248,294
$1,661,048
85,345
(19,886)
100,369
1,231,348
$1,582,226
78,100
15,919
73,926
1,229,224
Steel Group
Intersegment sales
EBIT, as adjusted
$1,327,836
144,424
41,496
206,691
52,199
828,650
$1,236,908
178,157
51,033
175,772
29,110
770,325
$ 995,201
161,941
51,721
52,672
20,134
771,763
$
—
$ 243,442
$ 206,230
Total
EBIT, as adjusted
$4,973,365
196,592
334,329
296,093
4,031,533
$4,823,167
209,656
355,822
217,411
3,993,734
$4,287,197
201,173
246,504
143,781
3,942,909
Reconciliation to Income from Continuting Operations Before Income
Taxes
Total EBIT, as adjusted, for reportable segments
Impairment and restructuring
Rationalization and integration charges
Gain on sale of non-strategic assets, net of dissolution of subsidiary
Adoption of FIN 46 for investment in PEL
Other
Interest expense
Interest income
Intersegment adjustments
Income from Continuing Operations before Income Taxes
$ 334,329
(44,881)
(64,271)
(24,393)
7,953
87,907
—
(1,210)
(49,387)
4,605
3,582
$ 254,234
$ 355,822
(26,093)
—
(17,270)
8,547
77,069
—
(194)
(51,585)
3,437
(3,195)
$ 346,538
$ 246,504
(13,538)
—
(27,025)
190
44,429
(948)
(719)
(50,834)
1,397
(1,865)
$ 197,591
68
147
15 Income Taxes
Income before income taxes, based on geographic location of the operation to which such earnings are attributable, is provided
below. As the company has elected to treat certain foreign subsidiaries as branches for U.S. income tax purposes, pretax income
attributable to the U.S. shown below may differ from the pretax income reported on the company’s annual U.S. Federal income tax
return.
2006
United States
Non-United States
Income before income taxes
2005
$225,028
29,206
$254,234
$278,212
68,326
$346,538
2004
$160,188
37,403
$197,591
The provision for income taxes consisted of the following for the years ended December 31:
2006
Current:
Federal
State and local
Foreign
Deferred:
Federal
State and local
Foreign
United States and foreign taxes on income
2005
$ 86,206
(651)
18,635
104,190
$
9,271
(2,559)
24,778
31,490
(20,977)
1,086
(6,504)
(26,395)
$ 77,795
85,377
1,987
(5,972)
81,392
$112,882
2004
$ (8,873)
4,578
10,982
6,687
49,019
509
7,330
56,858
$63,545
The company made income tax payments of approximately $90,600, $29,200 and $49,800 in 2006, 2005 and 2004, respectively.
Following is the reconciliation between the provision for income taxes and the amount computed by applying U.S. Federal income
tax rate of 35% to income before taxes for the years ended December 31:
2006
Income tax at the U.S. federal statutory rate
Adjustments:
State and local income taxes, net of federal tax benefit
Tax on foreign remittances
Losses without current tax benefits
Tax holidays and foreign earnings taxes at different rates
Deductible dividends paid to ESOP
Benefits related to U.S. exports
Accrual of tax-free Medicare subsidy
Goodwill impairment
Accruals and settlements related to tax audits
Change in tax status of certain entities
Other items (net)
Effective income tax rate
2005
2004
$ 88,982
$121,288
$ 69,157
283
6,395
7,242
(13,334)
(2,318)
(5,325)
(2,604)
3,773
(3,294)
—
(2,005)
$ 77,795
30.6%
(373)
16,124
1,365
(8,515)
(2,279)
(9,971)
(3,055)
—
4,001
—
(5,703)
$112,882
32.6%
3,307
4,164
28,630
(10,628)
(1,918)
(2,308)
(1,384)
—
(12,673)
(11,954)
(848)
$ 63,545
32.2%
69
148
In connection with various investment arrangements, the company was granted “holidays” from income taxes in the Czech
Republic and at two different affiliates in China. These agreements were new to the company in 2003 and are estimated to begin
to expire after 2008. In total, the agreements reduced income tax expenses by $3,700 in 2006, $4,300 in 2005 and $4,500 in
2004. These savings resulted in an increase to earnings per diluted share of $0.04 in 2006, $0.05 in 2005, and $0.05 in 2004.
The company plans to reinvest undistributed earnings of all non-U.S. subsidiaries, which amounted to approximately $235,000
and $152,000 at December 31, 2006 and December 31, 2005, respectively. Accordingly, taxes on the repatriation of such
earnings have not been provided. If these earnings were repatriated, additional tax expense of approximately $82,000 as of
December 31, 2006 and $52,000 as of December 31, 2005 would have been incurred.
In October 2004, the President signed the American Jobs Creation Act of 2004 (the AJCA). The AJCA created a temporary
incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received
deduction for certain dividends from foreign subsidiaries. During 2005, the company repatriated $118,800 under the AJCA. This
amount consisted of dividends, previously taxed income and returns of capital, and resulted in net income tax expense of $8,100.
The AJCA also contains a provision that eliminates the benefits of the extraterritorial income exclusion for U.S. exports after 2006.
The company recognized tax benefits of approximately $5,300 related to the extraterritorial income exclusion in 2006. Additionally,
the AJCA contains a provision that enables companies to deduct a percentage (3% in 2005 and 2006, 6% in 2007 through 2009,
and 9% in 2010 and later years) of the taxable income derived from qualified domestic manufacturing operations. The company
recognized tax benefits of approximately $1,600 relating to the manufacturing deduction for 2006.
In December 2006, the Tax Relief and Health Care Act of 2006 (the TRHCA) was signed into law. The TRHCA retroactively
extends the U.S. federal income tax credit for qualified research and development activities (the R&D credit), which had expired
on December 31, 2005, through December 31, 2007. The TRHCA also provides an alternative simplified method for calculating
the R&D credit for 2007. The company expects the alternative simplified method to result in an increased R&D credit in 2007
versus prior years.
The effect of temporary differences giving rise to deferred tax assets and liabilities at December 31, 2006 and 2005 were as
follows:
Deferred tax assets:
Inventory
Benefit accruals
Tax loss and credit carryforwards
Other—net
Valuation allowance
Deferred tax liability — depreciation & amortization
Net deferred tax asset
2006
2005
$ 232,638
198,576
33,244
7,030
159,240
47,978
(191,894)
486,812
(239,116)
$ 247,696
$ 205,919
53,447
21,414
15,954
172,509
43,062
(171,357)
340,948
(282,754)
$ 58,194
The company has U.S. loss carryforwards with tax benefits totaling $14,900. These losses will start to expire in 2008. In addition,
the company has loss carryforwards in various foreign jurisdictions with tax benefits totaling $135,200 having various expiration
dates, and state and local loss carryforwards and credit carryforwards, with tax benefits of $6,300 and $2,800 respectively, which
will begin to expire in 2007. The company has provided valuation allowances of $146,100 against certain of these carryforwards.
The company has provided valuation allowances of $45,800 against deferred tax assets other than tax losses and credit
carryforwards.
The calculation of the company’s provision for income taxes involves the interpretation of complex tax laws and regulations. Tax
benefits for certain items are not recognized, unless it is probable that the company’s position will be sustained if challenged by
tax authorities. Tax liabilities for other items are recognized for anticipated tax contingencies based on the company’s estimate of
whether, and the extent to which, additional taxes will be due.
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149
Quarterly Financial Data
(Unaudited)
2006
Net sales
Gross profit
Income from continuing operations (1)
Income from discontinued operations (3)
Net income
Net income per share — Basic:
Total net income per share
Net income per share — Diluted:
Dividends per share
2005
1st
2nd
3rd
4th
Total
$1,254,308
269,813
1,040
57,094
8,846
65,940
$1,302,174
293,849
7,469
64,888
9,803
74,691
$1,185,962
232,397
2,682
38,688
7,859
46,547
$1,230,921
209,785
33,690
15,769
19,580
35,349
$4,973,365
1,005,844
44,881
176,439
46,088
222,527
0.61
0.10
0.71
0.70
0.10
0.80
0.41
0.09
0.50
0.17
0.21
0.38
1.89
0.49
2.38
0.61
0.09
0.70
0.15
0.69
0.10
0.79
0.15
0.41
0.08
0.49
0.16
0.17
0.20
0.37
0.16
1.87
0.49
2.36
0.62
1st
2nd
3rd
4th
Total
Net sales
$1,223,669
$1,243,671
$1,166,196
$1,189,631
$4,823,167
Gross profit
259,234
264,956
236,444
239,323
999,957
—
(44)
24,451
1,686
26,093
Income from continuing operations (2)
52,876
62,276
32,390
86,114
233,656
Income from discontinued operations (3)
5,359
5,058
7,441
8,767
26,625
Net income
58,235
67,334
39,831
94,881
260,281
Net income per share — Basic:
0.58
0.68
0.35
0.93
2.55
0.06
0.06
0.08
0.10
0.29
0.64
0.74
0.43
1.03
2.84
Net income per share — Diluted:
0.57
0.67
0.35
0.92
2.52
0.06
0.06
0.08
0.09
0.29
0.63
0.73
0.43
1.01
2.81
Dividends per share
0.15
0.15
0.15
0.15
0.60
Earnings per share are computed independently for each of the quarters presented, therefore, the sum of the quarterly earnings
per share may not equal the total computed for the year.
(1)
(2)
(3)
Income from continuing operations for the second quarter includes $10.0 million related to the loss on divestiture of the
company’s Timken Precision Components — Europe business. Income from continuing operations for the third quarter
includes a $7.0 million charge for product warranty. Income from continuing operations for the fourth quarter includes
$54.3 million related to the loss on divestiture of the company’s steering business, a $11.8 million charge for product
warranty and income of $87.9 million, resulting from the CDSOA.
Income from continuing operations includes $77.1 million, resulting from the CDSOA.
Discontinued operations for 2006 reflects the operating results and gain on sale of Latrobe Steel, net of tax. Discontinued
operations for 2005 reflects the operating results of Latrobe Steel, net of tax.
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150
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
The Timken Company
We have audited the accompanying consolidated balance sheets of The Timken Company and subsidiaries as of December 31,
2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three
years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the Index at
Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position
of The Timken Company and subsidiaries at December 31, 2006 and 2005, and the consolidated results of their operations and
their cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Notes 9 and 13 to the consolidated financial statements, the Company adopted Statement of Financial
Accounting Standards No. 123(R), “Shared-Based Payment” and Statement of Financial Accounting Standards No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” in 2006.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
effectiveness of The Timken Company’s internal control over financial reporting as of December 31, 2006, based on criteria
established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 22, 2007 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Cleveland, Ohio
February 22, 2007
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151
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
As of the end of the period covered by this report, the company’s management carried out an evaluation, under the supervision
and with the participation of 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 as defined to Exchange Act Rule 13a-15(e). 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 the end of the period covered by this report.
There have been no changes in the company’s internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the company’s internal control over financial reporting during the company’s fourth quarter of
2006.
Report of Management on Internal Control Over Financial Reporting
The management of The Timken Company is responsible for establishing and maintaining adequate internal control over financial
reporting for the company. Timken’s internal control system was designed to provide reasonable assurance regarding the
preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Timken management assessed the effectiveness of the company’s internal control over financial reporting as of December 31,
2006. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Based on this assessment under COSO’s “Internal Control-Integrated Framework,” management believes
that, as of December 31, 2006, Timken’s internal control over financial reporting is effective.
Ernst & Young LLP, independent registered public accounting firm, has issued an audit report on our assessment of Timken’s
internal control over financial reporting as of December 31, 2006, which is presented below.
Management Certifications
James W. Griffith, President and Chief Executive Officer of Timken, has certified to the New York Stock Exchange that he is not
aware of any violation by Timken of New York Stock Exchange corporate governance standards.
Section 302 of the Sarbanes-Oxley Act of 2002 requires Timken’s principal executive officer and principal financial officer to file
certain certifications with the SEC relating to the quality of Timken’s public disclosures. These certifications are filed as exhibits to
this report.
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152
The Board of Directors and Shareholders of The Timken Company
We have audited management’s assessment, included in the accompanying Report of Management on Internal Control Over
Financial Reporting, that The Timken Company maintained effective internal control over financial reporting as of December 31,
2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). The Timken Company’s management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness
of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal
control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions
of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that The Timken Company maintained effective internal control over financial reporting
as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, The Timken
Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based
on the COSO criteria.
consolidated balance sheets of The Timken Company as of December 31, 2006 and 2005, and the related consolidated
statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006 of
The Timken Company and our report dated February 22, 2007 expressed an unqualified opinion thereon.
Cleveland, Ohio
February 22, 2007
74
153
Item 9B. Other Information
Not applicable
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Required information is set forth under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership Report
Compliance” in the proxy statement filed in connection with the annual meeting of shareholders to be held May 1, 2007, and is
incorporated herein by reference. Information regarding the executive officers of the registrant is included in Part I hereof.
Information regarding the company’s Audit Committee and its Audit Committee Financial Expert is set forth under the caption
“Audit Committee” in the proxy statement filed in connection with the annual meeting of shareholders to be held May 1, 2007, and
is incorporated herein by reference.
The General Policies and Procedures of the Board of Directors of the company and the charters of its Audit Committee,
Compensation Committee and Nominating and Governance Committee are also available on its website at www.timken.com and
are available to any shareholder upon request to the Corporate Secretary. The information on the company’s website is not
incorporated by reference into this Annual Report on Form 10-K.
The company has adopted a code of ethics that applies to all of its employees, including its principal executive officer, principal
financial officer and principal accounting officer, as well as its directors. The company’s code of ethics, The Timken Company
Standards of Business Ethics Policy, is available on its website at www.timken.com. The company intends to disclose any
amendment to, or waiver from, its code of ethics by posting such amendment or waiver, as applicable, on its website.
Item 11. Executive Compensation
Required information is set forth under the captions “ Compensation Discussion and Analysis,” “Summary Compensation Table,”
“2006 Grants of Plan-Based Awards,” “Outstanding Equity Awards at Fiscal Year-End,” “2006 Option Exercises and Stock
Vested,” “Pension Benefits,” “Non —Qualified Deferred Compensation Plan,” “Termination of Employment and Change-in-Control
Agreements,” “Director Compensation — 2006,” “Compensation Committee,” “Compensation Committee Report” in the proxy
statement filed in connection with the annual meeting of shareholders to be held May 1, 2007, and is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Required information, including with respect to institutional investors owning more than 5% of the company’s Common Stock, is
set forth under the caption “Beneficial Ownership of Common Stock” in the proxy statement filed in connection with the annual
meeting of shareholders to be held May 1, 2007, and is incorporated herein by reference.
Required information is set forth under the caption “Equity Compensation Plan Information” in the proxy statement filed in
connection with the annual meeting of shareholders to be held May 1, 2007, and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Required information is set forth under the caption “Election of Directors” in the proxy statement issued in connection with the
annual meeting of shareholders to be held May 1, 2007, and is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
Required information regarding fees paid to and services provided by the company’s independent auditor during the years ended
December 31, 2006 and 2005 and the pre-approval policies and procedures of the Audit Committee of the company’s Board of
Directors is set forth under the caption “Auditors” in the proxy statement issued in connection with the annual meeting of
shareholders to be held May 1, 2007, and is incorporated herein by reference.
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154
Introductory Note
The Annual Report to the shareholders for the Company's fiscal year ended December 31, 2005 (the
"2005 Annual Report") includes, as an integrated report, the annual report that was prepared on Form
10-K under the US Securities Exchange Act of 1934, and that was filed with the US Securities and
Exchange Commission on March 13, 2006. The historical financial information presented in the 2005
Annual Report includes the business relating to the Company’s Latrobe Steel subsidiary sold in
December 2006. The following excerpts are extracted without adjustment from the 2005 Annual
Report. Since these excerpts contain text references to page numbers in the 2005 Annual Report, the
following pages also show the original page numbers printed in the 2005 Annual Report in addition to
the consecutive paging placed at the bottom right of each page of this prospectus.
Table of Contents
Page 192.
Pages 193.
Page 194.
Page 195.
Pages 196 et seq.
Auditors' Reports
Pages 220 and 223.
155
THE TIMKEN COMPANY
INDEX TO FORM 10-K REPORT
I.
PART I.
Item 1.
Item 1A.
PAGE
Description of Business
1
General
1
Products
1
2
Industry Segments
3
4
Competition
4
5
Joint Ventures
6
Backlog
6
Raw Materials
6
Research
7
7
8
Employment
8
8
Risk Factors
8
Item 1B.
Unresolved Staff Comments
12
Item 2.
Properties
12
Item 3.
Legal Proceedings
13
Item 4.
Submission of Matters to a Vote of Security Holders
13
Item 4A.
Executive Officers of the Registrant
14
II. PART II.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
15
Item 6.
Selected Financial Data
16
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
35
Item 8.
Financial Statements and Supplementary Data
36
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
63
Item 9A.
Controls and Procedures
63
Item 9B.
Other Information
64
III. Part III.
Item 10.
Directors and Executive Officers of the Registrant
66
Item 11.
Executive Compensation
66
Item 12.
Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
66
Item 13.
Certain Relationships and Related Transactions
66
Item 14.
Principal Accountant Fees and Services
66
Exhibits and Financial Statement Schedules
67
IV. Part IV.
Item 15.
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PART I
Item 1. Description of Business
General
As used herein, the term "Timken" or the "company" refers to The Timken Company and its subsidiaries unless the context otherwise
requires. Timken, an outgrowth of a business originally founded in 1899, was incorporated under the laws of the state of Ohio in
1904.
Timken is a leading global manufacturer of highly engineered bearings, alloy and specialty steel and related components. The
company is the world's largest manufacturer of tapered roller bearings and alloy seamless mechanical steel tubing and the largest
North American-based bearings manufacturer. Timken had facilities in 27 countries on six continents and employed approximately
27,000 people as of December 31, 2005.
On February 18, 2003, the company completed the acquisition of the Engineered Solutions business of Ingersoll-Rand Company
Limited, including certain joint venture interests, operating assets and subsidiaries, including The Torrington Company. This business,
referred to as Torrington, is now integrated into the company and is a leading worldwide producer of needle roller, heavy-duty roller
and ball bearings and motion control components and assemblies.
Products
The Timken Company manufactures two basic product lines: anti-friction bearings and steel products. Differentiation in these two
product lines comes in two different ways: (1) differentiation by bearing type or steel type, and (2) differentiation in the applications
of bearings and steel.
Tapered Roller Bearings. In the bearing industry, Timken is best known for the tapered roller bearing, which was originally patented
by the company founder, Henry Timken. The tapered roller bearing is Timken's principal product in the anti-friction industry segment.
It consists of four components: (1) the cone or inner race, (2) the cup or outer race, (3) the tapered rollers, which roll between the
cup and cone, and (4) the cage, which serves as a retainer and maintains proper spacing between the rollers. Timken manufactures
or purchases these four components and then sells them in a wide variety of configurations and sizes.
The tapered rollers permit ready absorption of both radial and axial load combinations. For this reason, tapered roller bearings are
particularly well-adapted to reducing friction where shafts, gears or wheels are used. The uses for tapered roller bearings are diverse
and include applications on passenger cars, light and heavy trucks and trains, as well as a variety of industrial applications, ranging
from very small gear drives to bearings over two meters in diameter for wind energy machines.
A number of applications
utilize bearings with sensors to measure parameters such as speed, load, temperature or overall bearing condition.
Matching bearings to the specific requirements of customers' applications requires engineering and often sophisticated analytical
techniques. The design of Timken's tapered roller bearing permits distribution of unit pressures over the full length of the roller.
This design, combined with high precision tolerances, proprietary internal geometry and premium quality material, provides Timken
bearings with high load-carrying capacity, excellent friction-reducing qualities and long life.
Precision Cylindrical and Ball Bearings. Timken's aerospace and super precision facilities produce high-performance ball and
cylindrical bearings for ultra high-speed and/or high-accuracy applications in the aerospace, medical and dental, computer and other
industries. These bearings utilize ball and straight rolling elements and are in the super precision end of the general ball and straight
roller bearing product range in the bearing industry. A majority of Timken's aerospace and super precision bearings products are
custom-designed bearings and spindle assemblies. They often involve specialized materials and coatings for use in applications that
subject the bearings to extreme operating conditions of speed and temperature.
Spherical and Cylindrical Bearings. Timken produces spherical and cylindrical roller bearings for large gear drives, rolling mills and
other process industry and infrastructure development applications. Timken's cylindrical and spherical roller bearing capability was
significantly enhanced with the acquisition of Torrington's broad range of spherical and heavy-duty cylindrical roller bearings for
standard industrial and specialized applications.
These products are sold worldwide to original equipment manufacturers and
industrial distributors serving major industries, including construction and mining, natural resources, defense, pulp and paper
production, rolling mills and general industrial goods.
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Products (continued)
Needle Bearings. With the acquisition of Torrington, the company became a leading global manufacturer of highly engineered needle
roller bearings. Timken produces a broad range of radial and thrust needle roller bearings, as well as bearing assemblies, which
are sold to original equipment manufacturers and industrial distributors worldwide. Major applications include automotive, consumer,
construction, agriculture and general industrial.
Bearing Reconditioning. A small part of the business involves providing bearing reconditioning services for industrial and railroad
customers, both internationally and domestically. These services account for less than 5% of the company's net sales for the year
ended December 31, 2005.
Steel. Steel products include steels of low and intermediate alloy, vacuum-processed alloys, tool steel and some carbon grades. These
products are available in a wide range of solid and tubular sections with a variety of lengths and finishes. These steel products
are used in a wide array of applications, including bearings, automotive transmissions, engine crankshafts, oil drilling components,
aerospace parts and other similarly demanding applications.
Timken also produces custom-made steel products, including steel components for automotive and industrial customers. This steel
components business has provided the company with the opportunity to further expand its market for tubing and capture higher valueadded steel sales. It also enables Timken's traditional tubing customers in the automotive and bearing industries to take advantage of
higher-performing components that cost less than current alternative products. Customizing of products is an important portion of the
company's steel business.
United
States
Europe
2005
Net sales
Non-current assets
$ 3,619,432
1,494,780
$ 821,472
337,657
$ 727,530
177,988
$ 5,168,434
2,010,425
2004
Net sales
Non-current assets
$ 3,114,138
1,483,674
$ 784,778
398,925
$ 614,755
221,112
$ 4,513,671
2,103,711
2003
Net sales
Non-current assets
$ 2,673,007
1,753,221
$ 648,412
365,969
$ 466,678
193,494
$ 3,788,097
2,312,684
2
Other
Countries Consolidated
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Industry Segments
The company has three reportable segments: Industrial Group, Automotive Group, and Steel Group. Financial information for the
segments is discussed in Note 14 to the Consolidated Financial Statements and is incorporated herein by reference.
The company’s reportable segments are business units that target different industry segments. Each reportable segment is managed
separately because of the need to specifically address customer needs in these different industries.
Beginning in the first quarter of 2003, 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 manages 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. Emerging market sales to automotive original equipment manufacturers are now included in the Automotive Group.
The Automotive Group includes sales of bearings and other products and services (other than steel) to automotive original equipment
manufacturers, or OEMs, for passenger cars, trucks and trailers. The Industrial Group includes sales of bearings and other products
and services (other than steel) to a diverse customer base, including: industrial equipment, off-highway, rail and aerospace and defense
customers. The Industrial Group also includes aftermarket distribution operations, including automotive applications, for
products other than steel. The company’s bearing products are used in a variety of products and applications, including passenger
cars, trucks, locomotive and railroad cars, machine tools, rolling mills and farm and construction equipment, aircraft, missile guidance
systems, computer peripherals and medical instruments.
The Steel Group includes sales of low and intermediate alloy, vacuum-processed alloys, tool steel and some carbon grades. These are
available in a wide range of solid and tubular sections with a variety of finishes. The company also manufactures custom-made steel
products, including precision steel components. Approximately 10% of the company’s steel is consumed in its bearing operations. In
addition, sales are made to other anti-friction bearing companies and to aircraft, automotive, forging, tooling, oil and gas drilling
industries and steel service centers. Tool steels are sold through the company’s distribution facilities.
The company evaluates performance and allocates resources based on return on capital and profitable growth. The primary measurement used by management to measure the financial performance of each segment is adjusted EBIT (earnings before interest
and taxes, excluding special items such as impairment and restructuring charges, rationalization and integration costs, one-time gains
or losses on sales of assets, allocated receipts received or payments made under the Continued Dumping and Subsidy Offset
Act (CDSOA), loss on dissolution of subsidiary, acquisition-related currency exchange gains, and other items similar in nature). The
accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.
Intersegment sales and transfers are recorded at values based on market prices, which creates intercompany profit on intersegment
sales or transfers that is eliminated in consolidation.
Prior to 2004, the company reported net sales by geographic area based on the location of its selling subsidiary. Beginning in 2004,
the company changed its reporting of net sales by geographic area to be more reflective of how the company operates its segments,
which is by the destination of net sales. Net sales by geographic area for 2003 have been reclassified to conform to the 2004 and 2005
presentation. Non-current assets by geographic area are reported by the location of the subsidiary.
Export sales from the U.S. and Canada are less than 10% of revenue. The company's Automotive and Industrial Groups have
historically participated in the global bearing industry, while the Steel Group has concentrated primarily on U.S. customers.
Timken's non-U.S. operations are subject to normal international business risks not generally applicable to domestic business. These
risks include currency fluctuation, changes in tariff restrictions, difficulties in establishing and maintaining relationships with local
distributors and dealers, import and export licensing requirements, difficulties in staffing and managing geographically diverse
operations, and restrictive regulations by foreign governments, including price and exchange controls.
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Timken's products in the Automotive Group and Industrial Group are sold principally by their own internal sales organizations.
A portion of the Industrial Group's sales are made through authorized distributors.
Traditionally, a main focus of the company's sales strategy has consisted of collaborative projects with customers. For this reason,
Timken's sales forces are primarily located in close proximity to its customers rather than at production sites. In some instances, the
sales forces are located inside customer facilities. Timken's sales force is highly trained and knowledgeable regarding all products,
and associates assist customers during the development and implementation phases and provide ongoing support.
The company has a joint venture in North America focused on joint logistics and e-business services. This alliance is called CoLinx
and was founded by Timken, SKF, INA and Rockwell Automation. The e-business service was launched in April 2001, and is focused
on information and business services for authorized distributors in the Industrial Group. The company also has another e-business joint
venture which focuses on information and business services for authorized industrial distributors in Europe, Latin America and Asia.
This alliance, which Timken founded with SKF, Sandvik AB, INA and Reliance, is called Endorsia.com International AB.
Timken's steel products are sold principally by its own sales organization. Most orders are customized to satisfy customer-specific
applications and are shipped directly to customers from Timken's steel manufacturing plants. Approximately 10% of Timken's Steel
Group net sales are intersegment sales. In addition, sales are made to other anti-friction bearing companies and to the aircraft,
automotive and truck, construction, forging, oil and gas drilling, and tooling industries. Sales are also made to steel service centers.
Timken has entered into individually negotiated contracts with some of its customers in its Automotive Group, Industrial Group
and Steel Group. These contracts may extend for one or more years and if a price is fixed for any period extending beyond current
shipments, customarily include a commitment by the customer to purchase a designated percentage of its requirements from Timken.
Contracts extending beyond one year that are not subject to price adjustment provisions do not represent a material portion of
Timken's sales. Timken does not believe that there is any significant loss of earnings risk associated with any given contract.
Competition
The anti-friction bearing business is highly competitive in every country in which Timken sells products. Timken competes primarily
based on price, quality, timeliness of delivery, product design and the ability to provide engineering support and service on a
global basis.
The company competes with domestic manufacturers and many foreign manufacturers of anti-friction bearings,
including SKF, INA, NTN Corporation, Koyo Seiko Co., Ltd. and NSK Ltd.
Competition within the steel industry, both domestically and globally, is intense and is expected to remain so. However, the
combination of a weakened U.S. dollar, worldwide rationalization of uncompetitive capacity, raw material cost increases and North
American and global market strength have allowed steel industry prices to increase and margins to improve. Timken's worldwide
competitors for seamless mechanical tubing include Dofasco, Plymouth Tube, Michigan Seamless Tube, V & M Tube, Sanyo Special
Steel, Ovako and Tenaris. Competitors for steel bar products include North American producers such as Republic Engineered
Products, Mac Steel, Ispat Inland, Steel Dynamics and a wide variety of offshore steel producers who import into North America.
Competitors in the precision steel components sector include Metaldyne, Linamar and overseas companies such as Showa Seiko,
Ovako and FormFlo. In the specialty steel category, manufacturers compete for sales of high-speed, tool and die, and aerospace
steels. High-speed steel competitors in North America and Europe include Erasteel, Bohler and Crucible. Tool and die steel competitors include Crucible, Bohler and Swiss Steel. The principal competitors for Timken's aerospace steels include Ellwood Specialty,
Republic Special Metals, Aubert & Duval and Corus.
Maintaining high standards of product quality and reliability while keeping production costs competitive is essential to Timken's
ability to compete with domestic and foreign manufacturers in both the anti-friction bearing and steel businesses.
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The U.S. government has eight antidumping duty orders in effect covering ball bearings from six countries, tapered roller bearings from
China and spherical plain bearings from France. The six countries covered by the ball bearing orders are France, Germany, Italy, Japan,
Singapore and the United Kingdom. The company is a producer of all of these products in the United States. The U.S. government
is currently conducting five-year sunset reviews on each of these eight antidumping duty orders in order to determine whether or not
each should remain in effect for an additional five years. Decisions are expected by July of 2006. All of these eight antidumping orders
were continued after a previous government review ending in 2000, while some other bearing antidumping orders were revoked
following their earlier reviews. There were several court challenges arising from those 2000 reviews, but all have been resolved now
with no change in the 2000 outcomes.
The CDSOA provides for distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic producers
where the domestic producers have continued to invest in their technology, equipment and people. The company reported CDSOA
receipts, net of expenses, of $77.1 million, $44.4 million and $65.6 million in 2005, 2004 and 2003, respectively. Amounts received
in 2003 were net of a one-time repayment, due to a miscalculation by the U.S. Treasury Department, of funds received by the
company in 2002.
Amounts for 2003 and 2004 were net of the amounts that Timken delivered to the seller of the Torrington business, pursuant to the
terms of the agreement under which the company purchased Torrington. In 2003 and 2004, Timken delivered to the seller of the
Torrington business 80% of the CDSOA payments received in 2003 and 2004 for Torrington's bearing business. Timken is under no
further obligation to transfer any CDSOA payments to the seller of the Torrington business.
In September 2002, the World Trade Organization (WTO) ruled that such payments are not consistent with international trade rules.
In February 2006, U.S. legislation was enacted that would end CDSOA distributions for imports covered by antidumping duty orders
entering the U.S. after September 30, 2007.
Instead, any such antidumping duties collected would remain with the U.S. Treasury.
This legislation is not expected to have a significant effect on potential CDSOA distributions in 2006 or 2007, but would be expected
to reduce likely distributions in years beyond 2007, with distributions eventually ceasing. There are a number of factors that can affect
whether the company receives any CDSOA distributions and the amount of such distributions in any year. These factors include,
among other things, potential additional changes in the law, ongoing and potential additional legal challenges to the law, the administrative operation of the law and the status of the underlying antidumping orders. Accordingly, the company cannot reasonably
estimate the amount of CDSOA distributions it will receive in future years, if any. If the company does receive CDSOA distributions
in 2006, they likely will be received in the fourth quarter.
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161
Joint Ventures
As part of the Torrington acquisition, several equity interests were acquired, one of which was NTC, a needle bearing manufacturing
venture in Japan, that had been operated by NSK Ltd. and Torrington. In July 2003, the company sold its interest in NTC to NSK for
approximately $146.3 million, pretax.
In October 2005, the company divested its 26% equity stake in Indian bearing manufacturer NRB Bearings Ltd., which it had earlier
obtained as part of the acquisition of Torrington in 2003.
Backlog
The backlog of orders of Timken's domestic and overseas operations is estimated to have been $2.06 billion at December 31, 2005,
and $1.76 billion at December 31, 2004. Actual shipments are dependent upon ever-changing production schedules of the customer.
Accordingly, Timken does not believe that its backlog data and comparisons thereof, as of different dates, are reliable indicators of
future sales or shipments.
Raw Materials
The principal raw materials used by Timken in its North American bearing plants to manufacture bearings are its own steel tubing and
bars, purchased strip steel and energy resources. Outside North America, the company purchases raw materials from local sources
with whom it has worked closely to ensure steel quality, according to its demanding specifications. In addition, Timken Alloy Steel
Europe Limited in Leicester, England is a major source of raw materials for the Timken plants in Western Europe.
The principal raw materials used by Timken in steel manufacturing are scrap metal, nickel and other alloys. The availability and prices
of raw materials and energy resources are subject to curtailment or change due to, among other things, new laws or regulations,
changes in demand levels, suppliers' allocations to other purchasers, interruptions in production by suppliers, changes in exchange
rates and prevailing price levels. For example, the weighted average price of scrap metal increased 19.2% from 2002 to 2003,
increased 87.1% from 2003 to 2004, and decreased 7.7% from 2004 to 2005. Prices for raw materials and energy resources
continue to remain high.
The company continues to expect that it will be able to pass a significant portion of these increased costs through to customers in the
form of price increases or raw material surcharges.
Disruptions in the supply of raw materials or energy resources could temporarily impair the company's ability to manufacture its
products for its customers or require the company to pay higher prices in order to obtain these raw materials or energy resources from
other sources, which could thereby affect the company's sales and profitability. Any increase in the prices for such raw materials or
energy resources could materially affect the company's costs and therefore its earnings.
Timken believes that the availability of raw materials and alloys are adequate for its needs, and, in general, it is not dependent on any
single source of supply.
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Research
Timken's major technical center, located in Canton, Ohio near its world headquarters, is focused on innovation and know-how for
friction management and power transmission technologies, with related engineering technical capabilities.
Technology centers are also located within the United States in Latrobe, Pennsylvania; Torrington and Watertown, Connecticut;
Norcross, Georgia; and Keene and Lebanon, New Hampshire. Within Europe, technology is developed in Ploiesti, Romania; Colmar
and Vierzon, France; Halle-Westfallen, Germany; and Brno, Czech Republic. Within Asia, a technical center has been growing in
Bangalore, India.
The company's technology commitment is to develop new and improved friction management and power transmission product
designs, related steel materials, as well as more efficient manufacturing processes and techniques. All of the technology centers also
support the expansion of applications for existing products.
Expenditures for research, development and testing amounted to approximately $60.1 million, $56.7 million and $54.5 million in 2005,
2004 and 2003, respectively. Of these amounts, $7.2 million, $6.7 million and $2.1 million, respectively, were funded by others.
The company continues its efforts to protect the environment and comply with environmental protection laws. Additionally, it
has invested in pollution control equipment and updated plant operational practices. The company is committed to implementing a
documented environmental management system worldwide and to becoming certified under the ISO 14001 standard where
appropriate to meet or exceed customer requirements. By the end of 2005, 32 of the company's plants had obtained ISO 14001
certification.
The company believes it has established adequate reserves to cover its environmental expenses and has a well-established
environmental compliance audit program, which includes a proactive approach to bringing its domestic and international units to
higher standards of environmental performance. This program measures performance against applicable laws, as well as standards
that have been established for all units worldwide. It is difficult to assess the possible effect of compliance with future requirements
that differ from existing ones. As previously reported, the company is unsure of the future financial impact to the company that could
result from the United States Environmental Protection Agency's (EPA's) final rules to tighten the National Ambient Air Quality
Standards for fine particulate and ozone.
The company and certain U.S. subsidiaries have been designated as potentially responsible parties by the EPA for site investigation
and remediation at certain sites under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), known
as the Superfund, or state laws similar to CERCLA. The claims for remediation have been asserted against numerous other entities,
which are believed to be financially solvent and are expected to fulfill their proportionate share of the obligation.
Management believes any ultimate liability with respect to pending actions will not materially affect the company's operations, cash
flows or consolidated financial position. The company is also conducting voluntary environmental investigations and/or remediations
at a number of current or former operating sites. Any liability with respect to such investigations and remediations, in the aggregate,
is not expected to be material to the operations or financial position of the company.
New laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination
or the imposition of new clean-up requirements may require the company to incur costs or become the basis for new or increased
liabilities that could have a material adverse effect on Timken's business, financial condition or results of operations.
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163
Timken owns a number of U.S. and foreign patents, trademarks and licenses relating to certain products. While Timken regards these
as important, it does not deem its business as a whole, or any industry segment, to be materially dependent upon any one item or
group of items.
Employment
At December 31, 2005, Timken had 27,345 associates. Approximately 20% of Timken's U.S. associates are covered under collective
bargaining agreements.
Timken's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports
filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available, free of charge, on Timken's
website at www.timken.com as soon as reasonably practicable after electronically filing or furnishing such material with the SEC.
Item 1A: Risk Factors
The following are certain risk factors that could affect our business, financial condition and result of operations. The risks that are
highlighted below are not the only ones that we face. If any of the following risks actually occur, our business, financial condition or
results of operations could be negatively affected.
The bearing industry is highly competitive, and this competition results in significant pricing pressure for our products that could
affect our revenues and profitability.
The global bearing industry is highly competitive. We compete with domestic manufacturers and many foreign manufacturers
of anti-friction bearings, including SKF, INA, NTN, Koyo and NSK. The bearing industry is also capital-intensive and profitability is
dependent on factors such as labor compensation and productivity and inventory management, which are subject to risks that we may
not be able to control. Due to the competitiveness within the bearing industry, we may not be able to increase prices for our
products to cover increases in our costs and, in many cases, we may face pressure from our customers to reduce prices, which could
adversely affect our revenues and profitability.
Competition and consolidation in the steel industry, together with potential global overcapacity, could result in significant pricing
pressure for our products.
Competition within the steel industry, both domestically and worldwide, is intense and is expected to remain so. Global production
overcapacity has occurred in the past and may reoccur in the future, which, when combined with high levels of steel imports into the
United States, may exert downward pressure on domestic steel prices and result in, at times, a dramatic narrowing, or with many
companies the elimination, of gross margins. In addition, many of our competitors are continuously exploring and implementing
strategies, including acquisitions, which focus on manufacturing higher margin products that compete more directly with our steel
products. These factors could lead to significant downward pressure on prices for our steel products, which could have a material
adverse effect on our revenues and profitability.
We may not be able to realize the anticipated benefits from, or successfully execute, Project ONE.
During 2005, we began implementing Project ONE, a five-year program designed to improve business processes and systems to
deliver enhanced customer service and financial performance. We may not be able to realize the anticipated benefits from or successfully execute this program. Our future success will depend, in part, on our ability to improve our business processes and systems.
We may not be able to successfully do so without substantial costs, delays or other difficulties. We may face significant challenges
in improving our systems and processes in a timely and efficient manner.
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Risk Factors (continued)
Implementing Project ONE will be complex and time-consuming, may be distracting to management and disruptive to our businesses,
and may cause an interruption of, or a loss of momentum in, our businesses as a result of a number of obstacles, such as:
• the loss of key associates or customers,
• the failure to maintain the quality of customer service that we have historically provided;
• the need to coordinate geographically diverse organizations; and
• the resulting diversion of management’s attention from our day-to-day business and the need to dedicate additional
management personnel to address obstacles to the implementation of Project ONE.
If we are not successful in executing Project ONE, or if it fails to achieve the anticipated results, then our operations, margins, sales
and reputation could be adversely affected.
Any change in the operation of our raw material surcharge mechanisms or the availability or cost of raw materials and energy
resources could materially affect our earnings.
We require substantial amounts of raw materials, including scrap metal and alloys and natural gas to operate our business. Many
of our customer contracts contain surcharge pricing provisions. The surcharges are tied to a widely-available market index for that
specific raw material. Any change in the relationship between the market indices and our underlying costs could materially affect
our earnings.
Moreover, future disruptions in the supply of our raw materials or energy resources could impair our ability to manufacture our
products for our customers or require us to pay higher prices in order to obtain these raw materials or energy resources from other
sources, and could thereby affect our sales and profitability. Any increase in the prices for such raw materials or energy resources
could materially affect our costs and therefore our earnings.
The failure to achieve the anticipated results of our Automotive Group restructuring could materially adversely affect our earnings.
During 2005, we began restructuring our Automotive Group operations to address challenges in the automotive markets. We expect
that this restructuring will cost approximately $80 million to $90 million and we are targeting annual savings of approximately
$40 million by the end of 2007. The failure to achieve the anticipated results of our Automotive Group restructuring, including our
targeted annual savings, could adversely affect our earnings.
The failure to achieve the anticipated results of our Canton bearing operation rationalization initiative could materially adversely
affect our earnings.
After reaching a new four-year agreement with the union representing employees in the Canton, Ohio bearing and steel plants,
we refined our plans to rationalize our Canton bearing operations. We expect that this rationalization initiative will cost approximately
$35 million to $40 million over the next four years and we are targeting annual savings of approximately $25 million. The failure to
achieve the anticipated results of this initiative, including our targeted annual savings, could adversely affect our earnings.
We may incur further impairment and restructuring charges that could negatively affect our profitability.
We have taken approximately $26.1 million in impairment and restructuring charges for our Automotive Group restructuring and the
rationalization of our Canton bearing operations during 2005 and expect to take additional charges in connection with these initiatives.
Changes in business or economic conditions, or our business strategy may result in additional restructuring programs and may require
us to take additional charges in the future, which could have a material adverse effect on our earnings.
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Expiration of antidumping orders may materially adversely affect our business.
The U.S. government has eight antidumping duty orders in effect covering ball bearings from six countries, tapered roller bearings
from China and spherical plain bearings from France. The company is a producer of these products in the United States. The U.S.
government is currently conducting five-year sunset reviews on each of these eight antidumping duty orders in order to determine
whether or not each should remain in effect for an additional five years. Decisions are expected by July of 2006. If any of these
antidumping orders are revoked and conditions of fair trade in the United States deteriorate, we may experience significant downward
pressure on prices for our bearing products, which could have a material adverse effect on our revenues and profitability.
Any reduction of CDSOA distributions in the future would reduce our earnings.
CDSOA provides for distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic producers where
the domestic producers have continued to invest in their technology, equipment and people. The company reported CDSOA receipts,
net of expenses, of $77.1 million, $44.4 million, and $65.6 million in 2005, 2004 and 2003, respectively. In February 2006, U.S.
legislation was enacted that would end CDSOA distributions for imports covered by antidumping duty orders entering the U.S. after
September 30, 2007. Instead, any such antidumping duties collected would remain with the U.S. Treasury. This legislation is not
expected to have a significant effect on potential CDSOA distributions in 2006 or 2007, but would be expected to reduce likely
distributions in years beyond 2007, with distributions eventually ceasing. Additionally, there are a number of factors that can affect
whether the company receives any CDSOA distributions and the amount of such distributions in any year. These factors include,
among other things, potential additional changes in the law, ongoing and potential additional legal challenges to the law, the
administrative operation of the law and the status of the underlying antidumping orders. Any reduction of CDSOA distributions would
reduce our earnings.
Weakness in any of the industries in which our customers operate, as well as the cyclical nature of our customers’ businesses
generally, could adversely impact our revenues and profitability by reducing demand and margins.
Our revenues may be negatively affected by changes in customer demand, changes in the product mix and negative pricing pressure
in the industries in which we operate. Many of the industries in which our end customers operate are cyclical. Margins in those
industries are highly sensitive to demand cycles, and our customers in those industries historically have tended to delay large capital
projects, including expensive maintenance and upgrades, during economic downturns. As a result, our business is also cyclical and
our revenues and earnings are impacted by overall levels of industrial production.
Certain automotive industry companies have recently experienced significant financial downturns. In 2005 we increased our reserve
for accounts receivable relating to our automotive industry customers.
If any of our automotive industry customers becomes
insolvent or files for bankruptcy, our ability to recover accounts receivable from that customer would be adversely affected and any
payment we received in the preference period prior to a bankruptcy filing may be potentially recoverable. In addition, financial
instability of certain companies that participate in the automotive industry supply chain could disrupt production in the industry.
A disruption of production in the automotive industry could have a material adverse effect on our financial condition and earnings.
Unexpected equipment failures or other disruptions of our operations may increase our costs and reduce our sales and earnings
due to production curtailments or shutdowns.
Interruptions in production capabilities, especially in our Steel Group, would inevitably increase our production costs and reduce sales
and earnings for the affected period. In addition to equipment failures, our facilities are also subject to the risk of catastrophic loss
due to unanticipated events such as fires, explosions or violent weather conditions. Our manufacturing processes are dependent upon
critical pieces of equipment, such as furnaces, continuous casters and rolling equipment, as well as electrical equipment, such as
transformers, and this equipment may, on occasion, be out of service as a result of unanticipated failures. In the future, we may
experience material plant shutdowns or periods of reduced production as a result of these types of equipment failures.
10
THE TIMKEN COMPANY
166
The global nature of our business exposes us to foreign currency fluctuations that may affect our asset values, results of operations
and competitiveness.
We are exposed to the risks of currency exchange rate fluctuations because a significant portion of our net sales, costs, assets
and liabilities, are denominated in currencies other than the U.S. dollar. These risks include a reduction in our asset values, net sales,
operating income and competitiveness.
For those countries outside the United States where we have significant sales, devaluation in the local currency would reduce the
value of our local inventory as presented in our Consolidated Financial Statements. In addition, a stronger U.S. dollar would result in
reduced revenue, operating profit and shareholders’ equity due to the impact of foreign exchange translation on our Consolidated
Financial Statements. Fluctuations in foreign currency exchange rates may make our products more expensive for others to purchase
or increase our operating costs, affecting our competitiveness and our profitability.
Changes in exchange rates between the U.S. dollar and other currencies and volatile economic, political and market conditions in
emerging market countries have in the past adversely affected our financial performance and may in the future adversely affect the
value of our assets located outside the United States, our gross profit and our results of operations.
Global political instability and other risks of international operations may adversely affect our operating costs, revenues and the
price of our products.
Our international operations expose us to risks not present in a purely domestic business, including primarily:
• changes in tariff regulations, which may make our products more costly to export or import;
• difficulties establishing and maintaining relationships with local OEMs, distributors and dealers;
• import and export licensing requirements;
• compliance with a variety of foreign laws and regulations, including unexpected changes in taxation and environmental
or other regulatory requirements, which could increase our operating and other expenses and limit our operations; and
• difficulty in staffing and managing geographically diverse operations.
These and other risks may also increase the relative price of our products compared to those manufactured in other countries,
reducing the demand for our products in the markets in which we operate, which could have a material adverse effect on our revenues
and earnings.
Underfunding of our pension fund assets has caused and may continue to cause a significant reduction in our shareholders’ equity.
As a result of the underfunded status of our pension fund assets, we were required to take total net charges of $245.6 million, net of
income taxes, against our shareholders’ equity over the last four years. We may be required to take further charges related to pension liabilities in the future and these charges may be significant.
The underfunded status of our pension fund assets will cause us to prepay the funding of our pension obligations which may divert
funds from other uses.
The increase in our defined benefit pension obligations, as well as our ongoing practice of managing our funding obligations over time,
have led us to prepay a portion of our funding obligations under our pension plans. We made cash contributions of $226 million,
$185 million and $169 million in 2005, 2004 and 2003, respectively, to our U.S.-based pension plans and currently expect to make cash
contributions of $150 million in 2006 to such plans. However, we cannot predict whether changing economic conditions or other
factors will lead us or require us to make contributions in excess of our current expectations, diverting funds we would otherwise apply
to other uses.
Moreover, legislation has been proposed which, if enacted, may require us to significantly increase our contributions to our pension
funds, which could have a material adverse effect on our financial condition, results of operations or cash flows. In addition, this
legislation may require us to reevaluate our method of funding pensions in the long-term.
Strikes or work stoppages by our unionized associates could disrupt our manufacturing operations, reduce our revenues or increase
our labor costs.
Approximately 20% percent of our U.S. associates are covered by collective bargaining agreements. Any potential strikes or work
stoppages, and the resulting adverse impact on our relationships with customers, could disrupt our manufacturing operations, reduce
our revenue or increase our labor costs, which could have a material adverse effect on our business, financial condition or results of
operations.
THE TIMKEN COMPANY
11
167
Item 1B: Unresolved Staff Comments
None.
Item 2. Properties
Timken has Automotive Group, Industrial Group and Steel Group manufacturing facilities at multiple locations in the United States and
in a number of countries outside the United States. The aggregate floor area of these facilities worldwide is approximately 18,641,000
square feet, all of which, except for approximately 1,197,000 square feet, is owned in fee. The facilities not owned in fee are leased.
The buildings occupied by Timken are principally made of brick, steel, reinforced concrete and concrete block construction.
All buildings are in satisfactory operating condition in which to conduct business.
Timken's Automotive and Industrial Groups' manufacturing facilities in the United States are located in Bucyrus, Canton, New
Philadelphia, and Niles, Ohio; Altavista, Virginia; Watertown and Torrington, Connecticut; Randleman, Iron Station and Rutherfordton,
North Carolina; Carlyle, Illinois; South Bend, Indiana; Gaffney, Clinton, Union, Honea Path and Walhalla, South Carolina; Cairo, Norcross,
Sylvania, Ball Ground, and Dahlonega, Georgia; Pulaski and Mascot, Tennessee; Keene and Lebanon, New Hampshire; Lenexa,
Kansas; Ogden, Utah; Gilbert, Arizona; and Los Alamitos, California. These facilities, including the research facility in Canton, Ohio,
and warehouses at plant locations, have an aggregate floor area of approximately 7,814,000 square feet.
Timken's Automotive and Industrial Groups' manufacturing plants outside the United States are located in Benoni, South Africa;
Brescia, Italy; Colmar, Vierzon, Maromme and Moult, France; Northampton and Wolverhampton, England; Medemblik, The
Netherlands; Bilbao, Spain; Halle-Westfallen, Germany; Olomouc, Czech Republic; Ploiesti, Romania; Mexico City, Mexico; Sao Paulo
and Nova Friburgo, Brazil; Singapore, Singapore; Jamshedpur, India; Sosnowiec, Poland; St. Thomas and Bedford, Canada; and
Yantai and Wuxi, China. The facilities, including warehouses at plant locations, have an aggregate floor area of approximately
4,746,741 square feet.
Timken's Steel Group's manufacturing facilities in the United States are located in Canton, Eaton, Wauseon, Wooster, and
Vienna, Ohio; Columbus, North Carolina; White House, Tennessee; and Franklin and Latrobe, Pennsylvania. These facilities have an
aggregate floor area of approximately 5,340,000 square feet. The manufacturing facility in Wooster, Ohio ceased operations on
December 31, 2005.
Timken's Steel Group's manufacturing facilities outside the United States are located in Leicester and Sheffield, England; and Fougeres
and Marnaz, France. These facilities have an aggregate floor area of approximately 739,000 square feet.
In addition to the manufacturing and distribution facilities discussed above, Timken owns warehouses and steel distribution facilities
in the United States, United Kingdom, France, Singapore, Mexico, Argentina, Australia, Brazil, Germany and China, and leases
several relatively small warehouse facilities in cities throughout the world.
During 2005, the utilization by plant varied significantly due to increasing demand in heavy-truck markets, increasing demand
in Industrial sectors served by Automotive Group plants, and the production decline in North American traditional light vehicles. The
overall Automotive Group plant utilization was between approximately 75% and 85%, similar to 2004. In 2005, as a result of the
higher industrial global demand, Industrial Group plant utilization was between 85% and 90%, which was slightly higher than
2004. Also, in 2005, Steel Group plants operated at near capacity, which was similar to 2004.
12
THE TIMKEN COMPANY
168
Item 3. Legal Proceedings
The company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management,
the ultimate disposition of these matters will not have a material adverse effect on the company's consolidated financial position or
results of operations.
The company is currently in discussions with the State of Ohio concerning a violation of Ohio air pollution control laws which was
discovered by the company and voluntarily disclosed to the State of Ohio approximately nine years ago. Although no final settlement
has been reached, the company believes that the final settlement will not be material to the company or have a material adverse effect
on the company's consolidated financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2005.
THE TIMKEN COMPANY
13
169
Item 4A. Executive Officers of the Registrant
The executive officers are elected by the Board of Directors normally for a term of one year and until the election of their successors.
All executive officers, except for three, have been employed by Timken or by a subsidiary of the company during the past five-year
period. The executive officers of the company as of February 28, 2006, are as follows:
Name
Age
Current Position and Previous Positions During Last Five Years
Ward J. Timken, Jr.
38
2000
2002
2003
2005
Corporate Vice President – Office of the Chairman
Corporate Vice President – Office of the Chairman; Director
Executive Vice President and President – Steel Group; Director
James W. Griffith
52
2000
2002
President and Chief Operating Officer; Director
President and Chief Executive Officer; Director
Michael C. Arnold
49
2000
President – Industrial Group
Sallie B. Bailey
46
2000
2001
2003
Treasurer
Corporate Controller
Senior Vice President – Finance and Controller
William R. Burkhart
40
2000
Alastair R. Deane
44
2000
Senior Vice President of Engineering, Automotive Driveline
Driveshaft business group of GKN Automotive, Incorporated,
a global supplier of driveline components and systems
Senior Vice President – Technology, The Timken Company
2005
Jacqueline A. Dedo
44
2000
2004
Glenn A. Eisenberg
44
2000
2002
Salvatore J. Miraglia, Jr.
14
55
2000
2005
Vice President and General Manager Worldwide Market
Operations, Motorola, Inc., a global communications company
President – Automotive Group, The Timken Company
President and Chief Operating Officer, United Dominion
Industries, an international manufacturing, construction and
engineering firm
Executive Vice President – Finance and Administration,
The Timken Company
Senior Vice President – Technology
President – Steel Group
THE TIMKEN COMPANY
170
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
The company's common stock is traded on the New York Stock Exchange under the symbol “TKR.” The estimated number of record
holders of the company's common stock at December 31, 2005 was approximately 7,025. The estimated number of beneficial shareholders at December 31, 2005 was approximately 54,514.
The following table provides information about the high and low sales prices for the company’s common stock and dividends paid for
each quarter for the last two fiscal years.
2005
Stock Prices Dividends
High
Low per share
2004
Stock Prices
Dividends
High
Low per share
First quarter
$29.50
$22.73
$0.15
$24.70
$18.74
$0.13
Second quarter
$27.68
$22.80
$0.15
$26.49
$20.81
$0.13
Third quarter
$30.06
$22.90
$0.15
$26.49
$22.50
$0.13
Fourth quarter
$32.84
$25.25
$0.15
$27.50
$22.82
$0.13
Issuer Purchases of Common Stock:
The following table provides information about purchases by the company during the quarter ended December 31, 2005 of its common
stock.
Period
10/1/05 – 10/31/05
11/1/05 – 11/30/05
12/1/05 – 12/31/05
Total
Total number
of shares
purchased(1)
60,609
63
60,672
Average
price paid
per share(2)
$29.34
30.99
$29.34
Total number
Maximum
of shares
number of
purchased as
shares that
part of publicly
may yet
announced
be purchased
plans or under the plans
programs(3)
or programs(3)
-
3,793,700
3,793,700
3,793,700
3,793,700
(1)
The company repurchases shares of its common stock that are owned and tendered by employees to satisfy tax withholding
obligations in connection with the vesting of restricted shares and the exercise of stock options.
(2)
The average price paid per share is calculated using the daily high and low sales prices of the company's common stock as quoted
on the New York Stock Exchange at the time the employee tenders the shares.
(3)
Pursuant to the company’s 2000 common stock purchase plan, it may purchase up to four million shares of common stock at an
amount not to exceed $180 million in the aggregate. The company may purchase shares under its 2000 common stock purchase
plan until December 31, 2006.
Information regarding the company's stock compensation plan is presented in Notes 1 and 9 to the Consolidated Financial Statements.
THE TIMKEN COMPANY
15
171
Item 6. Selected Financial Data
2005
2004
2003
1,661,048
1,925,211
1,582,175
5,168,434
$ 1,582,226
1,709,770
1,221,675
4,513,671
$ 1,396,104
1,498,832
893,161
3,788,097
1,058,721
661,592
26,093
371,036
67,658
438,694
51,585
838,585
587,923
13,434
237,228
11,988
249,216
50,834
2002
2001
(Thousands of dollars, except per share data)
Net sales:
Automotive
Industrial
Steel
Total net sales
$
Gross profit
Operating income (loss)
Other income (expense) - net
Earnings before interest and taxes (EBIT)(1)
Interest expense
Income (loss) before cumulative effect of
accounting changes
Net income (loss)
Balance Sheets
Inventories – net
Property, plant and equipment – net
Total assets
Total debt:
Commercial paper
Short-term debt
Long-term debt
Total debt
Net debt:
Total debt
Net debt (2)
Total liabilities
Capital:
Net debt
Net income (loss) / Total assets
Net income (loss) / Net sales
EBIT / Net sales
Capital expenditures / Net sales
Dividends per share
Earnings per share - assuming dilution
Number of associates at year-end
$
$
998,368
1,547,044
3,993,734
$
$
63,437
95,842
561,747
721,026
$
$
$
$
(5)
260,281
260,281
$
$
$
135,656
135,656
874,833
1,583,425
3,942,909
$
639,118(7)
521,717(7)
19,154
98,247
9,833
108,080
48,401
$
$
36,481
36,481
695,946
1,610,848
3,689,789
752,763
971,534
825,778
2,550,075
$
469,577
358,866
32,143
78,568
36,814
115,382
31,540
$
$
51,451
38,749
488,923
1,226,244
2,748,356
642,943
990,365
813,870
2,447,178
400,720
363,683
54,689
(17,652)
22,061
4,409
33,401
$
$
(41,666)
(41,666)
429,231
1,305,345
2,533,084
157,417
1,273
620,634
779,324
114,469
6,725
613,446
734,640
8,999
78,354
23,781
350,085
461,219
1,962
84,468
42,434
368,151
497,015
779,324
(50,967)
728,357
2,673,061
$ 1,269,848
734,640
(28,626)
706,014
2,600,162
$ 1,089,627
461,219
(82,050)
379,169
2,139,270
$ 609,086
497,015
(33,392)
463,623
1,751,349
$ 781,735
655,609
1,497,067
2,152,676
728,357
1,269,848
1,998,205
706,014
1,089,627
1,795,641
379,169
609,086
988,255
463,623
781,735
1,245,358
6.5%
5.0%
8.5%
17.4%
194.0
225,537
218,059
4.4%
0.60
2.84
2.81
30.5%
27,345
54,514
3.4%
3.0%
5.5%
10.7%
173.6
147,554
209,431
3.3%
0.52
1.51
1.49
36.5%
25,931
42,484
1.0%
1.0%
2.9%
3.3%
172.0
129,315
208,851
3.4%
0.52
0.44
0.44
39.3%
26,073
42,184
1.4%
1.5%
4.5%
6.4%
139.0
90,673
146,535
3.6%
0.52
0.63
0.62
38.4%
17,963
44,057
(1.6)%
(1.7)%
0.2%
(5.3)%
124.8
102,347
152,467
4.2%
0.67
(0.69)
(0.69)
37.2%
18,735
39,919
721,026
(65,417)
655,609
2,496,667
1,497,067
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
(1)
EBIT is defined as operating income plus other income (expense) - net.
The company presents net debt because it believes net debt is more representative of the company's indicative financial position due to temporary changes in
cash and cash equivalents.
(3)
Return on equity is defined as income (loss) before cumulative effect of accounting changes divided by ending shareholders’ equity.
(4)
(5)
Based on average number of shares outstanding during the year and includes the cumulative effect of accounting change in 2002, which is related to the
adoption of SFAS No. 142.
(6)
Includes an estimated count of shareholders having common stock held for their accounts by banks, brokers and trustees for benefit plans.
(7)
Gross profit for 2003 included a reclassification of $7.5 million from cost of products sold to selling, administrative and general expenses for Torrington
engineering and research and development expenses to be consistent with the company's 2004 cost classification methodology.
(2)
16
THE TIMKEN COMPANY
172
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
Introduction
The Timken Company is a leading global manufacturer of highly engineered anti-friction bearings and alloy steels and a provider of
related products and services. Timken operates under three segments: Industrial Group, Automotive Group and Steel Group.
The Industrial and Automotive Groups design, manufacture and distribute a range of bearings and related products and services.
Industrial Group customers include both original equipment manufacturers and distributors for agriculture, construction, mining,
energy, mill, machine tooling, aerospace and rail applications. Automotive Group customers include original equipment manufacturers
and suppliers for passenger cars, light trucks, and medium- to heavy-duty trucks. Steel Group products include steels of low and
intermediate alloy, vacuum-processed alloys, tool steel and some carbon grades, in both solid and tubular sections, as well as custommade steel products, for both industrial and automotive applications, including bearings.
Financial Overview
Overview:
2005
2004
$ 5,168.4
$ 260.3
$
2.81
92,537,529
$ 4,513.7
$ 135.7
$
1.49
90,759,571
$ Change
% Change
Net sales
Net income
Earnings per share - diluted
Average number of shares - diluted
$
$
$
654.7
124.6
1.32
-
14.5%
91.8%
88.6%
2.0%
The Timken Company reported record net sales for 2005 of approximately $5.2 billion, compared to $4.5 billion in 2004, an increase
of 14.5%. Sales were higher across all three business segments. For 2005, earnings per diluted share were $2.81, compared to
$1.49 per diluted share for 2004.
The company achieved record sales and net income in 2005. Higher demand across a broad range of industrial markets drove sales.
The company expanded its presence in the aerospace aftermarket through acquisitions and alliances. The company also leveraged
demand and continued the use of surcharges and price increases to recover high raw material costs. The company improved its
product mix and increased production capacity in targeted areas, including significant investments in the United States, China and
Romania. The company launched two significant initiatives: (1) Project ONE, a five-year program designed to improve business
processes and systems; and (2) a growth initiative in Asia with the objective of increasing market share, influencing major design
centers and expanding the company’s network of sources of globally competitive friction management products. In addition, the
company announced a significant restructuring within its Automotive Group.
The company expects continued strong financial performance in 2006. Global industrial markets are expected to remain strong, while
improvements in the company’s operating performance will be partially constrained by investments in Project ONE and Asia growth
initiatives, as well as the expensing of stock options.
In 2005, the Industrial Group’s net sales increased 12.6% from 2004 to a record $1.9 billion. The increase was the result of higher
volume and improved product mix. Many end markets were strong, especially mining, metals, rail, aerospace, oil and gas, which also
drove strong distribution sales. The Industrial Group also benefited from growth in emerging markets, especially China. The Industrial
Group’s profitability in 2005 increased from 2004, reflecting volume growth and price increases, partially offset by investments in
Project ONE and Asia growth initiatives.
The Automotive Group’s net sales in 2005 increased 5.0% from 2004 to $1.7 billion. Sales grew as a result of favorable pricing actions
and growth in medium- and heavy-truck markets. The Automotive Group had a loss in 2005. The positive impact of increased volume
and pricing were more than offset by higher manufacturing costs associated with ramping up plants serving industrial customers and
from reduced unit volume from light vehicle customers. Automotive results were also impacted by investments in Project ONE and
an increase in the accounts receivable reserve. The company has announced a restructuring plan as part of its effort to improve the
Automotive Group performance and address challenges in the automotive markets.
In 2005, the Steel Group’s net sales, including intersegment sales, were $1.8 billion, up 27.2% from 2004. The sales growth
reflected record shipments, driven by strong industrial markets, as well as surcharges and price increases to offset higher raw
material and energy costs. For 2005, the Steel Group’s profitability increased from 2004 as a result of higher volume, raw material
surcharges, price increases, high capacity utilization and record productivity.
THE TIMKEN COMPANY
17
173
Sales by Segment:
2005
2004
$ 1,925.2
1,661.0
1,582.2
$ 5,168.4
$ 1,709.8
1,582.2
1,221.7
$ 4,513.7
$ Change
% Change
Industrial Group
Automotive Group
Steel Group
Total company
$
$
215.4
78.8
360.5
654.7
12.6%
5.0%
29.5%
14.5%
The Industrial Group’s net sales increased from 2004 due to higher volume and improved product mix. Many end markets were strong,
especially mining, metals, rail, aerospace and oil and gas, which also drove strong distribution sales. The Automotive Group's net sales
increased from 2004 due to improved pricing and growth in medium- and heavy-truck markets. The Steel Group’s net sales increased
from 2004 due to strong industrial, aerospace and energy sector demand, as well as increased pricing and surcharges to recover high
raw material and energy costs.
Gross Profit:
2005
2004
$ Change
% Change
Gross profit
Rationalization and integration charges included in cost of products sold
$ 1,058.7
20.5%
$
14.5
$
838.6
18.6%
$
4.5
$
$
220.1
10.0
26.2%
1.9%
-
Gross profit benefited from price increases and surcharges, favorable sales volume and mix. In 2005, manufacturing rationalization and
integration charges related to the rationalization of the company's Canton, Ohio bearing facilities and costs for certain facilities in
Torrington, Connecticut. In 2004, manufacturing rationalization and integration charges related primarily to expenses associated with
the integration of Torrington.
2005
2004
$ Change
% Change
Rationalization and integration charges included in selling, administrative
and general expenses
$
661.6
12.8%
$
587.9
13.0%
$
73.7
-
12.5%
(0.2)%
$
2.8
$
22.5
$
(19.7)
(87.6)%
The increase in selling, administrative and general expenses in 2005, compared to 2004, was due primarily to higher costs associated
with performance-based compensation and growth initiatives, partially offset by lower manufacturing rationalization and integration
charges. Growth initiatives included investments in Project ONE, as well as targeted geographic growth in Asia.
In 2005, the manufacturing rationalization and integration charges primarily related to the rationalization of the company's Canton, Ohio
bearing facilities and costs associated with the Torrington acquisition. In 2004, the manufacturing rationalization and integration
charges related primarily to expenses associated with the integration of Torrington, mostly for information technology and
purchasing initiatives.
18
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174
2005
2004
$ Change
8.5
4.2
0.7
13.4
$
Impairment charges
Exit costs
Total
$
$
0.8
20.3
5.0
26.1
$
$
(7.7)
16.1
4.3
12.7
$
In 2005, the company recorded approximately $20.3 million of severance and related benefit costs and $2.8 million of exit costs as a
result of environmental charges related to the closure of manufacturing facilities in Clinton, South Carolina, and administrative facilities in Torrington, Connecticut and Norcross, Georgia. These closures are part of the restructuring plans for the Automotive Group
announced in July 2005. These restructuring efforts, along with other future actions, are targeted to deliver annual pretax savings of
approximately $40 million by the end of 2007, with expected net workforce reductions of approximately 400 to 500 positions and
pretax costs of approximately $80 to $90 million.
Asset impairment charges of $0.8 million and exit costs of $2.2 million related to environmental charges were recorded in 2005 as
a result of the rationalization of the company’s three bearing plants in Canton, Ohio within the Industrial Group. This initiative is
expected to deliver annual pretax savings of approximately $25 million through streamlining operations and workforce reductions, with
pretax restructuring costs of approximately $35 to $40 million over the next four years.
facilities, based on the company’s estimate of its fair value. The severance and related benefit costs related to associates who exited
the company as a result of the integration of Torrington. The exit costs related primarily to domestic facilities.
Rollforward of Restructuring Accruals:
2005
2004
Expense
Payments
$
$
4.1
25.3
(3.4)
26.0
$
$
4.5
4.9
(5.3)
4.1
The restructuring accrual for 2005 and 2004 is included in accounts payable and other liabilities in the Consolidated Balance Sheet.
THE TIMKEN COMPANY
19
175
2005
2004
$ Change
50.8
1.4
$
$
Interest expense
Interest income
$
$
51.6
3.4
$
$
0.8
2.0
Interest expense for 2005 increased slightly, compared to last year due to higher effective interest rates. Interest income increased
due to higher cash balances and interest rates.
2005
2004
$ Change
Other expense – net:
Other
Other expense – net
$
77.1
$
44.4
$
32.7
$
8.9
(0.6)
(17.7)
(9.4)
$
16.4
(16.2)
(32.6)
(32.4)
$
(7.5)
15.6
14.9
23.0
$
$
$
U.S. Continued Dumping and Subsidy Offset Act (CDSOA) receipts are reported net of applicable expenses. CDSOA provides for
distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic producers where the domestic
producers have continued to invest in their technology, equipment and people. In 2005, the company received CDSOA receipts, net
of expenses of $77.1 million. In 2004, the CDSOA receipts of $44.4 million were net of the amounts that Timken delivered to the
seller of the Torrington business, pursuant to the terms of the agreement under which the company purchased Torrington. In 2004,
Timken delivered to the seller of the Torrington business 80% of the CDSOA payments received for Torrington’s bearing business.
Timken is under no further obligation to transfer any CDSOA payments to the seller of the Torrington business. In September 2002,
the World Trade Organization (WTO) ruled that such payments are inconsistent with international trade rules. In February 2006, U.S.
legislation was signed into law that would end CDSOA distributions for imports covered by antidumping duty orders entering the U.S.
after September 30, 2007. Instead, any such antidumping duties collected would remain with the U.S. Treasury. This legislation is not
expected to have a significant effect on potential CDSOA distributions in 2006 or 2007, but would be expected to reduce likely
distributions in years beyond 2007, with distributions eventually ceasing. There are a number of factors that can affect whether the
company receives any CDSOA distributions and the amount of such distributions in any year. These factors include, among other
things, potential additional changes in the law, ongoing and potential additional legal challenges to the law, the administrative
operation of the law and the status of the underlying antidumping orders. Accordingly, the company cannot reasonably estimate the
amount of CDSOA distributions it will receive in future years, if any. If the company does receive CDSOA distributions in 2006, they
likely will be received in the fourth quarter.
In 2005, the gain on divestitures of non-strategic assets of $8.9 million related to the sale of certain non-strategic assets, which
included NRB Bearings, a joint venture based in India, and the Industrial Group’s Linear Motion Systems business, based in Europe.
In 2004, the $16.4 million gain included the sale of real estate at a facility in Duston, England, which ceased operations in 2002,
offset by a loss on the sale of the company’s Kilian bearing business, which was acquired in the Torrington acquisition.
In 2004, the company began the process of liquidating one of its inactive subsidiaries, British Timken Ltd., located in Duston, England.
The company recorded non-cash charges on dissolution of $0.6 million and $16.2 million in 2005 and 2004, respectively, which
related primarily to the transfer of cumulative foreign currency translation losses to the Statement of Income.
For 2005, other expense included losses on the disposal of assets, losses from equity investments, donations, minority interests and
foreign currency exchange losses. For 2004, other expense included losses from equity investments, losses on the disposal of assets,
foreign currency exchange losses, donations, minority interests, and a non-cash charge for the adoption of Financial Accounting
Standards Board (FASB) Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting
Research Bulletin No. 51" (FIN 46). During 2000, the company’s Steel Group invested in a joint venture, PEL Technologies (PEL), to
commercialize a proprietary technology that converts iron units into engineered iron oxide for use in pigments, coatings and abrasives.
The company previously accounted for its investment in PEL, which is a development stage company, using the equity method. Refer
to Note 12 – Equity Investments in the Notes to Consolidated Financial Statements for additional discussion.
20
THE TIMKEN COMPANY
176
Income Tax Expense:
2005
2004
$ Change
% Change
Income tax expense
Effective tax rate
$
130.3
33.4%
$
64.1
32.1%
$
66.2
-
103.3%
1.3%
The effective tax rate for 2005 was less than the U.S. statutory tax rate due to tax benefits on foreign income, including the extraterritorial income exclusion on U.S. exports, tax holidays in China and the Czech Republic, and earnings of certain foreign subsidiaries
being taxed at a rate less than 35%, as well as the aggregate tax benefit of other U.S. tax items. These benefits were offset
partially by taxes incurred on foreign remittances, U.S. state and local income taxes and the inability to record a tax benefit for
losses at certain foreign subsidiaries.
The effective tax rate for 2004 was less than the U.S. statutory tax rate due to benefits from the settlement of prior years’ liabilities,
the changes in the tax status of certain foreign subsidiaries, benefits of tax holidays in China and the Czech Republic, earnings of
certain subsidiaries being taxed at a rate less than 35% and the aggregate impact of certain other items. These benefits were
partially offset by the establishment of a valuation allowance against certain deferred tax assets associated with loss carryforwards
attributable to a subsidiary that is in the process of liquidation, U.S. state and local income taxes, taxes incurred on foreign remittances
and the inability to record a tax benefit for losses at certain foreign subsidiaries.
On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (Act). The Act created a temporary incentive for
U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction
for certain dividends from foreign subsidiaries. During 2005, the company repatriated $118.8 million under the Act. This amount
consisted of dividends, previously taxed income and returns of capital and resulted in income tax expense of $11.7 million. The Act
also contains a provision to gradually eliminate the benefits received by extraterritorial income exclusion on U.S. exports. For 2005,
80% of the benefit is allowed, decreasing to 60% in 2006 and zero in 2007 and thereafter. Additionally, the Act contains a provision
that enables companies to deduct a percentage (3% in 2005, increasing to 9% in 2010) of the taxable income derived from qualified
domestic manufacturing operations. Due to its net operating loss position in the U.S., the company did not receive any benefit from
the manufacturing deduction in 2005. However, it expects to start recognizing these benefits in 2006.
Business Segments:
The primary measurement used by management to measure the financial performance of each segment is adjusted EBIT (earnings
before interest and taxes, excluding the effect of amounts related to certain items that management considers not representative of
ongoing operations such as impairment and restructuring, rationalization and integration charges, one-time gains or losses on sales
of assets, allocated receipts received or payments made under the CDSOA and loss on the dissolution of subsidiary). Refer to
Note 14 – Segment Information in the Notes to Consolidated Financial Statements for the reconciliation of adjusted EBIT by Group to
consolidated income before income taxes.
Industrial Group:
2005
2004
$ 1,927.1
$ 199.9
10.4%
$ 1,711.2
$ 177.9
10.4%
$ Change
% Change
Adjusted EBIT
$
$
215.9
22.0
-
12.6%
12.4%
-
THE TIMKEN COMPANY
21
177
Sales by the Industrial Group include global sales of bearings and other products and services (other than steel) to a diverse customer
base, including: industrial equipment, construction and agriculture, rail and aerospace and defense customers. The Industrial Group
also includes aftermarket distribution operations, including automotive applications, for products other than steel.
The Industrial Group’s net sales increased in 2005 due to higher volume and improved product mix. Many end markets were strong,
especially mining, metals, rail, aerospace and oil and gas, which also drove strong distribution sales. While sales increased in 2005,
adjusted EBIT margin was comparable to 2004, as volume growth and pricing were partially offset by higher manufacturing costs
associated with ramping up of capacity to meet customer demand, investments in the Asia growth initiative and Project ONE, and
write-offs of obsolete and slow-moving inventory. The Industrial Group continues to focus on improving capacity utilization, product
availability and customer service in response to strong industrial demand. During the year, operations were expanded in Wuxi, China,
to serve industrial customers. The company also increased capacity at two large-bore bearings operations located in Ploiesti, Romania,
and Randleman (Asheboro), North Carolina. The company expects the Industrial Group to benefit from continued strength in global
industrial markets.
Automotive Group:
2005
2004
$ 1,661.0
$ (19.9)
(1.2)%
$ 1,582.2
$
15.9
1.0%
$ Change
% Change
$
$
78.8
(35.8)
-
5.0%
(225.2)%
(2.2)%
The Automotive Group includes sales of bearings and other products and services (other than steel) to automotive original equipment
manufacturers and suppliers. The Automotive Group's net sales increased due to improved pricing and increased demand for heavytruck products, partially offset by reduced volume for light vehicle products. While the Automotive Group's improved sales favorably
impacted profitability, it was more than offset by the higher manufacturing costs associated with ramping up plants serving industrial
customers and from reduced unit volume from light vehicle customers. Automotive results were also impacted by investments in
Project ONE and an increase in the accounts receivable reserve. The Automotive Group continues to make progress in its ability to
recover higher raw material costs through price increases.
During 2005, the company announced a restructuring plan as part of its effort to improve Automotive Group performance and address
challenges in the automotive markets. The company recorded approximately $20.3 million of severance and related benefit costs and
$2.8 million of exit costs as a result of environmental and curtailment charges related to the closure of manufacturing facilities in
Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross, Georgia. The Automotive Group's
adjusted EBIT (loss) will exclude these restructuring costs, as they are not representative of ongoing operations. The company expects
to see improvement in the Automotive Group, despite the challenging environment in the North American automotive industry.
Steel Group:
2005
2004
$ 1,760.3
$ 219.8
12.5%
$ 1,383.6
$
54.8
4.0%
$ Change
% Change
Adjusted EBIT
$
$
376.7
165.0
-
27.2%
301.1%
8.5%
The Steel Group sells many products, including steels of low and intermediate alloy, vacuum-processed alloys, tool steel and
some carbon grades in both solid and tubular sections, as well as custom-made steel products for both automotive and industrial
applications, including bearings. The Steel Group’s 2005 net sales increased over 2004 due to strong demand in industrial, aerospace
and energy sectors, as well as increased pricing and surcharges to recover high raw material and energy costs. The Steel Group's
improved profitability reflects price increases and surcharges to recover high raw material costs, improved volume and mix, as well as
continued high labor productivity. The company expects Steel Group adjusted EBIT to be lower in 2006 due to lower surcharges.
22
THE TIMKEN COMPANY
178
Overview:
2004
2003
$ 4,513.7
$ 135.7
$
1.49
90,759,571
$ 3,788.1
$
36.5
$
0.44
83,159,321
2004
2003
$ 1,709.8
1,582.2
1,221.7
$ 4,513.7
$ 1,498.8
1,396.1
893.2
$ 3,788.1
$ Change
% Change
Net sales
Net income
$
$
$
725.6
99.2
1.05
-
19.2%
271.8%
238.6%
9.1%
$ Change
% Change
Sales by Segment:
Industrial Group
Automotive Group
Steel Group
Total company
$
$
211.0
186.1
328.5
725.6
14.1%
13.3%
36.8%
19.2%
The Industrial Group’s net sales increased in 2004 due to higher demand, increased prices and favorable foreign currency translation.
Many end markets recorded substantial growth, especially construction, agriculture, rail and general industrial equipment. The
Automotive Group’s net sales benefited in 2004 from increased light vehicle penetration from new products, strong medium- and
heavy-truck production and favorable foreign currency translation. For both the Industrial and Automotive Groups, a portion of the net
sales increase over 2003 was attributable to Torrington’s results only being included from February 18, 2003, the date it was acquired.
The increase in the Steel Group’s net sales in 2004 resulted primarily from surcharges and price increases, which were driven by higher
raw material costs, as well as increased volume. Demand increased across steel customer segments, led by strong industrial demand.
Gross Profit:
2004
2003
$ Change
% Change
Gross profit
Integration and special charges included in cost of products sold
$
838.6
18.6%
$
4.5
$
639.1
16.9%
$
3.4
$
$
199.5
1.1
31.2%
1.7%
32.4%
Gross profit for 2003 included a reclassification of $7.5 million from cost of products sold to selling, administrative and general
expenses for Torrington engineering and research and development expenses to be consistent with the company’s 2004 cost
classification methodology.
Gross profit in 2004 benefited from higher sales and volume, strong operating performance and
operating cost improvements. Gross profit was negatively impacted by higher raw material costs, although the company recovered a
significant portion of these costs through price increases and surcharges.
In 2004, integration charges related to the continued integration of Torrington. In 2003, integration and special charges related
primarily to the integration of Torrington in the amount of $9.3 million and costs incurred for the Duston, England plant closure in the
amount of $4.0 million. These charges were partially offset by curtailment gains in 2003 in the amount of $9.9 million, resulting from
the redesign of the company’s U.S.-based employee benefit plans.
THE TIMKEN COMPANY
23
179
2004
2003
$ Change
% Change
Integration charges included in selling, administrative and general expenses
$
587.9
13.0%
$
22.5
$
521.7
13.8%
$
30.5
$
$
66.2
(8.0)
12.7%
(0.8)%
(26.2)%
Selling, administrative and general expenses for 2003 included a reclassification of $7.5 million from cost of products sold. The
increase in selling, administrative and general expenses in 2004 was due primarily to higher sales, higher accruals for performancebased compensation and foreign currency translation, partially offset by lower integration charges. The decrease between years in
selling, administrative and general expenses as a percentage of net sales was primarily the result of the company’s ability to leverage
expenses on higher sales, continued focus on controlling spending and savings resulting from the integration of Torrington.
The integration charges for 2004 related to the continued integration of Torrington, primarily for information technology and
purchasing initiatives. In 2003, integration charges included integration costs for the Torrington acquisition of $27.6 million and
curtailment losses resulting from the redesign of the company’s U.S.-based employee benefit plans of $2.9 million.
2004
2003
$ Change
12.5
2.9
3.7
19.1
$
Impairment charges
Exit costs
Total
$
$
8.5
4.2
0.7
13.4
$
$
$
(4.0)
1.3
(3.0)
(5.7)
facilities. The severance and related benefit costs related to associates who exited the company as a result of the integration of
Torrington. The exit costs related primarily to facilities in the U.S.
In 2003, impairment charges represented the write-off of the remaining goodwill for the Steel Group in accordance with Statement of
Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” of $10.2 million and impairment charges for
the Columbus, Ohio plant of $2.3 million. The severance and related benefit costs of $2.9 million related to associates who exited the
company as a result of the integration of Torrington and other actions taken by the company to reduce costs. The exit costs were
comprised of $3.0 million for the Columbus, Ohio plant and $0.7 million for the Duston, England plant. The Duston and Columbus
plants were closed as part of the company’s manufacturing strategy initiative (MSI) program in 2001. The additional costs that were
incurred in 2003 for these two projects were the result of changes in estimates.
24
THE TIMKEN COMPANY
180
2004
2003
$ Change
48.4
1.1
$
$
2003
$ Change
Interest expense
Interest income
$
$
50.8
1.4
$
$
2.4
0.3
Interest expense increased due primarily to higher average debt balances during 2004, compared to 2003.
2004
Other expense – net:
Impairment charge – equity investment
Other
$
44.4
$
65.6
$
(21.2)
$
16.4
(16.2)
$
(45.7)
2.0
(12.0)
(55.7)
$
45.7
14.4
(16.2)
(20.6)
23.3
(32.6)
(32.4)
$
$
$
CDSOA receipts are reported net of applicable expenses. CDSOA provides for distribution of monies collected by U.S. Customs
from antidumping cases to qualifying domestic producers where the domestic producers have continued to invest in their technology,
equipment and people.
The CDSOA receipts of $44.4 million and $65.6 million in 2004 and 2003, respectively were net of the amounts that Timken delivered
to the seller of the Torrington business, pursuant to the terms of the agreement under which the company purchased Torrington. In
2004 and 2003, Timken delivered to the seller of the Torrington business 80% of the CDSOA payments received in 2004 and 2003 for
Torrington’s bearing business. Amounts received in 2003 are net of a one-time repayment of $2.8 million, due to a miscalculation by
the U.S. Treasury Department of funds received by the company in 2002.
During 2004, the company sold certain non-strategic assets, which included: real estate at its facility in Duston, England, which
ceased operations in 2002, for a gain of $22.5 million; and the company’s Kilian bearing business, which was acquired in the Torrington
acquisition, for a loss of $5.4 million. In 2003, the gain related primarily to the sale of property in Daventry, England.
In 2004, the company began the process of liquidating one of its inactive subsidiaries, British Timken Ltd., located in Duston, England.
The company recorded a non-cash charge of $16.2 million on dissolution, which related primarily to the transfer of cumulative foreign
currency translation losses to the Statement of Income.
For 2004, Other included losses on the disposal of assets, losses from equity investments, foreign currency exchange losses,
donations, minority interests, and a non-cash charge for the adoption of FIN 46. For 2003, Other included losses from equity investments, losses on the disposal of assets, foreign currency exchange gains and minority interests.
During 2000, the company’s Steel Group invested in a joint venture, PEL Technologies (PEL), to commercialize a proprietary
technology that converts iron units into engineered iron oxide for use in pigments, coatings and abrasives. The company previously
accounted for its investment in PEL, which is a development stage company, using the equity method. In the fourth quarter of 2003,
the company concluded that its investment in PEL was impaired and recorded a non-cash impairment charge totaling $45.7 million.
Refer to Note 12 – Equity Investments in the Notes to Consolidated Financial Statements for additional discussion.
THE TIMKEN COMPANY
25
181
Income Tax Expense:
2004
2003
$ Change
% Change
Income tax expense
Effective tax rate
$
64.1
32.1%
$
24.3
40.0%
$
39.8
-
163.8%
(7.9)%
Income tax expense for 2004 was favorably impacted by tax benefits relating to settlement of prior years’ liabilities, the changes
in the tax status of certain foreign subsidiaries, earnings of certain subsidiaries being taxed at a rate less than 35%, benefits of tax
holidays in China and the Czech Republic, tax benefits from extraterritorial income exclusion, and the aggregate impact of certain items
of income that were not subject to income tax. These benefits were partially offset by the establishment of a valuation allowance
against certain deferred tax assets associated with loss carryforwards attributable to a subsidiary, which was in the process of
liquidation; state and local income taxes; and taxes incurred on foreign remittances. The effective tax rate for 2003 exceeded the U.S.
statutory tax rate as a result of state and local income taxes, withholding taxes on foreign remittances, losses incurred in foreign
jurisdictions that were not available to reduce overall tax expense and the aggregate effect of certain nondeductible expenses. The
unfavorable tax rate adjustments were partially mitigated by benefits from extraterritorial income.
Business Segments:
Industrial Group:
2004
2003
$ 1,711.2
$ 177.9
10.4%
$ 1,499.7
$ 128.0
8.5%
$ Change
% Change
Adjusted EBIT
$
$
211.5
49.9
-
14.1%
39.0%
1.9%
The Industrial Group’s net sales in 2004 increased due to higher demand, increased prices and favorable foreign currency translation.
Many end markets recorded substantial growth, especially construction, agriculture, rail and general industrial equipment. A portion of
the net sales increase was attributable to the acquisition of Torrington.
Sales to distributors increased slightly in 2004 as
distributors reduced their inventories of Torrington-branded products.
26
THE TIMKEN COMPANY
182
Automotive Group:
2004
2003
$ 1,582.2
$
15.9
1.0%
$ 1,396.1
$
15.7
1.1%
$ Change
% Change
Adjusted EBIT
$
$
186.1
0.2
-
13.3%
1.3%
(0.1)%
The Automotive Group’s net sales in 2004 benefited from increased light vehicle penetration from new products, strong medium- and
heavy-truck production and favorable foreign currency translation. Sales for light vehicle applications increased, despite lower vehicle
production in North America. Medium- and heavy-truck demand continued to be strong, primarily due to a 37% increase in North
American vehicle production.
A portion of the net sales increase in 2004 was attributable to the acquisition of Torrington. The Automotive Group’s profitability in
2004 benefited from higher sales and strong operating performance, but was negatively impacted by higher raw material costs.
Steel Group:
2004
2003
$ Change
% Change
$ 1,383.6
$
54.8
4.0%
$ 1,026.5
$
(6.0)
(0.6)%
$
$
357.1
60.8
-
34.8%
4.6%
The increase in the Steel Group’s net sales in 2004 resulted primarily from surcharges and price increases, which were driven by
higher raw material costs, as well as increased volume. Demand increased across all steel customer segments, led by strong
industrial market growth. The strongest customer segments for the Steel Group were oil production, aerospace and general
industrial customers. The Steel Group’s profitability improved significantly in 2004 due to volume, raw material surcharges and price
increases. Raw material costs, especially scrap steel prices, increased over 2003. The company recovered these cost increases
primarily through surcharges.
During the second quarter of 2004, the company’s Faircrest steel facility was shut down for 10 days to clean up contamination from
a material commonly used in industrial gauging. This material entered the facility from scrap steel provided by one of its suppliers. In
2004, the company recovered all of the clean-up, business interruption and disposal costs in excess of $4 million of insurance
deductibles.
THE TIMKEN COMPANY
27
183
The Balance Sheet
Total assets as shown on the Consolidated Balance Sheet at December 31, 2005 increased by $50.8 million from December 31, 2004.
This increase was due primarily to increased working capital required to support higher sales offset by lower total other assets and
property, plant and equipment - net.
Current Assets:
12/31/05
12/31/04
$ Change
$
$
$
% Change
Current assets
Accounts receivable, less allowances: 2005 – $40,618; 2004 – $36,279
Inventories - net
65.4
711.8
998.4
105.0
21.2
81.5
$ 1,983.3
51.0
706.1
874.8
113.3
20.3
73.7
$ 1,839.2
$
14.4
5.7
123.6
(8.3)
0.9
7.8
144.1
28.2%
0.8%
14.1%
(7.3)%
4.4%
10.6%
7.8%
The increase in cash and cash equivalents in 2005 was partially due to accumulated cash at certain debt-free foreign subsidiaries. Refer
to the Consolidated Statement of Cash Flows for further explanation. Net accounts receivable increased as a result of the higher sales
in the fourth quarter of 2005 as compared to 2004, offset by the impact of foreign currency translation and higher allowance for doubtful accounts. The increase in inventories was due primarily to higher volume and increased raw material costs, partially offset by the
impact of foreign currency translation. The decrease in deferred income taxes related primarily to the utilization of loss carryforwards,
offset by a reclassification of the benefit of certain other loss carryforwards from non-current deferred income tax asset.
Property, Plant and Equipment – Net:
12/31/05
12/31/04
$ 3,640.5
(2,093.5)
$ 1,547.0
$ 3,622.6
(2,039.2)
$ 1,583.4
$ Change
% Change
Property, plant and equipment - cost
Property, plant and equipment - net
$
$
17.9
(54.3)
(36.4)
0.5%
2.7%
(2.3)%
The decrease in property, plant and equipment – net in 2005 was due primarily to the impact of foreign currency translation.
Other Assets:
12/31/05
12/31/04
$ Change
% Change
Goodwill
Total other assets
$
$
204.1
184.6
5.8
68.9
463.4
$
$
189.3
179.0
85.2
66.8
520.3
$
$
14.8
5.6
(79.4)
2.1
(56.9)
7.8%
3.1%
(93.2)%
3.1%
(10.9)%
The increase in goodwill and other intangible assets in 2005 was due primarily to the acquisition of Bearing Inspection, Inc. (BII), a
provider of bearing inspection, reconditioning and engineering services, in the fourth quarter of 2005. The excess of the purchase
price over the fair value of the net assets acquired was recorded as goodwill in the amount of $15.3 million. The increase in other
intangible assets related to BII of $27.2 million was offset by the decrease in intangible pension assets, resulting from the decrease
in minimum pension liability. The decrease in deferred income taxes related primarily to pension contributions and the reclassification
of certain loss carryforwards to current deferred income tax asset.
28
THE TIMKEN COMPANY
184
12/31/05
12/31/04
$ Change
% Change
Short-term debt
$
63.4
501.0
375.3
34.1
4.9
95.8
$ 1,074.5
$
157.4
501.8
334.6
19.0
16.5
1.3
$ 1,030.6
$
$
(94.0)
(0.8)
40.7
15.1
(11.6)
94.5
43.9
(59.7)%
(0.2)%
12.2%
79.5%
(70.3)%
4.3%
The decrease in short-term debt was the result of lower short-term debt requirements in Europe. The increase in salaries, wages
and benefits was due primarily to an increase in the current portion of accrued pension cost, based upon the company’s estimate of
contributions to its pension plans in the next twelve months, and higher accruals for performance-based compensation. The increase
in income taxes payable is due primarily to higher earnings in 2005 and foreign dividends received in the fourth quarter. The decrease
in deferred income taxes is due primarily to the reversal of timing differences at certain foreign affiliates. The current portion of
long-term debt increased due to the reclassification of debt maturing within the next twelve months to current.
12/31/05
12/31/04
$ Change
% Change
Long-term debt
$
561.7
246.7
513.8
42.9
57.1
$ 1,422.2
$
620.6
468.6
490.4
15.1
47.7
$ 1,642.4
$
(58.9)
(221.9)
23.4
27.8
9.4
$ (220.2)
(9.5)%
(47.4)%
4.8%
184.1%
19.7%
(13.4)%
The decrease in long-term debt is related to the reclassification of debt maturing within the next twelve months from long-term to
current, partially offset by a new long-term bank loan. The decrease in accrued pension cost in 2005 was due primarily to U.S.-based
pension plan contributions and the decrease in the minimum pension liability, partially offset by current year accruals for pension
expense. The increase in accrued postretirement benefits cost was due primarily to higher expense accrued versus disbursements
made in 2005, as well as the curtailment charges associated with the automotive restructuring announced in 2005. Refer to Note 13
– Retirement and Postretirement Benefit Plans in the Notes to Consolidated Financial Statements. The increase in deferred income
taxes is due primarily to pension contributions and CDSOA receipts in 2005, as well as other normal timing differences, which
resulted in a higher non-current, deferred tax liability, compared to 2004.
THE TIMKEN COMPANY
29
185
12/31/05
12/31/04
$ Change
% Change
Common stock
Treasury shares
$
772.1
1,052.9
(323.5)
(4.4)
$ 1,497.1
$
711.8
847.7
(289.5)
(0.2)
$ 1,269.8
$
$
60.3
205.2
(34.0)
(4.2)
227.3
8.5%
24.2%
11.7%
17.9%
The increase in common stock related to stock option exercises by employees and the related income tax benefits. Earnings
invested in the business were increased in 2005 by net income, partially reduced by dividends declared. The increase in accumulated
other comprehensive loss was due primarily to foreign currency translation, partially offset by a decrease in the minimum pension
liability. The decrease in the foreign currency translation adjustment was due to strengthening of the U.S. dollar relative to other
currencies, such as the Euro and Polish zloty. For discussion regarding the impact of foreign currency translation, refer to Item
7A. Quantitative and Qualitative Disclosures About Market Risk.
Cash Flows
12/31/05
12/31/04
$ Change
$
$
$
Net cash used by investing activities
Net cash (used) provided by financing activities
Increase (decrease) in cash and cash equivalents
318.7
(242.8)
(56.3)
(5.2)
$
14.4
120.5
(108.6)
(1.9)
12.3
$
22.3
198.2
(134.2)
(54.4)
(17.5)
$
(7.9)
The increase in net cash provided by operating activities of $198.2 million was primarily the result of higher net income of
$260.3 million, adjusted for non-cash items of $308.7 million, compared to net income of $135.7 million, adjusted for non-cash items
of $290.5 million in 2004. The non-cash items include depreciation and amortization expense, gain or loss on disposals of assets,
deferred income tax provision and amortization of restricted share awards. Accounts receivable was a use of cash of $29.4 million in
2005, compared to a use of cash of $114.3 million in 2004. In 2005, inventory was a use of cash of $160.3 million, compared to a use
of cash of $130.4 million in 2004. Accounts receivable and inventory increased during the year due to higher sales volume. Excluding
cash contributions to the company's U.S.-based pension plans, accounts payable and accrued expenses were a source of cash of
$181.6 million in 2005, compared to a source of cash of $111.8 million in 2004. The company made cash contributions to its
U.S.-based pension plans in 2005 of $226.2 million, compared to $185.0 million in 2004.
The increase in net cash used by investing activities was due primarily to higher capital expenditures in 2005, compared to 2004, and
the $42.4 million acquisition of Bearing Inspection, Inc. in the fourth quarter of 2005. Purchases of property, plant and equipment –
net of $221.0 million increased from $155.2 million in 2004. The cash proceeds from the sale of the Industrial Group's Linear
Motion Systems business in 2005 partially offset the increase in cash used by investing activities. The proceeds from disposals of
non-strategic assets were $21.8 million in 2005, compared to $50.7 million in 2004.
Net cash used by financing activities related primarily to dividends paid in 2005 and 2004 of $55.1 million and $46.8 million,
respectively. In 2005, the proceeds from the exercise of stock options were offset by net repayments on the company’s credit
facilities. In 2004, the dividends paid were offset by the company’s increased borrowings on its credit facilities and proceeds from the
exercise of stock options.
30
THE TIMKEN COMPANY
186
Total debt was $720.9 million at December 31, 2005, compared to $779.3 million at December 31, 2004. Net debt was $655.5 million
at December 31, 2005, compared to $728.3 million at December 31, 2004. The net debt to capital ratio was 30.5% at December 31,
2005, compared to 36.5% at December 31, 2004.
Reconciliation of total debt to net debt and the ratio of net debt to capital:
Net Debt:
12/31/05
12/31/04
Short-term debt
Long-term debt
Total debt
Net debt
$
$
63.4
95.8
561.7
720.9
(65.4)
655.5
$
$
157.4
1.3
620.6
779.3
(51.0)
728.3
12/31/05
12/31/04
Net debt
$
655.5
1,497.1
2,152.6
30.5%
$
728.3
1,269.8
1,998.1
36.5%
The company presents net debt because it believes net debt is more representative of the company’s indicative financial position.
On June 30, 2005, the company entered into a $500 million Amended and Restated Credit Agreement (Senior Credit Facility) that
replaced the company's previous credit agreement, dated as of December 31, 2002. The Senior Credit Facility matures on June 30,
2010. At December 31, 2005, the company had no outstanding borrowings under its $500 million Senior Credit Facility, and letters of
credit totaling $77.1 million, which reduced the availability under the Senior Credit Facility to $422.9 million. Under this Senior Credit
Facility, the company has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio.
At December 31, 2005, the company was in full compliance with the covenants under the Senior Credit Facility and its other debt
agreements.
In addition, the company entered into a new $200 million Accounts Receivable Securitization Financing Agreement (2005 Asset
Securitization), as of December 30, 2005, replacing a $125 million Asset Securitization Financing Agreement. The 2005 Asset
Securitization provides for borrowings up to $200 million, limited to certain borrowing base calculations, and is secured by certain
domestic trade receivables of the company. The 2005 Asset Securitization is in effect for one year, and there were no outstanding
borrowings as of December 31, 2005.
The company expects that any cash requirements in excess of cash generated from operating activities will be met by the availability
under its 2005 Asset Securitization and Senior Credit Facility. The company believes it has sufficient liquidity to meet its obligations
through 2006.
THE TIMKEN COMPANY
31
187
Financing Obligations and Other Commitments
Total
Less than
1 Year
1-3 Years
3-5 Years
$
$
$
More than
5 Years
Interest payments
Long-term debt
Short-term debt
Operating leases
Supply agreement
Total
$
391.7
657.6
63.4
133.1
2.3
$ 1,248.1
$
36.9
95.8
63.4
27.7
2.3
226.1
$
63.3
26.2
43.7
133.2
$
53.4
297.7
28.9
380.0
$
$
238.1
237.9
32.8
508.8
The interest payments are primarily related to medium-term notes that mature over the next twenty-eight years.
In December 2005, the company entered into a $49.8 million unsecured loan in Canada. The principal balance of the loan is payable in
full in December 2010. The interest rate is variable based on the Canadian LIBOR rate and interest payments are due quarterly.
The company expects to make cash contributions of $160.2 million to its global defined benefit pension plans in 2006. Refer to Note
13 – Retirement and Postretirement Benefit Plans in the Notes to Consolidated Financial Statements. In connection with the sale of
the company’s Ashland, Ohio tooling plant in 2002, the company entered into a $25.9 million four-year supply agreement that expires
on June 30, 2006, pursuant to which the company is obliged to purchase tooling.
During 2005, the company did not purchase any shares of its common stock 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. This plan authorizes purchases up
to an aggregate of $180 million. The company may exercise this authorization until December 31, 2006. The company does not expect
to be active in repurchasing its shares under the plan in the near-term.
The company does not have any off-balance sheet arrangements with unconsolidated entities or other persons.
Recent Accounting Pronouncements:
In November 2004, the FASB issued SFAS 151, “Inventory Costs, an amendment of ARB 43, Chapter 4.” SFAS 151 requires certain
inventory costs to be recognized as current period expenses. SFAS 151 also provides guidance for the allocation of fixed production
costs. This standard is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Accordingly, the
company will adopt this standard in 2006. The company believes that the adoption of this standard will not have a material impact on
the financial statements of the company.
In December 2004, the FASB issued SFAS No. 123 – revised 2004 (SFAS 123R), "Share-Based Payment" which replaces SFAS No. 123
(SFAS 123), "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS 123R requires the measurement of all employee share-based payments to employees, including grants of employee
stock options, using a fair-value-based method and the recording of such expense in the company’s Consolidated Statement of
Income. In April 2005, the SEC announced that the accounting provisions of SFAS 123R are to be applied in the first quarter of the fiscal
year beginning after June 15, 2005. As a result, the company is now required to adopt SFAS 123R in the first quarter of fiscal 2006
and will recognize stock-based compensation expense using the modified prospective method. The pro forma disclosures previously
permitted under SFAS 123 no longer will be an alternative to financial statement recognition. The company estimates that compensation
expense related to employee stock options for fiscal 2006 is expected to be approximately $7 million pretax, which will be reflected as
compensation expense. No expense is recognized for awards vested in prior periods. This estimate assumes that the number and the
fair value of stock options granted are similar to historical activity for all years. SFAS 123R also requires the benefits of tax deductions
in excess of recognized compensation costs to be reported as financing cash flow, rather than as an operating cash flow, as required
under previous accounting literature. This requirement will reduce net operating cash flows and increase net financing cash flows in
periods after adoption. The company believes this reclassification will not have a material impact on its Consolidated Statement of
Cash Flows.
32
THE TIMKEN COMPANY
188
In May 2005, the FASB issued SFAS No. 154, (SFAS 154)“Accounting Changes and Error Corrections,” which changes the
accounting for and reporting of a change in accounting principle. This statement also carries forward the guidance from APB No. 20
regarding the correction of an error and changes in accounting estimates. This statement requires retrospective application to prior
period financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific or cumulative effects of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005.
The company believes that the adoption of this standard will not have a material impact on the financial statements of the company.
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.
The company’s revenue recognition policy is to recognize revenue when title passes to the customer. This occurs at the shipping
point, except for certain exported goods for which it occurs when the goods reach their destination. Selling prices are fixed based on
purchase orders or contractual arrangements.
Goodwill:
SFAS No. 142, “Goodwill and Other Intangible Assets,” requires that goodwill and indefinite-lived intangible assets be tested
for impairment at least annually. Furthermore, goodwill is reviewed for impairment whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. The company engages an independent valuation firm and performs its
annual impairment test during the fourth quarter after the annual forecasting process is completed. In 2005 and 2004, the fair values
of the company’s reporting units exceeded their carrying values, and no impairment losses were recognized. However, in 2003, the
carrying value of the company’s Steel reporting units exceeded their fair value. As a result, an impairment loss of $10.2 million was
recognized. Refer to Note 8 – Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements.
The company’s policy is to recognize restructuring costs in accordance with SFAS No. 146, “Accounting for Costs Associated with
Exit or Disposal Activities.” Detailed contemporaneous documentation is maintained and updated on a monthly basis to ensure that
accruals are properly supported. If management determines that there is a change in estimate, the accruals are adjusted to reflect this
change.
Benefit plans:
The company sponsors a number of defined benefit pension plans, which cover eligible associates. The company also sponsors
several unfunded postretirement plans that provide health care and life insurance benefits for eligible retirees and dependents. The
measurement of liabilities related to these plans is based on management’s assumptions related to future events, including discount
rate, return on pension plan assets, rate of compensation increases and health care cost trend rates. The discount rate is determined
using a model that matches corporate bond securities against projected future pension and postretirement disbursements. Actual
pension plan asset performance either reduces or increases net actuarial gains or losses in the current year, which ultimately affects
net income in subsequent years.
THE TIMKEN COMPANY
33
189
For expense purposes in 2005, the company applied a discount rate of 6.0% and an expected rate of return of 8.75% for the
company’s pension plan assets. For 2006 expense, the company reduced the discount rate to 5.875%. The assumption for expected
rate of return on plan assets was not changed from 8.75% for 2006. The lower discount rate will result in an increase in 2006 pretax
pension expense of approximately $2.4 million. A 0.25 percentage point reduction in the discount rate would increase pension expense
by approximately $4.9 million for 2006. A 0.25 percentage point reduction in the expected rate of return would increase pension
expense by approximately $4.7 million for 2006.
Effective on January 1, 2004, the company made revisions to certain benefit programs for its U.S.-based employees, resulting in a
pretax curtailment gain of $10.7 million. Depending on an associate’s combined age and years of service with the company on January
1, 2004, defined benefit pension plan benefits were reduced or replaced by a new defined contribution plan. The company no longer
subsidizes retiree medical coverage for those associates who did not meet a threshold of combined age and years of service with the
company on January 1, 2004.
For measurement purposes for postretirement benefits, the company assumed a weighted-average annual rate of increase in the per
capita cost (health care cost trend rate) for medical benefits of 9.0% for 2006, declining gradually to 5.0% in 2010 and thereafter; and
12.0% for 2006, declining gradually to 6.0% in 2014 and thereafter for prescription drug benefits. 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 2005 total service and interest components by $1.4 million and would have increased the
postretirement obligation by $25.8 million. A one percentage point decrease would provide corresponding reductions of $1.3 million
and $23.8 million, respectively.
The U.S. Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Medicare Act) was signed into law on
December 8, 2003. The Medicare Act provides for prescription drug benefits under Medicare Part D and contains a subsidy to plan
sponsors who provide “actuarially equivalent” prescription plans. In May 2004, the FASB issued FASB Staff Position No. FAS 106-2,
“Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”
(FSP 106-2). During 2005, the company’s actuary determined that the prescription drug benefit provided by the company’s postretirement plan is considered to be actuarially equivalent to the benefit provided under the Medicare Act. The effects of the Medicare Act
are reductions to the accumulated postretirement benefit obligation of $73.5 million and to the net periodic postretirement benefit cost
of $9.2 million. No Medicare cash subsidies were received in 2005.
Income taxes:
SFAS No. 109, “Accounting for Income Taxes,” requires that a valuation allowance be established when it is more likely than not that
all or a portion of a deferred tax asset will not be realized. The company estimates current tax due and temporary differences,
resulting from the different treatment of items for tax and financial reporting purposes. These differences result in deferred tax assets
and liabilities that are included within the Consolidated Balance Sheet. Based on known and projected earnings information and
prudent tax planning strategies, the company then assesses the likelihood that deferred tax assets will be realized. If the company
determines it is more likely than not that a deferred tax asset will not be realized, a charge is recorded to establish a valuation allowance
against it, which increases income tax expense in the period in which such determination is made. If the company later determines
that realization of the deferred tax asset is more likely than not, a reduction in the valuation allowance is recorded, which reduces
income tax expense in the period in which such determination is made. Net deferred tax assets relate primarily to pension and
postretirement benefits and tax loss and credit carryforwards, which the company believes are more likely than not to result in future
tax benefits. Significant management judgment is required in determining the provision for income taxes, deferred tax assets and
liabilities, and any valuation allowance recorded against deferred tax assets. Historically, actual results have not differed
significantly from those used in determining the estimates described above.
34
THE TIMKEN COMPANY
190
Other Matters:
The company continues its efforts to protect the environment and comply with environmental protection laws. Additionally, it
has invested in pollution control equipment and updated plant operational practices. The company is committed to implementing a
documented environmental management system worldwide and to becoming certified under the ISO 14001 standard to meet or
exceed customer requirements. As of the end of 2005, 32 of the company’s plants had ISO 14001 certification. The company believes
it has established adequate reserves to cover its environmental expenses and has a well-established environmental
compliance audit program, which includes a proactive approach to bringing its domestic and international units to higher standards of
environmental performance. This program measures performance against local laws, as well as standards that have been established
for all units worldwide. It is difficult to assess the possible effect of compliance with future requirements that differ from existing ones.
As previously reported, the company is unsure of the future financial impact to the company that could result from the United States
Environmental Protection Agency’s (EPA’s) final rules to tighten the National Ambient Air Quality Standards for fine particulate
and ozone.
The company and certain of its U.S. subsidiaries have been designated as potentially responsible parties by the EPA for site
(Superfund). The claims for remediation have been asserted against numerous other entities, which are believed to be financially
solvent and are expected to fulfill their proportionate share of the obligation. Management believes any ultimate liability with respect
to all pending actions will not materially affect the company’s results of operations, cash flows or financial position.
On February 7, 2006, the company’s Board of Directors declared a quarterly cash dividend of $0.15 per share. The dividend was paid
on March 2, 2006 to shareholders of record as of February 21, 2006. This was the 335th consecutive dividend paid on the common
stock of the company.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Changes in short-term interest rates related to several separate funding sources impact the company’s earnings. These sources
are borrowings under an Asset Securitization, borrowings under the $500 million Senior Credit Facility, floating rate tax-exempt U.S.
municipal bonds with a weekly reset mode and short-term bank borrowings at international subsidiaries. The company is also
sensitive to market risk for changes in interest rates, as they influence $80 million of debt that is subject to interest rate swaps. The
company has interest rate swaps with a total notional value of $80 million to hedge a portion of its fixed-rate debt. Under the terms
of the interest rate swaps, the company receives interest at fixed rates and pays interest at variable rates. The maturity dates of the
interest rate swaps are January 15, 2008 and February 15, 2010. If the market rates for short-term borrowings increased by onepercentage-point around the globe, the impact would be an increase in interest expense of $1.8 million with a corresponding decrease
in income before income taxes of the same amount. The amount was determined by considering the impact of hypothetical interest
rates on the company’s borrowing cost, year-end debt balances by category and an estimated impact on the tax-exempt municipal
bonds’ interest rates.
Fluctuations in the value of the U.S. dollar compared to foreign currencies, predominately in European countries, also impact the
company’s earnings. The greatest risk relates to products shipped between the company’s European operations and the United States.
Foreign currency forward contracts are used to hedge these intercompany transactions. Additionally, hedges are used to cover
third-party purchases of product and equipment. As of December 31, 2005, there were $238.4 million of hedges in place. A uniform
10% weakening of the U.S. dollar against all currencies would have resulted in a charge of $23.0 million for these hedges. In addition
to the direct impact of the hedged amounts, changes in exchange rates also affect the volume of sales or foreign
currency sales price as competitors’ products become more or less attractive.
THE TIMKEN COMPANY
35
191
Item 8. Financial Statements and Supplementary Data
Year Ended December 31
2005
2004
2003
$ 5,168,434
4,109,713
1,058,721
$ 4,513,671
3,675,086
838,585
$ 3,788,097
3,148,979
639,118
Operating Income
661,592
26,093
371,036
587,923
13,434
237,228
521,717
19,154
98,247
Interest expense
Interest income
Receipt of Continued Dumping & Subsidy Offset Act (CDSOA)
payment, net of expenses
Net Income
(51,585)
3,437
(50,834)
1,397
(48,401)
1,123
77,069
(9,411)
390,546
130,265
260,281
44,429
(32,441)
199,779
64,123
135,656
65,559
(55,726)
60,802
24,321
36,481
Net sales
Gross Profit
Earnings per share:
Earnings per share
Earnings per share–assuming dilution
$
$
$ 2.84
$ 2.81
$
$
$ 1.51
$ 1.49
$
$
$ 0.44
$ 0.44
36
THE TIMKEN COMPANY
192
December 31
2005
2004
(Thousands of dollars)
ASSETS
Current Assets
Accounts receivable, less allowances: 2005 – $40,618; 2004 – $36,279
Inventories - net
$
$
50,967
706,098
874,833
113,300
20,325
73,675
1,839,198
1,547,044
1,583,425
204,129
184,624
5,834
68,794
463,381
$ 3,993,734
189,299
178,986
85,192
66,809
520,286
$ 3,942,909
$
$
Property, Plant and Equipment - Net
Other Assets
Goodwill
Total Other Assets
Total Assets
65,417
711,783
998,368
104,978
21,225
81,538
1,983,309
Current Liabilities
Short-term debt
Long-term debt
Authorized–10,000,000 shares each class, none issued
Authorized–200,000,000 shares
Issued (including shares in treasury) (2005 – 93,160,285 shares;
2004 – 90,511,833 shares)
Stated capital
Treasury shares at cost (2005 – 154,374 shares; 2004 – 7,501 shares)
63,437
500,939
375,264
34,131
4,862
95,842
1,074,475
157,417
501,832
334,654
18,969
16,478
1,273
1,030,623
561,747
246,692
513,771
42,891
57,091
1,422,192
620,634
468,644
490,366
15,113
47,681
1,642,438
-
-
53,064
719,001
1,052,871
(323,449)
(4,420)
1,497,067
$ 3,993,734
53,064
658,730
847,738
(289,486)
(198)
1,269,848
$ 3,942,909
THE TIMKEN COMPANY
37
193
2005
2004
2003
$ 260,281
$135,656
$ 36,481
218,059
10,145
(8,960)
606
78,775
9,294
770
209,431
6,336
(16,393)
16,186
62,039
2,775
10,154
208,851
4,944
4,406
2,744
55,967
(29,426)
(160,287)
(21,099)
(44,614)
5,157
318,701
(114,264)
(130,407)
9,544
(73,218)
2,690
120,529
(27,543)
33,229
(29,019)
(83,982)
(2,234)
203,844
Purchases of property, plant and equipment–net
Proceeds from disposals of non-strategic assets
Acquisitions
(220,985)
5,341
21,838
(48,996)
(242,802)
(155,180)
5,268
50,690
(9,359)
(108,581)
(118,530)
26,377
152,279
(725,120)
(664,994)
Proceeds from exercise of stock options
Proceeds from issuance of common stock
Common stock issued to finance acquisition
Short-term debt activity–net
Net Cash (Used) Provided by Financing Activities
Increase (Decrease) In Cash and Cash Equivalents
(55,148)
231,500
(231,500)
39,793
346,454
(308,233)
(79,160)
(56,294)
(5,155)
14,450
50,967
$ 65,417
(46,767)
198,000
(198,000)
17,628
335,068
(328,651)
20,860
(1,862)
12,255
22,341
28,626
$ 50,967
(42,078)
127,000
(127,000)
1,044
54,985
180,010(1)
629,800
(379,790)
(41,082)
402,889
4,837
(53,424)
82,050
$ 28,626
Net income
Adjustments to reconcile net income to net cash
Loss on disposals of property, plant and equipment
Deferred income tax provision
Accounts receivable
Inventories
Other assets
Foreign currency translation loss (gain)
(1)
Excluding $140 million of common stock (9,395,973 shares) issued to the seller of the Torrington business, in conjunction
with the acquisition.
38
THE TIMKEN COMPANY
194
Common Stock
Total
Stated
Capital
Other
Paid-In
Capital
$ 53,064
$ 257,992
Earnings
Invested
in the
Business
Accumulated
Other
Comprehensive
Loss
Treasury
Stock
$ 609,086
Net income
36,481
75,062
31,813
reclassifications
420
143,776
Dividends – $0.52 per share
(42,078)
Tax benefit from exercise of stock options
1,104
Issuance (tender) of 29,473 shares from treasury(1)
301
Issuance of 25,624,198 shares from authorized(1)(2) 377,438
$1,089,627
Net income
135,656
105,736
(36,468)
reclassifications
(372)
204,552
(46,767)
3,068
(1,067)
Issuance of 1,435,719 shares from authorized(1)
20,435
$ 1,269,848
Net income
260,281
(49,940)
13,395
reclassifications
2,582
226,318
(55,148)
8,151
(5,831)
53,729
$ 1,497,067
$ 764,446
36,481
$ (465,677) $
(739)
75,062
31,813
420
(42,078)
$ 53,064
1,104
(262)
377,438
$ 636,272
563
$ 758,849
$ (358,382) $
(176)
135,656
105,736
(36,468)
(372)
(46,767)
$ 53,064
3,068
(1,045)
20,435
$ 658,730
(22)
$ 847,738
$ (289,486) $
(198)
260,281
(49,940)
13,395
2,582
(55,148)
$ 53,064
8,151
(1,609)
53,729
$ 719,001
(4,222)
$1,052,871
$ (323,449) $
(4,420)
(1)
(2)
Share activity includes the issuance of 22,045,973 shares in connection with the Torrington acquisition and an additional public
equity offering of 3,500,000 shares in October 2003. See accompanying Notes to Consolidated Financial Statements.
THE TIMKEN COMPANY
39
195
Principles of Consolidation: The consolidated financial statements include the accounts and operations of the company and its
subsidiaries. All significant intercompany accounts and transactions are eliminated upon consolidation. Investments in affiliated
companies are accounted for by the equity method.
Revenue Recognition: The company recognizes revenue when title passes to the customer. This is FOB shipping point except for
certain exported goods, which is FOB destination. Selling prices are fixed based on purchase orders or contractual arrangements.
Shipping and handling costs are included in cost of products sold in the Consolidated Statement of Income.
Cash Equivalents: The company considers all highly liquid investments with a maturity of three months or less when purchased to be
cash equivalents.
Allowance for Doubtful Accounts: The company has recorded an allowance for doubtful accounts, which represents an estimate of
the losses expected from the accounts receivable portfolio, to reduce accounts receivable to their net realizable value. The allowance
was based upon historical trends in collections and write-offs, management’s judgment of the probability of collecting accounts and
management’s evaluation of business risk.
Inventories: Inventories are valued at the lower of cost or market, with 54% valued by the last-in, first-out (LIFO) method and the
remaining 46% valued by first-out, first-in (FIFO). If all inventories had been valued at FIFO costs, inventories would have been
$283,100 and $232,400 greater at December 31, 2005 and 2004, respectively. The components of inventories are as follows:
December 31
Inventories:
Finished products
Total Inventories
2005
2004
74,188
469,517
454,663
$ 998,368
$ 58,357
423,808
392,668
$ 874,833
$
Property, Plant and Equipment: Property, plant and equipment is valued at cost less accumulated depreciation. Maintenance and
repairs are charged to expense as incurred. Provision for depreciation is computed principally by the straight-line method based upon
the estimated useful lives of the assets. The useful lives are approximately 30 years for buildings, 5 to 7 years for computer software
and 3 to 20 years for machinery and equipment. The components of Property, plant and equipment are as follows:
December 31
2004
2005
Property, Plant and Equipment:
Land and buildings
Subtotal
Property, Plant and Equipment - net
$
639,833
3,000,719
3,640,552
(2,093,508)
$ 1,547,044
$
648,646
2,974,010
3,622,656
(2,039,231)
$ 1,583,425
Impairment of long-lived assets is recognized when events or changes in circumstances indicate that the carrying amount of the asset
or related group of assets may not be recoverable. If the expected future undiscounted cash flows are less than the carrying amount of
the asset, an impairment loss is recognized at that time to reduce the asset to the lower of its fair value or its net book value in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
Goodwill: The company tests goodwill and indefinite-lived intangible assets for impairment at least annually. The company engages
an independent valuation firm and performs its annual impairment test during the fourth quarter after the annual forecasting process is
completed. Furthermore, goodwill is reviewed for impairment whenever events or changes in circumstances indicate that the carrying
value may not be recoverable in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets."
Income Taxes: Deferred income taxes are provided for the temporary differences between the financial reporting basis and tax basis of
the company’s assets and liabilities.
Valuation allowances are recorded when and to the extent the company determines it is more
likely than not that all or a portion of its deferred tax assets will not be realized.
Foreign Currency Translation: Assets and liabilities of subsidiaries, other than those located in highly inflationary countries, are
translated at the rate of exchange in effect on the balance sheet date; income and expenses are translated at the average rates of
40
THE TIMKEN COMPANY
196
Note 1 Significant Accounting Policies (continued)
exchange prevailing during the year. The related translation adjustments are reflected as a separate component of accumulated other
comprehensive loss. Gains and losses resulting from foreign currency transactions and the translation of financial statements of
subsidiaries in highly inflationary countries are included in the Statement of Income. The company recorded a foreign currency exchange
gain of $7,115 in 2005, and losses of $7,687 in 2004 and $2,666 in 2003. During 2004, the American Institute of Certified
Public Accountants SEC Regulations Committee’s International Practices Task Force concluded that Romania should come off highly
inflationary status no later than October 1, 2004. Effective October 1, 2004, the company no longer accounted for Timken Romania as
highly inflationary.
Stock-Based Compensation: On December 31, 2002, the FASB issued SFAS No. 148 (SFAS 148), "Accounting for Stock-Based
Compensation – Transition and Disclosure." SFAS 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," by
providing alternative methods of transition to SFAS 123’s fair value method of accounting for stock-based compensation. SFAS 148 also
amends the disclosure requirements of SFAS 123. The company has elected to follow Accounting Principles Board (APB) Opinion
No. 25 (APB 25), "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock options to key
associates and directors. Under APB 25, if the exercise price of the company’s stock options equals the market price of the underlying
common stock on the date of grant, no compensation expense is required. Restricted stock rights are awarded to certain employees
and directors. The market price on the grant date is charged to compensation expense ratably over the vesting period of the restricted
stock rights.
The effect on net income and earnings per share as if the company had applied the fair value recognition provisions of SFAS No. 123
is as follows for the years ended December 31:
2005
2004
2003
$ 260,281
$ 135,656
$ 36,481
Add: Stock-based employee compensation expense, net of related taxes
5,955
Deduct: Stock-based employee compensation expense determined under fair value
based methods for all awards, net of related taxes
(10,042)
Pro forma net income
$ 256,194
1,884
1,488
Net income, as reported
Earnings per share:
Basic – as reported
Basic – pro forma
Diluted – as reported
Diluted – pro forma
(6,751)
$ 130,789
(7,305)
$ 30,664
$2.84
$2.80
$1.51
$1.46
$0.44
$0.37
$2.81
$2.77
$1.49
$1.44
$0.44
$0.37
Earnings Per Share: Earnings per share are computed by dividing net income by the weighted-average number of common shares
outstanding during the year. Earnings per share - assuming dilution are computed by dividing net income by the weighted-average
number of common shares outstanding, adjusted for the dilutive impact of potential common shares for options.
Derivative Instruments: The company accounts for its derivative instruments in accordance with SFAS No. 133 (SFAS 133),
"Accounting for Derivative Instruments and Hedging Activities," as amended. The company recognizes all derivatives on the balance
sheet at fair value. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. If the derivative is
designated and qualifies as a hedge, depending on the nature of the hedge, changes in the fair value of the derivatives are either
offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other
comprehensive loss until the hedged item is recognized in earnings. The company’s holdings of forward foreign exchange contracts
have been deemed derivatives pursuant to the criteria established in SFAS 133, of which the company has designated certain of those
derivatives as hedges. The critical terms, such as the notional amount and timing of the forward contract and forecasted transaction,
coincide, resulting in no significant hedge ineffectiveness. In 2004, the company entered into interest rate swaps to hedge a portion
of its fixed-rate debt. The critical terms, such as principal and notional amounts and debt maturity and swap termination dates,
coincide, resulting in no hedge ineffectiveness. These instruments qualify as fair value hedges. Accordingly, the gain or loss on both
the hedging instrument and the hedged item attributable to the hedged risk are recognized currently in earnings.
Recent Accounting Pronouncements: In November 2004, the FASB issued SFAS No. 151 (SFAS 151), “Inventory Costs, an amendment
of ARB 43, Chapter 4.” SFAS 151 requires certain inventory costs to be recognized as current period expenses. SFAS 151 also provides guidance for the allocation of fixed production costs. This standard is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. Accordingly, the company will adopt this standard in 2006. The company anticipates that the adoption
of this standard will not have a material impact on the financial statements of the company.
THE TIMKEN COMPANY
41
197
Note 1 Significant Accounting Policies (continued)
In December 2004, the FASB issued SFAS 123 – revised 2004 (SFAS 123R), "Share-Based Payment", which replaces SFAS No. 123,
“Accounting for Stock-Based Compensation", and supersedes APB Opinion No. 25 (APB 25), "Accounting for Stock Issued to
Employees." SFAS 123R requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in the company’s Consolidated Statement of
Income. In April 2005, the SEC announced that the accounting provisions of SFAS 123R are to be applied in the first quarter of the fiscal year beginning after June 15, 2005. As a result, the company will adopt SFAS 123R in the first quarter of fiscal 2006 and will recognize stock-based compensation expense using the modified prospective method. The pro forma disclosures previously permitted
under SFAS 123 no longer will be an alternative to financial statement recognition. The company estimates that compensation expense
related to employee stock options for fiscal 2006 is expected to be approximately $7,000 pretax, which will be reflected as compensation expense. No expense is recognized for awards vested in prior periods. This estimate assumes that the number and the fair value
of stock options granted are similar to historical activity for all years. SFAS 123R also requires the benefits of tax deductions in excess
of recognized compensation costs to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.
The company believes this reclassification will not have a material impact on its Consolidated Statement of Cash Flows.
In May 2005, the FASB issued SFAS No. 154 (SFAS 154), “Accounting Changes and Error Corrections,” which changes the
accounting for and reporting of a change in accounting principle. This statement also carries forward the guidance from APB
No. 20 regarding the correction of an error and changes in accounting estimates. This statement requires retrospective application to
prior period financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific or
cumulative effects of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15,
2005. The company believes that the adoption of this standard will not have a material impact on its Consolidated Financial Statements
or liquidity.
Use of Estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts reported in the Financial Statements and accompanying
notes. These estimates and assumptions are reviewed and updated regularly to reflect recent experience.
Reclassifications: Certain amounts reported in the 2004 and 2003 Consolidated Financial Statements have been reclassified to
conform to the 2005 presentation.
2 Acquisitions
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 for
approximately $840,000 plus $25,089 of acquisition cost. IR’s Engineered Solutions business was comprised of certain operating
assets and subsidiaries, including The Torrington Company. The company’s Consolidated Financial Statements include the results of
operations of Torrington since the date of the acquisition.
The company paid IR $700,000 in cash, which was subject to post-closing purchase price adjustments, and issued $140,000 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: $180,010, net of underwriting discounts and commissions, from a public offering of
12,650,000 shares of common stock at $14.90 per common share; $246,900, net of underwriting discounts and commissions,
from a public offering of $250,000 of 5.75% senior unsecured notes due 2010; $125,000 from its asset securitization facility; and
approximately $86,000 from its senior credit facility.
The final purchase price for the acquisition of Torrington was subject to adjustment upward or downward based on the differences for
both net working capital and net debt as of December 31, 2001 and February 15, 2003, both calculated in a manner as set forth in the
purchase agreement governing the acquisition. These adjustments were finalized in 2004 and did not have a material effect on the
company’s Consolidated Financial Statements.
42
THE TIMKEN COMPANY
198
Note 2 Acquisitions (continued)
The allocation of the purchase price was performed based on the assignment of fair values to assets acquired and liabilities assumed.
Fair values were based primarily on appraisals performed by an independent appraisal firm. Items that affected the ultimate purchase
price allocation included finalization of integration initiatives or plant rationalizations that qualified for accrual in the opening balance
sheet and other information that provided a better estimate of the fair value of assets acquired and liabilities assumed. In March 2003,
the company announced the planned closing of its plant in Darlington, England. This plant ceased manufacturing as of December 31,
2003. In July 2003, the company announced that it would close its plant in Rockford, Illinois. As of December 31, 2003, this plant
closed, and the fixed assets were either sold or scrapped. The building was sold during 2005. Prior to its sale, the building was
classified as an “asset held for sale” in other current assets on the Consolidated Balance Sheet. In October 2003, the company
reached an agreement with Roller Bearing Company of America, Inc. for the sale of the company’s airframe business, which included
certain assets at its Standard plant in Torrington, Connecticut. In connection with the Torrington integration efforts, the company
incurred severance, exit and other related costs of $22,602 for former Torrington associates, which were considered to be costs of
the acquisition and were included in the purchase price allocation. Severance, exit and other related costs associated with former
Timken associates were expensed during 2004 and 2003 and were not included in the purchase price allocation. Refer to Note 6 –
Impairment and Restructuring Charges for further discussion.
In accordance with FASB EITF Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” the
company recorded accruals for severance, exit and relocation costs in the purchase price allocation. A reconciliation of the beginning
and ending accrual balances is as follows:
Severance
Exit
Relocation
Add: additional accruals
Less: payments
$ 3,905
287
(1,871)
$ 2,325
6,560
(8,885)
$ 1,897
(570)
(1,327)
Less: accrual reversal
Less: payments
2,321
(350)
(619)
$ 1,352
-
-
$
$
Total
$
$
8,127
6,277
(12,083)
2,321
(350)
(619)
1,352
The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition.
Accounts receivable
Inventory
Property, plant and equipment
In-process research and development
Intangible assets subject to amortization – (12-year weighted average useful life)
Goodwill
Equity investment in needle bearing joint venture
Other non-current assets, including deferred taxes
Total Assets Acquired
$
177,227
210,194
4,418
429,014
1,800
91,642
56,909
146,335
36,451
$ 1,153,990
Accounts payable and other current liabilities
Non-current liabilities, including accrued postretirement benefit cost
Total Liabilities Assumed
$
Net Assets Acquired
$
192,689
96,212
288,901
$
865,089
THE TIMKEN COMPANY
43
199
Note 2 Acquisitions (continued)
There was no tax basis goodwill associated with the Torrington acquisition.
The $1,800 related to in-process research and development was written off at the date of acquisition in accordance with FASB
Interpretation No. 4, “Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method.” The
write-off is included in selling, administrative and general expenses in the Consolidated Statement of Income. The fair value assigned
to the in-process research and development was determined by an independent valuation using the discounted cash flow method.
In July 2003, the company sold to NSK Ltd. its interest in NTC, a needle bearing manufacturing venture in Japan that had been
operated by NSK and Torrington for $146,335 before taxes, which approximated the carrying value at the time of the sale.
The following unaudited pro forma financial information presents the combined results of operations of the company and Torrington
as if the acquisition had occurred at the beginning of 2003. The combined results of the company and Torrington are included in
the years ending December 31, 2005 and 2004 as presented in the Consolidated Statement of Income. The unaudited pro forma
financial information does 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.
Unaudited
Net sales
Net income
Earnings per share – assuming dilution:
$3,939,340
29,629
$ 0.36
Other Acquisitions in 2005 and 2004
The company purchased the assets of Bearing Inspection, Inc. (BII), a provider of bearing inspection, reconditioning and engineering
services during October 2005 for $42,367, including acquisition costs. The company acquired net assets of $36,399, including
$27,150 of amortizable intangible assets. The company also assumed liabilities with a fair value of $9,315. The excess of the
purchase price over the fair value of the net assets acquired was recorded as goodwill in the amount of $15,283. The results of the
operations of BII are included in the company’s Consolidated Statement of Income for the periods subsequent to the effective date of
the acquisition. Pro forma results of the operations are not presented because the effect of the acquisition is not significant.
During 2004, the company finalized several acquisitions. The total cost of these acquisitions amounted to $8,425. The purchase price
was allocated to the assets and liabilities acquired, based on their fair values at the dates of acquisition. The fair value of the assets
acquired was $5,513 in 2004 and the fair value of the liabilities assumed was $815. The excess of the purchase price over the fair
value of the net assets acquired was allocated to goodwill. The company’s Consolidated Statement of Income includes the results of
operations of the acquired businesses for the periods subsequent to the effective date of the acquisitions. Pro forma results of the
operations have not been presented because the effect of these acquisitions was not significant.
44
THE TIMKEN COMPANY
200
The following table sets forth the reconciliation of the numerator and the denominator of earnings per share and earnings per share assuming dilution for the years ended December 31:
Numerator:
Net income for earnings per share and earnings per share - assuming
dilution – income available to common shareholders
Denominator:
Denominator for earnings per share – weighted-average shares
Stock options and awards – based on the treasury stock method
Denominator for earnings per share - assuming dilution – adjusted
weighted-average shares
Earnings per share
2005
2004
2003
$ 260,281
$ 135,656
91,533,242
89,875,650
82,945,174
1,004,287
883,921
214,147
92,537,529
$ 2.84
$ 2.81
90,759,571
$ 1.51
$ 1.49
83,159,321
$ 0.44
$ 0.44
$
36,481
The exercise prices for certain stock options that the company has awarded exceed the average market price of the company’s
common stock. Such stock options are antidilutive and were not included in the computation of diluted earnings per share. The
antidilutive stock options outstanding were 596,800, 2,316,988 and 4,414,626 at December 31, 2005, 2004 and 2003, respectively.
Under the performance unit component of the company’s long-term incentive plan, the Compensation Committee of the Board of
Directors can elect to make payments that become due in the form of cash or shares of the company’s common stock. Refer to Note
9 – Stock Compensation Plans for additional discussion. Performance units granted, if fully earned, would represent 321,189 shares
of the company’s common stock at December 31, 2005. These performance units have not been included in the calculation of
dilutive securities.
Accumulated other comprehensive loss consists of the following:
2005
Foreign currency translation adjustment
Fair value of open foreign currency cash flow hedges
$
50,338
(374,355)
568
$ (323,449)
2004
$ 100,278
(387,750)
(2,014)
$ (289,486)
2003
$
(5,458)
(351,282)
(1,642)
$ (358,382)
In 2004, the company began the process of liquidating one of its inactive subsidiaries, British Timken, which is located in Duston,
England. The company recorded a non-cash charge of $16,186 on dissolution that related primarily to the transfer of cumulative
foreign currency translation losses to the Consolidated Statement of Income, which was included in other expense - net.
THE TIMKEN COMPANY
45
201
Variable-rate lines of credit for certain of the company’s European subsidiaries with
Variable-rate Ohio Water Development Authority revenue bonds for PEL
(3.59% and 2.07% at December 31, 2005 and 2004, respectively)
Other
Short-term debt
2005
2004
$
23,884
$ 109,260
$
23,000
11,491
5,062
63,437
23,000
11,561
13,596
$ 157,417
Refer to Note 7 – Contingencies and Note 12 – Equity Investments for a discussion of PEL’s debts, which are included above.
Fixed-rate Medium-Term Notes, Series A, due at various dates through
May 2028, with interest rates ranging from 6.20% to 7.76%
Variable-rate State of Ohio Air Quality and Water Development
Revenue Refunding Bonds, maturing on November 1, 2025
(3.68% at December 31, 2005)
Variable-rate State of Ohio Pollution Control Revenue Refunding
Bonds, maturing on June 1, 2033 (3.68% at December 31, 2005)
Variable-rate State of Ohio Water Development Revenue
Refunding Bonds, maturing on May 1, 2007 (3.58% at December 31, 2005)
Variable-rate State of Ohio Water Development Authority Solid Waste
Revenue Bonds, maturing on July 1, 2032 (3.62% at December 31, 2005)
Variable-rate Unsecured Canadian Note, maturing on December 22, 2010
(4.0% at December 31, 2005)
Other
Long-term debt
2005
2004
$ 286,474
$ 286,832
21,700
21,700
17,000
17,000
8,000
8,000
24,000
24,000
49,759
247,651
3,005
657,589
95,842
$ 561,747
249,258
15,117
621,907
1,273
$ 620,634
The maturities of long-term debt for the five years subsequent to December 31, 2005, are as follows: 2006–$95,842; 2007–$8,988;
2008–$17,202; 2009–$124; and 2010–$297,521.
Interest paid was approximately $52,000 in 2005, $52,000 in 2004 and $43,000 in 2003. This differs from interest expense due to
timing of payments and interest capitalized of $620 in 2005, $541 in 2004; and $0 in 2003. The weighted-average interest rate on
short-term debt during the year was 3.9% in 2005, 3.1% in 2004 and 4.1% in 2003. The weighted-average interest rate on short-term
debt outstanding at December 31, 2005 and 2004 was 4.9% and 3.4%, respectively.
In connection with the Torrington acquisition, the company entered into new $875 million senior credit facilities on December 31, 2002
with a syndicate of financial institutions, comprised of a five-year revolving credit facility of up to $500 million and a one-year term loan
facility of up to $375 million. The one-year term loan facility expired unused on February 18, 2003. The revolving facility replaced the
company’s then-existing senior credit facility. Proceeds of the senior credit facility were used to repay the amounts outstanding under
the then-existing credit facility.
46
THE TIMKEN COMPANY
202
Note 5 Financing Arrangements (continued)
On June 30, 2005, the company entered into a $500 million Amended and Restated Credit Agreement (Senior Credit Facility)
that replaced the company's previous credit agreement dated as of December 31, 2002. The Senior Credit Facility matures on
June 30, 2010. At December 31, 2005, the company had no outstanding borrowings under its $500 million Senior Credit Facility, and
letters of credit totaling $77.1 million, which reduced the availability under the Senior Credit Facility to $422.9 million. Under this Senior
Credit Facility, the company has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. At
December 31, 2005, the company was in full compliance with the covenants under the Senior Credit Facility and its other debt
agreements.
On December 19, 2002, the company entered into an Accounts Receivable Securitization financing, which provided for borrowings up
to $125 million, limited to certain borrowing base calculations, and is secured by certain trade receivables. On December 30, 2005, the
company entered into a new $200 million Accounts Receivable Securitization Financing Agreement (2005 Asset Securitization),
replacing the $125 million Asset Securitization Financing Agreement. The 2005 Asset Securitization provides for borrowings up to
$200 million, limited to certain borrowing base calculations, and is secured by certain domestic trade receivables of the company.
Under the terms of the 2005 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. Under the 2005 Asset Securitization,
the company also has the ability to issue letters of credit. As of December 31, 2005, 2004 and 2003, there were no amounts
outstanding under its receivables securitization facility.
Any amounts outstanding under this facility would be reported on the
company’s Consolidated Balance Sheet in short-term debt. 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 Statement of Income. This rate
was 4.59%, 2.57% and 1.56%, at December 31, 2005, 2004 and 2003, respectively.
In December 2005, the company entered into a $49.8 million unsecured loan in Canada. The principal balance of the loan is payable
in full in December 2010. The interest rate is variable based on the Canadian LIBOR rate and interest payments are due quarterly.
The company is also the guarantor of debt for PEL Technologies LLC (PEL), an equity investment of the company. A $23,494 letter of
credit was provided by the company to secure payment on Ohio Water Development Authority revenue bonds held by PEL. In case
of default by PEL, the company agrees to pay existing balances due as of the date of default. The letter of credit expires on July 22,
2006. Also, the company provided a guarantee for a $3,500 bank loan of PEL, which the company paid during 2004. During 2003, the
company recorded the amounts outstanding on the debts underlying the guarantees, which totaled $26,500 and approximated the fair
value of the guarantees. Refer to Note 12 – Equity Investments for additional discussion. In January 2006, the company repaid, in full,
the $23,000 balance outstanding of the revenue bonds held by PEL.
The lines of credit for certain of the company’s European subsidiaries provide for borrowings up to $171.7 million. At December 31,
2005, the company had borrowings outstanding of $24.1 million, which reduced the availability under these facilities to $147.6 million.
The company and its subsidiaries lease a variety of real property and equipment. Rent expense under operating leases amounted to
$27,919, $19,550, and $19,374 in 2005, 2004 and 2003, respectively. At December 31, 2005, future minimum lease payments for
noncancelable operating leases totaled $133,048 and are payable as follows: 2006–$27,682; 2007–$24,190; 2008–$19,491;
2009–$14,991; 2010–$13,862; and $32,832 thereafter.
THE TIMKEN COMPANY
47
203
Impairment and restructuring charges are comprised of the following:
2005
2004
2003
8.5
4.2
0.7
$ 13.4
$ 12.5
2.9
3.7
$ 19.1
Impairment charges
Exit costs
Total
$
$
0.8
20.3
5.0
26.1
$
In 2005, the company recorded approximately $20,319 of severance and related benefit costs and $2,800 of exit costs related to the
closure of manufacturing facilities in Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross,
Georgia. These closures are part of the restructuring plans for the Automotive Group announced in July 2005. These restructuring
efforts, along with other future actions, are targeted to deliver annual pretax savings of approximately $40,000 by the end of 2007,
with expected net workforce reductions of approximately 400 to 500 positions and pretax costs of approximately $80,000 to $90,000
by the end of 2007.
In addition, $770 of asset impairment and $2,239 of environmental exit costs were recorded in 2005 as a result of asset impairments
related to the rationalization of the company’s three bearing plants in Canton, Ohio within the Industrial Group. On September 15, 2005,
the company reached a new four-year agreement with the United Steelworkers of America, which went into effect on September 26,
2005, when the prior contract expired. This initiative is expected to deliver annual pretax savings of approximately $25,000 through
streamlining operations and workforce reductions, with costs of approximately $35,000 to $40,000 over the next four years.
In 2004, the impairment charge related primarily to the write-down of property, plant and equipment at one of the Steel Group’s
facilities based on the company’s estimate of its fair value. The severance and related benefit costs related to associates who exited
the company as a result of the integration of Torrington. The exit costs related primarily to facilities in the U.S.
In 2003, impairment charges represented the write-off of the remaining goodwill for the Steel Group in accordance with SFAS 142 of
$10,237 and impairment charges for the Columbus, Ohio plant of $2,220. The severance and related benefit costs of $2,928 related
to associates who exited the company as a result of the integration of Torrington and other actions taken by the company to reduce
costs. The exit costs were comprised of $3,065 for the Columbus, Ohio plant and $704 for the Duston, England plant as a result
of changes in estimates for these two projects. Manufacturing operations at Columbus and Duston ceased in 2001 and 2002,
respectively.
Auto
Steel
Industrial
Total
Impairment charges
Exit costs
Total
$
20.3
2.8
$ 23.1
$
$
0.8
2.2
3.0
$
$
-
$
0.8
20.3
5.0
$ 26.1
Steel
Total
Auto
Industrial
Impairment charges
Exit costs
Total
48
$
$
1.7
1.7
$
$
2.5
0.7
3.2
$
$
8.5
8.5
$
8.5
4.2
0.7
$ 13.4
THE TIMKEN COMPANY
204
Note 6 Impairment and Restructuring Charges (continued)
Auto
Steel
Total
2.3
2.2
3.0
7.5
$ 10.2
0.2
$ 10.4
$ 12.5
2.9
3.7
$ 19.1
2005
2004
2003
Industrial
Impairment charges
Exit costs
Total
$
$
0.5
0.7
1.2
$
$
The rollforward of restructuring accruals is as follows:
Expense
Payments
$
4.1
25.3
(3.4)
$ 26.0
$
4.5
4.9
(5.3)
$ 4.1
$
6.0
5.0
(6.5)
$ 4.5
7 Contingencies
The company and certain of its U.S. subsidiaries have been designated as potentially responsible parties (PRPs) by the United States
Environmental Protection Agency for site investigation and remediation under the Comprehensive Environmental Response,
Compensation and Liability Act (Superfund) with respect to certain sites. The claims for remediation have been asserted against
numerous other entities, which are believed to be financially solvent and are expected to fulfill their proportionate share of the
obligation. In addition, the company is subject to various lawsuits, claims and proceedings, which arise in the ordinary course of its
business. The company accrues costs associated with environmental and legal matters when they become probable and reasonably
estimable. Accruals are established based on the estimated undiscounted cash flows to settle the obligations and are not reduced by
any potential recoveries from insurance or other indemnification claims. Management believes that any ultimate liability with respect
to these actions, in excess of amounts provided, will not materially affect the company’s Consolidated Financial Statements.
The company is also the guarantor of debt for PEL Technologies LLC (PEL), an equity investment of the company. A $23,494 letter
of credit was provided by the company to secure payment on Ohio Water Development Authority revenue bonds held by PEL. In case
of default by PEL, the company has agreed to pay existing balances due as of the date of default. The letter of credit expires on July
22, 2006. Also, the company provided a guarantee for a $3,500 bank loan of PEL, which the company paid during 2004. During 2003,
the company recorded the amounts outstanding on the debts underlying the guarantees, which totaled $26,500 and approximated
the fair value of the guarantees. Refer to Note 12 – Equity Investments for additional discussion. In January 2006, the company repaid,
in full, the $23,000 balance outstanding of the revenue bonds held by PEL.
In connection with the Ashland, Ohio plant sale, the company entered into a four-year supply agreement with the buyer. The company
agreed to purchase a fixed amount of tooling each year ranging from $8,500 in the first year to $4,650 in year four or an aggregate
total of $25,900. The agreement also details the payment terms and penalties assessed if the buyer does not meet the company’s
performance standards as outlined. This agreement expires on June 30, 2006.
THE TIMKEN COMPANY
49
205
SFAS 142 requires that goodwill and indefinite-lived intangible assets be tested for impairment at least annually. The company
engages an independent valuation firm and performs its annual impairment test during the fourth quarter after the annual forecasting
process is completed. There was no impairment in 2005 or 2004.
In 2003, due to trends in the steel industry, the guideline company values for the Steel reporting unit were revised downward. The
valuation, which uses the guideline company method, resulted in a fair market value that was less than the carrying value for the
company’s Steel reporting unit. Accordingly, the company had concluded that the entire amount of goodwill for its Steel reporting
unit was impaired. The company recorded a pretax impairment loss of $10,200, which was reported in impairment and restructuring
charges.
Year ended December 31, 2005
Goodwill:
Industrial
Automotive
Total
Beginning
Balance
Acquisitions
$187,066
2,233
$189,299
$ 16,689
$ 16,689
Beginning
Balance
Acquisitions
Other
Ending
Balance
$171,283
1,816
$173,099
$ 13,774
$ 13,774
$ 2,009
417
$ 2,426
$187,066
2,233
$189,299
Other
$ (1,697)
(162)
$ (1,859)
Ending
Balance
$202,058
2,071
$204,129
Goodwill:
Industrial
Automotive
Total
50
THE TIMKEN COMPANY
206
Note 8 Goodwill and Other Intangible Assets (continued)
The following table displays other intangible assets as of December 31:
2005
2004
Gross
Carrying Accumulated
Amount Amortization
Intangible assets subject to amortization:
Industrial:
Know-how transfer
Patents
Technology use
Trademarks
PMA licenses
Automotive:
Land use rights
Patents
Technology use
Trademarks
Steel trademarks
Intangible assets not subject to amortization:
Goodwill
$ 27,339
2,000
1,065
1,328
4,823
1,729
7,370
2,212
$
2,333
1,349
412
467
787
931
2,127
168
Gross
Amount Amortization
Net
Carrying
Amount
$
25,006
651
653
861
4.036
798
5,243
2,044
$
15,209
2,000
486
963
5,548
1,507
7,200
1,412
$
1,398
880
431
242
333
626
1,350
63
Net
Carrying
Amount
$
13,811
1,120
55
721
5,215
881
5,850
1,349
21,960
3,000
6,762
18,997
5,736
2,225
11,055
894
$ 118,495
3,157
2,024
1,611
5,771
936
1,280
3,190
233
$ 26,776
18,803
976
5,151
13,226
4,800
945
7,865
661
$ 91,719
21,960
3,000
5,143
18,499
5,535
2,176
10,800
633
$ 102,071
2,059
1,320
1,296
3,673
333
897
2,025
126
$ 17,052
19,901
1,680
3,847
14,826
5,202
1,279
8,775
507
$ 85,019
$ 204,129
77,596
133
15,176
$ 297,034
$ 415,529
$
$ 204,129
77,596
133
15,176
$ 297,034
$ 388,753
$189,299
92,860
144
963
$283,266
$385,337
$
$189,299
92,860
144
963
$283,266
$368,285
$ 26,776
$ 17,052
Amortization expense for intangible assets was approximately $9,500 and $8,800 for the years ended December 31, 2005 and 2004
respectively, and is estimated to be approximately $8,900 annually for the next five years. The intangible assets subject to amortization acquired in the Torrington acquisition have useful lives ranging from 2 to 20 years with a weighted-average useful life of 12 years.
The intangible assets subject to amortization acquired in the Bearing Inspection, Inc. acquisition have useful lives ranging from 1 to 20
years with a weighted-average useful life of 19 years.
THE TIMKEN COMPANY
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207
Under the company’s long-term incentive plan, shares of common stock have been made available to grant at the discretion of the
Compensation Committee of the Board of Directors to officers and key associates in the form of stock options, stock appreciation
rights, restricted shares, performance units and deferred shares. In addition, shares can be awarded to directors not employed by the
company. The options have a ten-year term and vest in 25% increments annually beginning twelve months after the date of grant for
associates and vest 100% twelve months after the date of grant for directors. Pro forma information regarding net income and
earnings per share as required by SFAS 123 is included in Note 1 and has been determined as if the company had accounted for its
associate and director stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the
date of grant using a Black-Scholes option pricing model. For purposes of pro forma disclosures, the estimated fair value of the options
granted under the plan is amortized to expense over the options’ vesting periods.
Following are the related assumptions under the Black-Scholes method:
Assumptions:
Dividend yield
Expected life - years
2005
2004
2003
4.12%
3.28%
0.360
8
4.29%
3.65%
0.401
8
3.94%
3.69%
0.504
8
A summary of activity related to stock options for the above plans is as follows for the years ended December 31:
2005
Options
Outstanding - beginning of year
Granted
Exercised
Canceled or expired
Outstanding - end of year
Options exercisable
7,388,910
748,675
(2,510,376)
(187,296)
5,439,913
3,286,950
2004
WeightedAverage
Exercise Price
$21.50
25.50
19.28
30.06
22.78
$23.09
Options
8,334,920
702,250
(1,436,722)
(211,538)
7,388,910
5,081,063
2003
WeightedAverage
Exercise Price
$20.68
23.94
17.39
25.13
21.50
$21.95
Options
WeightedAverage
Exercise Price
7,310,026
1,491,230
(93,325)
(373,011)
8,334,920
5,771,810
$21.21
17.56
15.65
20.02
20.68
$21.53
The company has issued performance target options that vest contingent upon the company’s common shares reaching
specified fair market values. The number of performance target options awarded was zero, 25,000 and zero in 2005, 2004 and 2003,
respectively. Compensation expense under these plans was $3,500, $0 and $0 in 2005, 2004 and 2003, respectively.
Exercise prices for options outstanding as of December 31, 2005 range from $15.02 to $19.56; $21.99 to $26.44; and $28.30 to
$33.75. The number of options outstanding at December 31, 2005 that correspond to these ranges are 2,215,266; 2,615,897 and
608,750, respectively; and the number of options exercisable at December 31, 2005 that correspond to these ranges are 1,468,711;
1,240,739 and 577,500, respectively. The weighted-average remaining contractual life of these options is six years. The estimated
weighted-average fair values of stock options granted during 2005, 2004 and 2003 were $7.97, $7.82 and $6.78, respectively.
At December 31, 2005, a total of 755,290 deferred shares, deferred dividend credits, restricted shares and director common
shares have been awarded and are not vested. The company distributed 146,250, 73,025 and 125,967 shares in 2005, 2004 and 2003,
respectively, as a result of these awards. The shares awarded in 2005, 2004 and 2003 totaled 413,267, 371,650 and 38,500,
respectively.
The company offers a performance unit component under its long-term incentive plan to certain employees in which awards are
earned based on company performance measured by several metrics over a three-year performance period. The Compensation
Committee of the Board of Directors can elect to make payments that become due in the form of cash or shares of the company’s
common stock. 40,739, 34,398 and 48,225 performance units were granted in 2005, 2004, and 2003, respectively. 16,592 performance units were cancelled in 2005. Each performance unit has a cash value of $100.
The number of shares available for future grants for all plans at December 31, 2005 is 4,412,863.
52
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208
As a result of its worldwide operating activities, the company is exposed to changes in foreign currency exchange rates, which affect
its results of operations and financial condition. The company and certain subsidiaries enter into forward exchange contracts to
manage exposure to currency rate fluctuations, primarily related to anticipated purchases of inventory and equipment. At
December 31, 2005 and 2004, the company had forward foreign exchange contracts, all having maturities of less than eighteen
months, with notional amounts of $238,378 and $130,794, respectively, and fair values of a $2,691 asset and ($8,575) liability,
respectively. The forward foreign exchange contracts were entered into primarily by the company’s domestic entity to manage Euro
exposures relative to the U.S. dollar and by its European subsidiaries to manage Euro and U.S. dollar exposures. The realized and
unrealized gains and losses on these contracts are deferred and included in inventory or property, plant and equipment, depending on
the transaction. These deferred gains and losses are reclassified from accumulated other comprehensive loss and recognized in
earnings when the future transactions occur, or through depreciation expense.
During 2004, the company entered into interest rate swaps with a total notional value of $80,000 to hedge a portion of its fixed-rate
debt. Under the terms of the interest rate swaps, the company receives interest at fixed rates and pays interest at variable rates. The
maturity dates of the interest rate swaps are January 15, 2008 and February 15, 2010. The fair value of these swaps were $2,875 and
$909 at December 31, 2005 and 2004 respectively, and were included in other non-current liabilities. The critical terms, such as
principal and notional amounts and debt maturity and swap termination dates, coincide resulting in no hedge ineffectiveness. These
instruments are designated and qualify as fair value hedges. Accordingly, the gain or loss on both the hedging instrument and the
hedged item attributable to the hedged risk are recognized currently in earnings.
The carrying value of cash and cash equivalents, accounts receivable, commercial paper, short-term borrowings and accounts payable
are a reasonable estimate of their fair value due to the short-term nature of these instruments. The fair value of the company's
long-term fixed-rate debt, based on quoted market prices, was $525,000 and $549,000 at December 31, 2005 and 2004,
respectively. The carrying value of this debt at such dates was $538,000 and $539,000 respectively.
The company performs research and development under company-funded programs and under contracts with the Federal
government and others. Expenditures committed to research and development amounted to $60,100, $56,700 and $54,500 for 2005,
2004 and 2003, respectively. Of these amounts, $7,200, $6,700 and $2,100, respectively, were funded by others. Expenditures may
fluctuate from year to year depending on special projects and needs.
THE TIMKEN COMPANY
53
209
Consolidated Balance Sheet, which were approximately $19,900 and $29,800 at December 31, 2005 and 2004, respectively. In 2005,
the company sold a joint venture, NRB Bearings, based in India.
Equity investments are reviewed for impairment when circumstances (such as lower-than-expected financial performance or change
in strategic direction) indicate that the carrying value of the investment may not be recoverable. If impairment does exist, the equity
investment is written down to its fair value with a corresponding charge to the Consolidated Statement of Income. No impairments
were recorded during 2005 relating to the company’s equity investments.
During 2000, the company’s Steel Group invested in a joint venture, PEL, to commercialize a proprietary technology that converts iron
units into engineered iron oxides for use in pigments, coatings and abrasives. In the fourth quarter of 2003, the company concluded
its investment in PEL was impaired due to the following indicators of impairment: history of negative cash flow and losses; 2004
operating plan with continued losses and negative cash flow; and the continued required support from the company or another party.
In the fourth quarter of 2003, the company recorded a non-cash impairment loss of $45,700, which is reported in other expense-net
on the Consolidated Statement of Income.
The company concluded that PEL was a variable interest entity and that the company is the primary beneficiary. In accordance with
FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51,” (FIN
46), the company consolidated PEL effective March 31, 2004. The adoption of FIN 46 resulted in a charge, representing the cumulative effect of change in accounting principle, of $948, which is reported in other expense-net on the Consolidated Statement of
Income. Also, the adoption of FIN 46 increased the Consolidated Balance Sheet as follows: current assets by $1,659; property, plant
and equipment by $11,333; short-term debt by $11,561; accounts payable and other liabilities by $659; and other non-current liabilities
by $1,720. All of PEL’s assets are collateral for its obligations. Except for PEL’s indebtedness for which the company is a
guarantor, PEL’s creditors have no recourse to the general credit of the company. In January 2006, the company repaid, in full, the
$23,000 balance outstanding of the revenue bonds held by PEL.
The company sponsors defined contribution retirement and savings plans covering substantially all associates in the United States and
certain salaried associates at non-U.S. locations. The company contributes shares of the company’s common stock to certain plans based
on formulas established in the respective plan agreements. At December 31, 2005, the plans had 11,498,085 shares of the company’s
common stock with a fair value of $368,169. Company contributions to the plans, including performance sharing, amounted to $25,801
in 2005, $22,801 in 2004 and $21,029 in 2003. The company paid dividends totaling $7,224 in 2005; $6,467 in 2004 and $6,763 in 2003,
to plans holding shares of the company’s common stock.
The company and its subsidiaries sponsor several unfunded postretirement plans that provide health care and life insurance benefits for
eligible retirees and dependents. Depending on retirement date and associate classification, certain health care plans contain contributions
and cost-sharing features such as deductibles and coinsurance. The remaining health care and life insurance plans are noncontributory.
The company and its subsidiaries sponsor a number of defined benefit pension plans, which cover eligible associates. The cash
contributions for the company’s defined benefit pension plans were $238,089 and $196,951 in 2005 and 2004, respectively.
During 2003, the company made revisions, which became effective on January 1, 2004, to certain of its benefit programs for its
U.S.-based employees, resulting in a pretax curtailment gain of $10,720. Depending on an associate’s combined age and years of service
with the company, defined benefit pension plan benefits were reduced or replaced by a new defined contribution plan. The company will
no longer subsidize retiree medical coverage for those associates who did not meet a threshold of combined age and years of service
with the company as of December 31, 2003.
54
THE TIMKEN COMPANY
210
Note 13 Retirement and Postretirement Benefit Plans (continued)
The company uses a measurement date of December 31 to determine pension and other postretirement benefit measurements for
the pension plans and other postretirement benefit plans.
The following tables set forth the change in benefit obligation, change in plan assets, funded status and amounts recognized in the
Consolidated Balance Sheet of the defined benefit pension and postretirement benefits as of December 31, 2005 and 2004:
Defined Benefit
Pension Plans
2005
2004
2005
2004
$ 820,595
5,501
45,847
25,717
(32,662)
117
8,141
(52,010)
$ 821,246
$ 802,218
5,751
48,807
2
14,890
222
(51,295)
$ 820,595
Service cost
Interest cost
Amendments
Actuarial losses (gains)
Curtailment loss
Benefits paid
$ 2,586,146
40,049
152,265
4,730
188,962
993
(38,588)
729
(163,613)
$ 2,771,673
$2,337,722
37,112
145,880
1,258
197,242
962
25,953
(159,983)
$2,586,146
Change in plan assets(1)
Benefits paid
$ 1,840,866
210,234
993
238,089
(24,216)
(161,791)
$ 2,104,175
$1,548,142
234,374
962
196,951
17,823
(157,386)
$1,840,866
Funded status
Projected benefit obligation in excess of plan assets
Prepaid (accrued) benefit cost
$ (667,498)
812,353
(500)
88,059
$ 232,414
$ (745,280)
739,079
(598)
95,820
$ 89,021
$ (821,246)
254,307
(2,361)
$ (569,300)
$ (820,595)
303,244
(33,016)
$ (550,367)
$ (406,875)
77,595
$ (603,644)
92,860
$ (569,300)
-
$ (550,367)
-
599,805
89,021
$ (569,300)
$ (550,367)
Amounts recognized in the Consolidated Balance Sheet
Accrued benefit liability
Intangible asset
Minimum pension liability included in accumulated
other comprehensive loss
Net amount recognized
(1)
$
561,694
232,414
$
The current portion of accrued pension cost, which is included in salaries, wages and benefits on the Consolidated Balance Sheet, was
$160,200 and $135,000 at December 31, 2005 and 2004, respectively. The current portion of accrued postretirement benefit cost,
which is included in salaries, wages and benefits on the Consolidated Balance Sheet, was $55,500 and $60,000 at December 31, 2005
and 2004, respectively.
THE TIMKEN COMPANY
55
211
In 2005, investment performance and company contributions increased the company’s pension fund asset values. At the same time,
the company’s defined benefit pension liability also increased as a result of lowering the discount rate from 6.0% to 5.875%.
The accumulated benefit obligations at December 31, 2005 exceeded the market value of plan assets for the majority of the
company’s plans.
For these plans, the projected benefit obligation was $2,219,000; the accumulated benefit obligation was
$2,134,000; and the fair value of plan assets was $1,593,000 at December 31, 2005.
In 2005, as a result of increased contributions to the company’s defined benefit pension plans, the company recorded a reduction in
the minimum pension liability of $38,111 and a non-cash after tax benefit to accumulated other comprehensive loss of $13,395.
For 2006 expense, the company’s discount rate has been reduced from 6.0% to 5.875%. This change will result in an increase in
2006 pretax pension expense of approximately $2,400.
On September 10, 2002, the company issued 3,000,000 shares of its common stock to The Timken Company Collective Investment
Trust for Retirement Trusts (Trust) as a contribution to three company-sponsored pension plans. The fair market value of the 3,000,000
shares of common stock contributed to the Trust was approximately $54,500, which consisted of 2,766,955 shares of the company’s
treasury stock and 233,045 shares issued from authorized common stock. As of December 31, 2004, the company’s defined benefit
pension plans held 1,313,000 common shares with fair value of $34,164. The company paid dividends totaling $927 in 2004 to plans
holding common shares. In early 2005, the remaining common shares were sold. As of December 31, 2005, the company’s defined
benefit pension plans did not hold a material amount of shares of the company’s common stock.
The following table summarizes the assumptions used by the consulting actuary and the related benefit cost information:
Pension Benefits
2005
Assumptions
Discount rate
Expected long-term return on plan assets
Components of net periodic benefit cost
Service cost
Interest cost
Curtailment loss (gain)
2004
2003
2005
2004
2003
5.875%
6.00%
3% to 4% 3% to 4%
8.75%
8.75%
6.30%
3% to 4%
8.75%
5.875%
6.00%
6.30%
5,501
45,847
(4,446)
16,275
7,649
$ 70,826
$ 5,751
48,807
(4,683)
17,628
$ 67,503
$ 6,765
49,459
(5,700)
14,997
(8,856)
$ 56,665
$ 40,049
152,265
(153,493)
12,513
49,902
900
(118)
$102,018
$ 37,112
145,880
(146,199)
15,137
33,075
(106)
$ 84,899
$ 47,381
137,242
(133,474)
18,506
19,197
560
(574)
$ 88,838
$
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 9.0% for 2006, declining gradually to 5.0% in 2010 and thereafter; and 12.0% for 2006, declining
gradually to 6.0% in 2014 and thereafter for prescription drug benefits.
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 increase the 2005 total service and interest cost components by $1,413 and would
increase the postretirement benefit obligation by $25,836. A one percentage point decrease would provide corresponding reductions
of $1,312 and $23,836, respectively.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Medicare Act) was signed into law on December
8, 2003. The Medicare Act provides for prescription drug benefits under Medicare Part D and contains a subsidy to plan sponsors
who provide “actuarially equivalent” prescription plans. In May 2004, the FASB issued FASB Staff Position No. FAS 106-2,
“Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”
(FSP 106-2).
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THE TIMKEN COMPANY
212
During 2005, the company’s actuary determined that the prescription drug benefit provided by the company’s postretirement plan is
considered to be actuarially equivalent to the benefit provided under the Medicare Act. In accordance with FSP 106-2, all measures
of the accumulated postretirement benefit obligation or net periodic postretirement benefit cost in the financial statements or
accompanying notes reflect the effects of the Medicare Act on the plan for the entire fiscal year.
For the year 2005, the effect on the accumulated postretirement benefit obligation attributed to past service as of January 1, 2005 is
a reduction of $73,500 and the effect on the amortization of actuarial losses, service cost, and interest cost components of net
periodic benefit cost is a reduction of $9,189. No Medicare cash subsidies were received in 2005.
Plan Assets:
The company’s pension asset allocation at December 31, 2005 and 2004, and target allocation are as follows:
Current Target
Allocation
Percentage of Pension Plan
Assets at December 31
2006
Asset Category
Equity securities
Debt securities
Total
60% to 70%
30% to 40%
100%
2005
2004
67%
33%
100%
68%
32%
100%
The company recognizes its overall responsibility to ensure that the assets of its various pension plans are managed effectively and
prudently and in compliance with its policy guidelines and all applicable laws. Preservation of capital is important; however, the
company also recognizes that appropriate levels of risk are necessary to allow its investment managers to achieve satisfactory
long-term results consistent with the objectives and the fiduciary character of the pension funds. Asset allocation is established in a
manner consistent with projected plan liabilities, benefit payments and expected rates of return for various asset classes. The
expected rate of return for the investment portfolio is based on expected rates of return for various asset classes as well as
historical asset class and fund performance.
Cash Flows:
2004
2005
2006 (expected)
$ 196,951
$ 238,089
$ 160,200
Benefit Payments
Pension Benefits
Gross
2006
2007
2008
2009
2010
2011-2015
$
$
$
$
$
$
167,656
171,116
174,474
177,916
176,982
926,217
$ 62,641
$ 66,459
$ 68,811
$ 70,830
$ 70,814
$ 330,463
$
$
$
$
$
$
Expected
Medicare
Subsidies
Net Including
Medicare
Subsidies
3,347
3,502
3,933
4,351
4,771
26,235
$ 59,294
$ 62,957
$ 64,878
$ 66,479
$ 66,043
$ 304,228
The pension accumulated benefit obligation was $2,638,920 and $2,451,345 at December 31, 2005 and 2004, respectively.
THE TIMKEN COMPANY
57
213
The company’s reportable segments are business units that target different industry segments. Each reportable segment is managed
separately because of the need to specifically address customer needs in these different industries. The company has three reportable
segments: Industrial Group, Automotive Group and Steel Group.
The Industrial Group includes sales of bearings and other products and services (other than steel) to a diverse customer base,
including: industrial equipment, off-highway, rail and aerospace and defense customers. The Industrial Group also includes aftermarket distribution operations, including automotive applications, for products other than steel. The Automotive Group includes sales of
bearings and other products and services (other than steel) to automotive original equipment manufacturers for passenger cars, trucks
and trailers. The company’s bearing products are used in a variety of products and applications, including passenger cars, trucks,
locomotive and railroad cars, machine tools, rolling mills, farm and construction equipment, aircraft, missile guidance systems,
computer peripherals and medical instruments.
The Steel Group includes sales of low and intermediate alloy, vacuum-processed alloys, tool steel and some carbon grades. These are
available in a wide range of solid and tubular sections with a variety of finishes. The company also manufactures custom-made steel
products, including precision steel components. Approximately 10% of the company’s steel is consumed in its bearing operations. In
addition, sales are made to other anti-friction bearing companies and to aircraft, automotive, forging, tooling, oil and gas drilling
industries and steel service centers. Tool steels are sold through the company’s distribution facilities.
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 charges, rationalization and integration costs, one-time gains
or losses on sales of assets, allocated receipts or payments made under the CDSOA, loss on dissolution of subsidiary, acquisitionrelated currency exchange gains, and other items similar in nature). The accounting policies of the reportable segments are the same
as those described in the summary of significant accounting policies. Intersegment sales and transfers are recorded at values based
on market prices, which creates intercompany profit on intersegment sales or transfers that is eliminated in consolidation.
Prior to 2004, the company reported net sales by geographic area based on the location of its selling subsidiary. Beginning in 2004,
the company changed its reporting of net sales by geographic area to be more reflective of how the company operates its segments,
which is by the destination of net sales. Net sales by geographic area for 2003 have been reclassified to conform to the 2005 and 2004
presentation. Non-current assets by geographic area are reported by the location of the subsidiary.
United
States
Europe
Other
Countries
Consolidated
2005
Net sales
Non-current assets
$ 3,619,432
1,494,780
$ 821,472
337,657
$ 727,530
177,988
$ 5,168,434
2,010,425
2004
Net sales
Non-current assets
$ 3,114,138
1,483,674
$ 784,778
398,925
$ 614,755
221,112
$ 4,513,671
2,103,711
2003
Net sales
Non-current assets
$ 2,673,007
1,753,221
$ 648,412
365,969
$ 466,678
193,494
$ 3,788,097
2,312,684
58
THE TIMKEN COMPANY
214
Note 14 Segment Information (continued)
2005
2004
2003
$ 1,925,211
1,847
73,278
199,936
87,932
1,712,487
$ 1,709,770
1,437
71,352
177,913
49,721
1,682,589
$1,498,832
837
61,018
128,031
33,724
1,617,898
$ 1,661,048
85,345
(19,886)
100,369
1,267,479
$ 1,582,226
78,100
15,919
73,926
1,282,954
$1,396,104
82,958
15,685
71,294
1,180,537
$ 1,582,175
178,157
59,436
219,780
37,236
1,013,768
$ 1,221,675
161,941
59,979
54,756
23,907
977,366
$ 893,161
133,356
64,875
(6,043)
24,297
891,354
$ 5,168,434
218,059
399,830
225,537
3,993,734
$ 4,513,671
209,431
248,588
147,554
3,942,909
$ 3,788,097
208,851
137,673
129,315
3,689,789
$
$ 248,588
(13,434)
(27,025)
190
44,429
(948)
(719)
(50,834)
1,397
(1,865)
$ 199,779
$ 137,673
(19,154)
(33,913)
1,996
65,559
1,696
(45,730)
(48,401)
1,123
(47)
$
60,802
Industrial Group
Intersegment sales
EBIT, as adjusted
Automotive Group
EBIT (loss) as adjusted
Steel Group
Intersegment sales
EBIT (loss), as adjusted
Total
EBIT, as adjusted
Reconciliation to Income Before Income Taxes
Rationalization and integration charges
Gain on sale of non-strategic assets, net of dissolution of subsidiary
CDSOA net receipts, net of expenses
Acquisition-related unrealized currency exchange gains
Impairment charge for investment in PEL
Other
Interest expense
Interest income
399,830
(26,093)
(17,270)
8,547
77,069
-
$
(194)
(51,585)
3,437
(3,195)
390,546
THE TIMKEN COMPANY
59
215
15 Income Taxes
Income before income taxes, based on geographic location of the operation to which such earnings are attributable, is provided below.
As the company has elected to treat certain foreign subsidiaries as branches for U.S. income tax purposes, pretax income attributable to the U.S. shown below may differ from the pretax income reported on the company’s annual U.S. Federal income tax return.
United States
Non-United States
2005
2004
2003
$236,831
153,715
$ 390,546
$ 165,392
34,387
$ 199,779
$ 53,560
7,242
$ 60,802
$ 25,407
1,305
24,778
51,490
$ (12,976)
4,078
10,982
2,084
$
83,032
1,715
(5,972)
78,775
$130,265
53,646
1,063
7,330
62,039
$ 64,123
48
1,271
3,087
4,406
$ 24,321
The provision for income taxes consisted of the following:
Current:
Federal
State and local
Foreign
Deferred:
Federal
State and local
Foreign
United States and foreign taxes on income
1,020
18,895
19,915
The company made income tax payments of approximately $23,600, $49,800 and $13,800 in 2005, 2004 and 2003,
respectively.
Following is the reconciliation between the provision for income taxes and the amount computed by applying U.S. Federal
income tax rate of 35% to income before taxes:
Income tax at the statutory federal rate
Adjustments:
Tax holidays and foreign earnings taxes at different rates
Benefits related to U.S. exports
Accrual of tax-free Medicare subsidy
Accruals and settlements related to tax audits
Other items (net)
60
2005
2004
2003
$136,691
$ 69,922
$ 21,281
1,963
16,124
1,365
(8,515)
(2,399)
(9,971)
(3,216)
4,001
(5,778)
$130,265
33.4%
3,342
4,164
28,630
(10,628)
(2,013)
(2,308)
(1,452)
(12,673)
(11,954)
(907)
$ 64,123 $
32.1%
1,489
3,027
8,866
(4,990)
(1,975)
(8,626)
500
4,749
24,321
40%
THE TIMKEN COMPANY
216
Note 15 Income Taxes (continued)
In connection with various investment arrangements, the company has a “holiday” from income taxes in the Czech Republic and
China. These agreements were new to the company in 2003 and expire in 2010 and 2007, respectively. In total, the agreements
reduced income tax expenses by $4,300 in 2005, $4,500 in 2004 and $2,200 in 2003. These savings resulted in an increase to
earnings per diluted share of $0.05 in 2005, $0.05 in 2004 and $0.03 in 2003.
The company plans to reinvest undistributed earnings of all non-U.S. subsidiaries, which amounted to approximately $152,000 at
December 31, 2005. Accordingly, U.S. income taxes have not been provided on such earnings. If these earnings were repatriated,
additional tax expense of approximately $52,000 would be incurred.
On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the Act). The Act created a temporary
incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received
deduction for certain dividends from foreign subsidiaries. During 2005, the company repatriated $118,800 under the Act. This amount
consisted of dividends, previously taxed income and returns of capital, and resulted in income tax expense of $11,700. The Act also
contains a provision to gradually eliminate the benefits received by extraterritorial income exclusion for U.S. exports.
For 2005, 80% of the benefit is allowed, decreasing to 60% in 2006 and zero in 2007 and thereafter. Additionally, the Act contains a
provision that enables companies to deduct a percentage (3% in 2005, increasing to 9% in 2010) of the taxable income derived from
qualified domestic manufacturing operations. Due to its net operating loss position in the U.S., the company did not receive any
benefit from the manufacturing deduction in 2005. However, it expects to start recognizing these benefits in 2006.
The effect of temporary differences giving rise to deferred tax assets and liabilities at December 31, 2005 and 2004 were as
follows:
Inventory
Benefit accruals
Other–net
Valuation allowance
Deferred tax liability – depreciation and amortization
2005
2004
$ 217,478
52,369
25,227
18,885
172,509
44,821
(171,357)
359,932
(296,873)
$ 63,059
$198,210
166,525
32,634
14,479
216,869
12,500
(175,398)
465,819
(298,918)
$166,901
The company has U.S. loss carryforwards with tax benefits totaling $44,300. These losses will start to expire in 2007. In addition, the
company has loss carryforwards in various foreign jurisdictions with tax benefits totaling $108,800 having various expiration dates, and
state and local carryforwards with tax benefits of $8,300, which will begin to expire in 2006. The company has provided valuation
allowances of $147,500 against certain of these carryforwards. The company has provided valuation allowances of $23,900 against
deferred tax assets other than tax losses and credit carryforwards. The company has U.S. research tax credit carryforwards of $3,400
and alternative minimum tax credit carryforwards of $7,700. The research tax credits will begin to expire in 2019; the AMT credits
may be carried forward indefinitely.
The calculation of the company’s provision for income taxes involves the interpretation of complex tax laws and regulations. Tax
benefits for certain items are not recognized, unless it is probable that the company’s position will be sustained if challenged by tax
authorities. Tax liabilities for other items are recognized for anticipated tax contingencies based on the company’s estimate of whether,
and the extent to which, additional taxes will be due.
61
THE TIMKEN COMPANY
217
(Unaudited)
Net
Sales
Gross
Profit
Impairment &
Restructuring
Net
Income
Earnings per Share(1)
Basic
Diluted
Dividends
Per Share
2005
Q1
Q2
Q3
Q4
$
$
2004
Q1
Q2
Q3
Q4
$
$
1,304,540
1,324,678
1,258,133
1,281,083
5,168,434
$
271,850
276,812
252,411
257,648
$ 1,058,721
$
1,098,785
1,130,287
1,096,724
1,187,875
4,513,671
$
$
$
202,523
205,587
184,045
246,430
838,585
$
$
(44)
24,451
1,686
26,093
$
58,235
67,334
39,831
94,881(2)
$ 260,281
$0.64
0.74
0.43
1.03
$2.84
$0.63
0.73
0.43
1.01
$2.81
$0.15
0.15
0.15
0.15
$0.60
730
329
2,939
9,436
13,434
$
$0.32
0.28
0.19
0.71
$1.51
$0.32
0.28
0.19
0.71
$1.49
$0.13
0.13
0.13
0.13
$0.52
28,470
25,341
17,463
64,382(2)(3)
$ 135,656
Annual earnings per share do not equal the sum of the individual quarters due to differences in the average number of shares
outstanding during the respective periods.
(2)
Includes receipt (net of expenses) of $77.1 million and $44.4 million in 2005 and 2004, resulting from the U.S. Continued Dumping
and Subsidy Offset Act.
(3)
Includes $17.1 million for the gain in non-strategic assets and $16.2 million for the loss on dissolution of a subsidiary.
(1)
62
THE TIMKEN COMPANY
218
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
As of the end of the period covered by this report, the company’s management carried out an evaluation, under the supervision
and with the participation of 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 as defined to Exchange Act Rule 13a-15(e). 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 the end of the period covered by this report.
There have been no changes in the company's internal control over financial reporting that have materially affected, or are reasonably
likely to materially affect, the company's internal control over financial reporting during the company's fourth quarter of 2005.
Report of Management on Internal Control Over Financial Reporting
reporting for the company. Timken's internal control system was designed to provide reasonable assurance regarding the preparation
and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may
not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures
may deteriorate.
Timken management assessed the effectiveness of the company's internal control over financial reporting as of December 31, 2005.
In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). Based on management’s assessment under COSO’s “Internal Control-Integrated Framework,” management believes that,
as of December 31, 2005, Timken’s internal control over financial reporting is effective.
Ernst & Young LLP, independent registered public accounting firm, has issued an audit report on management’s assessment of
Timken’s internal control over financial reporting as of December 31, 2005.
James W. Griffith, President and Chief Executive Officer of Timken, has certified to the New York Stock Exchange that he is not aware
of any violation by Timken of New York Stock Exchange corporate governance standards.
Section 302 of the Sarbanes-Oxley Act of 2002 requires Timken’s principal executive officer and principal financial officer to file certain
certifications with the Securities and Exchange Commission relating to the quality of Timken’s public disclosures. These certifications
are filed as exhibits to this report.
THE TIMKEN COMPANY
63
219
We have audited management’s assessment, including the accompanying Report of Management on Internal Control Over Financial
Reporting, that The Timken Company maintained effective internal control over financial reporting as of December 31, 2005, based
on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). The Timken Company’s management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides
a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of
the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being
made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that The Timken Company maintained effective internal control over financial reporting as
of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, The Timken Company
maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO
criteria.
consolidated balance sheets of The Timken Company as of December 31, 2005 and 2004, and the related consolidated statements
of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005 of The Timken
Company and our report dated February 24, 2006 expressed an unqualified opinion thereon.
Cleveland, Ohio
February 24, 2006
Item 9B. Other Information
Not applicable.
64
THE TIMKEN COMPANY
220
Forward Looking Statements
Certain statements set forth in this document and in the company’s 2005 Annual Report to Shareholders (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. In particular, Management’s Discussion and Analysis on pages 17 through 35 contain numerous forward-looking statements. 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 important factors, such as:
a) 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;
b) 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 the rapid improvements in the industrial market, 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;
c) 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;
d) 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; higher cost and availability of raw materials and energy; the company's ability to
mitigate the impact of higher material costs through surcharges and/or price increases; changes resulting from inventory
management and cost reduction initiatives and different levels of customer demands; the effects of unplanned work stoppages; and
changes in the cost of labor and benefits;
e) the success of the company's operating plans, including its ability to achieve the benefits from its ongoing continuous improvement
and rationalization programs; the ability of acquired companies to achieve satisfactory operating results; and the company's ability
to maintain appropriate relations with unions that represent company associates in certain locations in order to avoid disruptions of
business;
f) 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;
g) 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; and
h) those items identified under Item 1A, Risk Factors on pages 8 through 11.
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 forwardlooking statement, whether as a result of new information, future events or otherwise.
THE TIMKEN COMPANY
65
221
PART III
Item 10. Directors and Executive Officers of the Registrant
Required information is set forth under the captions "Election of Directors" on Pages 4-7 and "Section 16(a) Beneficial Ownership
Report Compliance" on Page 27 of the proxy statement filed in connection with the annual meeting of shareholders to be held April
18, 2006, and is incorporated herein by reference. Information regarding the executive officers of the registrant is included in Part I
hereof. Information regarding the company's Audit Committee and its Audit Committee Financial Expert is set forth on page 8 of the
proxy statement filed in connection with the annual meeting of shareholders to be held April 18, 2006, and is incorporated herein by
reference.
The General Policies and Procedures of the Board of Directors of the company and the charters of its Audit Committee, Compensation
Committee and Nominating and Governance Committee are also available on its website at www.timken.com and are available to any
shareholder upon request to the Corporate Secretary. The information on the company's website is not incorporated by reference into
this Annual Report on Form 10-K.
The company has adopted a code of ethics that applies to all of its employees, including its principal executive officer, principal
financial officer and principal accounting officer, as well as its directors. The company's code of ethics, The Timken Company
Standards of Business Ethics Policy, is available on its website at www.timken.com.
The company intends to disclose any
amendment to, or waiver from, its code of ethics by posting such amendment or waiver, as applicable, on its website.
Item 11. Executive Compensation
Required information is set forth under the captions "Executive Compensation" on Pages 13-24 of the proxy statement filed in
connection with the annual meeting of shareholders to be held April 18, 2006, and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Required information, including with respect to institutional investors owning more than 5% of the company's Common Stock, is set
forth under the caption "Beneficial Ownership of Common Stock" on Pages 11-12 of the proxy statement filed in connection with the
annual meeting of shareholders to be held April 18, 2006, and is incorporated herein by reference.
Required information is set forth under the caption "Equity Compensation Plan Information" on Page 18 of the proxy statement filed in
connection with the annual meeting of shareholders to be held April 18, 2006, and is incorporated by reference.
Item 13. Certain Relationships and Related Transactions
Required information is set forth under the caption "Election of Directors" on Pages 4-7 of the proxy statement issued in connection
with the annual meeting of shareholders to be held April 18, 2006, and is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
Required information regarding fees paid to and services provided by the company's independent auditor during the years ended
December 31, 2005 and 2004 and the pre-approval policies and procedures of the Audit Committee of the company's Board of
Directors is set forth on Page 26 of the proxy statement issued in connection with the annual meeting of shareholders to be held April
18, 2006, and is incorporated herein by reference.
66
THE TIMKEN COMPANY
222
We have audited the accompanying consolidated balance sheets of The Timken Company and subsidiaries as of December 31, 2005
and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These
financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion
on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of
The Timken Company and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their
cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted
accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
effectiveness of The Timken Company's internal control over financial reporting as of December 31, 2005, based on criteria
established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 24, 2006 expressed an unqualified opinion thereon.
Cleveland, Ohio
February 24, 2006
76
THE TIMKEN COMPANY
223
Shareholder Information
Corporate Offices
Transfer Agent and Registrar
The Timken Company
1835 Dueber Ave., S.W.
National City Bank Shareholder Services
P.O. Box 92301
Cleveland, Ohio 44193-0900
www.nationalcitystocktransfer.com
Telephone: 330-438-3000
Web site: www.timken.com
Stock Listing
Timken stock is traded on the New York
Stock Exchange under the symbol TKR.
Annual Meeting of Shareholders
April 18, 2006, 10 a.m., Timken Corporate
Offices.
Please direct meeting inquiries to
Scott Scherff, Corporate Secretary and
Assistant General Counsel, at 330-471-4226.
Dividends on common stock are generally
payable in March, June, September and
December.
The Timken Company offers an open
enrollment dividend reinvestment and stock
purchase plan through its transfer agent.
This program allows current shareholders and
new investors the opportunity to purchase
shares of common stock without a broker.
Shareholders of record may increase their
investment in the company by reinvesting
their dividends at no cost. Shares held in the
name of a broker must be transferred to the
shareholder’s name to permit reinvestment.
Please direct inquiries to:
National City Bank Reinvestment Services
P.O. Box 94946
e-mail: [email protected]
Inquiries concerning dividend payments,
change of address or lost certificates
should be directed to National City Bank
at 1-800-622-6757 or 216-257-8663.
Independent Auditors
Ernst & Young LLP
1300 Huntington Building
925 Euclid Ave.
Publications
The Annual Meeting Notice, Proxy Statement
and Proxy Card are mailed to shareholders
in March.
Copies of Forms 10-K and 10-Q may be
obtained from the company’s Web site,
www.timken.com/investors, or by written
request at no charge from:
The Timken Company
Shareholder Relations, GNE-04
P.O. Box 6928
Investor Relations
Investors and securities analysts may contact:
Steve Tschiegg
Manager – Investor Relations
The Timken Company
Telephone: 330-471-7446
Trademarks
Spexx®, StatusCheck™, Sure-Fit™, Timken® and
Where You Turn™ are trademarks of The Timken
Company. Verado® is a trademark of Brunswick
Corporation. Home Depot race car image is
copyrighted by Joe Gibbs Racing 2006.
Printed on Recycled Paper
224
Introductory Note
The following financial information is extracted without adjustment from the Company's Annual
Report to the shareholders for the fiscal year ended December 31, 2004 (the "2004 Annual Report").
The historical financial information presented in the 2004 Annual Report includes the business
relating to the Company’s Latrobe Steel subsidiary sold in December 2006.
Since these excerpts contain text references to page numbers in the 2004 Annual Report, the
following pages also show the original page numbers printed in the 2004 Annual Report in addition to
the consecutive paging placed at the bottom right of each page of this prospectus.
Table of Contents
Page 246.
Page 247.
Page 248.
Page 249.
Page 250 et seq.
Auditors' Reports
Pages 270 and 271.
225
Financial Information
Contents
19 Management’s Discussion and Analysis
of Financial Condition and Results of Operations
38 Consolidated Statement of Income
39 Consolidated Balance Sheet
40 Consolidated Statement of Cash Flows
41 Consolidated Statement of Shareholders’ Equity
42 Notes to Consolidated Financial Statements
Significant Accounting Policies
44 Acquisitions
Financing Arrangements
49 Contingencies
Research and Development
Equity Investments
60 Income Taxes
62 Report of Management on Internal Control
over Financial Reporting
64 Forward-Looking Statements
65 Quarterly Financial Data
66 Summary of Operations and
68 Board of Directors
70 Officers and Executives
71 Shareholder Information
T H E T I M K E N C O M PA N Y
226
Management’s Discussion and Analysis of Financial
Condition and Results of Operations
Over vie w
Introduction
The Timken Company is a leading global manufacturer of highly
engineered antifriction bearings and alloy steels and a provider of
related products and services. Timken operates under three
segments: Automotive Group, Industrial Group and Steel Group.
The Automotive and Industrial Groups design, manufacture
and distribute a range of bearings and related products and
services. Automotive Group customers include original equipment
manufacturers of passenger cars, light trucks, and mediumto heavy-duty trucks and their suppliers. Industrial Group
customers include both original equipment manufacturers and
distributors for agriculture, construction, mining, energy, mill,
machine tooling, aerospace, and rail applications. Steel Group
products include different alloys in both solid and tubular sections,
as well as custom-made steel products, for both automotive and
industrial applications, including bearings.
On February 18, 2003, Timken acquired The Torrington Company
(Torrington), also a leading bearing manufacturer, for approximately
$840 million. The acquisition strengthened Timken’s market
position among global bearing manufacturers, while expanding
Timken’s product line with complementary products and services
and offering significant cost savings opportunities for the
combined organization.
Financial Overview
For 2004, The Timken Company reported net sales of approximately
$4.5 billion, an increase of approximately 19 percent from 2003.
Sales were higher across all three business segments. For 2004,
earnings per diluted share were $1.49, compared to $0.44 per
diluted share for 2003.
The company achieved record sales and strong earnings growth,
compared to 2003, despite unprecedented high raw material
costs. In 2004, the company leveraged higher volume from the
industrial recovery, implemented surcharges and price increases to
begin to recover high raw material costs, and continued to expand
in emerging markets. The integration of Torrington continued in
2004, with savings from purchasing synergies, workforce consolidation and other integration activities. During 2004, the company
divested certain non-strategic assets and completed two small
acquisitions, which enhanced its industrial product and service
capabilities.
The company expects the improvement in industrial demand to
continue in 2005. In the face of this strong demand, the company
will continue to focus on growth, improving margins, customer
service and productivity. As a result of strategic actions, including
the Torrington acquisition, the company has a more diversified
product portfolio and increased capacity to capitalize on strong
markets. In 2005, the company expects improved performance for
each of its three segments due to increased productivity, price
increases and surcharges, which are expected to recover a significant portion of raw material cost increases.
In 2004, the Automotive Group’s net sales increased from 2003
due to increased light vehicle penetration from new products,
strong medium and heavy truck production and favorable foreign
currency translation. The Automotive Group’s profitability benefited from higher sales and improved operating performance, but was
negatively impacted by higher raw material costs.
In 2004, the Industrial Group’s net sales increased from 2003
due to higher global demand (notably construction, agriculture, rail
and general industrial equipment), increased prices and favorable
foreign currency translation. In addition to the increased sales
volume, profit for the Industrial Group benefited from operating
cost improvements and price increases.
In 2004, the Steel Group’s net sales increased from 2003 due to
surcharges and price increases, which were driven by higher raw
material costs, as well as increased volume. Demand increased
across steel customer segments, led by strong industrial demand.
The Steel Group’s profitability improved significantly due to leveraging high volume and the recovery of raw material increases through
surcharges and price increases.
227
18 I 19
Overview:
2004
2003
$ 4,513.7
$ 135.7
$
1.49
90,759,571
$ 3,788.1
$
36.5
$
0.44
83,159,321
2004
2003
$ 1,582.2
1,709.8
1,221.7
$ 4,513.7
$ 1,396.1
1,498.8
893.2
$ 3,788.1
$ Change
% Change
Net sales
Net income
$
$
$
725.6
99.2
1.05
-
19.2%
271.8%
238.6%
9.1%
$ Change
% Change
Sales by Segment:
Automotive Group
Industrial Group
Steel Group
Total company
The Automotive Group’s net sales benefited from increased light
vehicle penetration from new products, strong medium and heavy
truck production and favorable foreign currency translation. The
Industrial Group’s net sales increased due to higher demand,
increased prices and favorable foreign currency translation. Many
end markets recorded substantial growth, especially construction,
agriculture, rail, and general industrial equipment. For both the
$
$
186.1
211.0
328.5
725.6
13.3%
14.1%
36.8%
19.2%
Automotive and Industrial Groups, a portion of the net sales
increase was attributable to Torrington’s results only being included
from February 18, 2003, the date it was acquired. The increase in
the Steel Group’s net sales resulted primarily from surcharges and
price increases, which were driven by higher raw material costs, as
well as increased volume. Demand increased across steel
customer segments, led by strong industrial demand.
Gross Profit:
2004
2003
$ Change
% Change
Gross profit
Integration and special charges included in cost of products sold
Gross profit for 2003 included a reclassification of $7.5 million from
cost of products sold to selling, administrative and general expenses for Torrington engineering and research and development
expenses to be consistent with the company’s 2004 cost classification methodology. Gross profit in 2004 benefited from higher sales
and volume, strong operating performance and operating cost
improvements. Gross profit was negatively impacted by higher
raw material costs, although the company recovered a significant
portion of these costs through price increases and surcharges.
$
$
838.6
18.6%
4.5
$
639.1
16.9%
$
3.4
$
$
199.5
1.1
31.2%
1.7%
32.4%
In 2004, integration charges related to the continued integration of
Torrington. In 2003, integration and special charges related primarily to the integration of Torrington in the amount of $9.3 million and
costs incurred for the Duston, England plant closure in the amount
of $4.0 million. These charges were partially offset by curtailment
gains in 2003 in the amount of $9.9 million resulting from the
redesign of the company’s U.S.-based employee benefit plans.
228
2004
2003
$ Change
% Change
Integration charges included in selling, administrative and general expenses
Selling, administrative and general expenses for 2003 included a
reclassification of $7.5 million from cost of products sold. The
increase in selling, administrative and general expenses in 2004
was due primarily to higher sales, higher accruals for performancebased compensation and foreign currency translation, partially
offset by lower integration charges. The decrease between years
in selling, administrative and general expenses as a percentage
of net sales was primarily the result of the company’s ability to
$
$
587.9
13.0%
22.5
$
521.7
13.8%
$
30.5
$
$
66.2
(8.0)
12.7 %
(0.8)%
(26.2)%
leverage expenses on higher sales, continued focus on controlling
spending, and savings resulting from the integration of Torrington.
The integration charges for 2004 related to the continued integration of Torrington, primarily for information technology and purchasing initiatives. In 2003, integration charges included integration
costs for the Torrington acquisition of $27.6 million and curtailment
losses resulting from the redesign of the company’s U.S.-based
employee benefit plans of $2.9 million.
2004
2003
$ Change
12.5
2.9
3.7
19.1
$
Impairment charges
Exit costs
Total
$
$
8.5
4.2
0.7
13.4
$
$
$
(4.0)
1.3
(3.0)
(5.7)
In 2004, the impairment charges related primarily to the writedown of property, plant and equipment at one of the Steel
Group’s facilities. The severance and related benefit costs related
to associates who exited the company as a result of the integration
of Torrington. The exit costs related primarily to facilities in the U.S.
The company continues to evaluate the competitiveness of its
operations and may from time to time determine to close
operations that are not competitive. The company may incur
charges associated with the closure of such operations in future
periods that may be material.
In 2003, impairment charges represented the write-off of the
remaining goodwill for the Steel Group in accordance with
Statement of Financial Accounting Standards (SFAS) No. 142,
“Goodwill and Other Intangible Assets,” of $10.2 million and
impairment charges for the Columbus, Ohio plant of $2.3 million.
The severance and related benefit costs of $2.9 million related to
associates who exited the company as a result of the integration of
Torrington and other actions taken by the company to reduce costs.
The exit costs were comprised of $3.0 million for the Columbus,
Ohio plant and $0.7 million for the Duston, England plant. The
Duston and Columbus plants were closed as part of the company’s
manufacturing strategy initiative (MSI) program in 2001. The
additional costs that were incurred in 2003 for these two projects
were the result of changes in estimates.
In May 2004, the company announced a plan to begin closing its
three bearing plants in Canton, Ohio. In June 2004, the company
and the United Steelworkers of America (Union) began the “effects
bargaining” process. In July 2004, the company and the Union
agreed to enter into early formal negotiations over the current labor
contract, which expires in September 2005. Because the company
and the Union are still in discussions, final decisions have not been
made regarding the plant closings, including the timing, the impact
on employment, and the magnitude of savings and charges for
restructuring, which could be material. Therefore, the company is
unable to determine the impact of these plant closings in
accordance with SFAS No. 146, “Accounting for Costs Associated
with Exit or Disposal Activities.”
229
20 I 21
2004
2003
$ Change
Interest expense
Interest income
$
$
50.8
1.4
$
$
48.4
1.1
$
$
2.4
0.3
2003
$ Change
Interest expense increased due primarily to higher average debt balances during 2004, compared to 2003.
2004
$
44.4
$
65.6
$
(21.2)
Other
$
$
$
$
$
16.4
(16.2)
(32.6)
(32.4)
$
$
$
$
$
(45.7)
2.0
(12.0)
(55.7)
$
$
$
$
$
45.7
14.4
(16.2)
(20.6)
23.3
U.S. Continued Dumping and Subsidy Offset Act (CDSOA) receipts
are reported net of applicable expenses. In addition, amounts
received in 2003 are net of a one-time repayment of $2.8 million,
due to a miscalculation by the U.S. Treasury Department, of funds
received by the company in 2002. CDSOA provides for distribution
of monies collected by U.S. Customs from antidumping cases to
qualifying domestic producers where the domestic producers have
continued to invest in their technology, equipment and people. In
2004, the CDSOA receipts of $44.4 million were net of the
amounts that Timken delivered to the seller of the Torrington
business, pursuant to the terms of the agreement under which
the company purchased Torrington. In 2003 and 2004, Timken
delivered to the seller of the Torrington business 80% of the
CDSOA payments received in 2003 and 2004 for Torrington’s
bearing business. Timken is under no further obligation to transfer
any CDSOA payments to the seller of the Torrington business. The
company cannot predict whether it will receive any additional
payments under CDSOA in 2005 or, if so, in what amount. If the
company does receive any additional CDSOA payments, they will
most likely be received in the fourth quarter. In September 2002,
the World Trade Organization (WTO) ruled that such payments
are inconsistent with international trade rules. The U.S. Trade
Representative appealed this ruling, but the WTO upheld the ruling
on January 16, 2003. CDSOA continues to be in effect in the
United States at this time.
During 2004, the company sold certain non-strategic assets, which
included: real estate at its facility in Duston, England, which ceased
operations in 2002, for a gain of $22.5 million; and the company’s
Kilian bearing business, which was acquired in the Torrington
acquisition, for a loss of $5.4 million. In 2003, the gain related
primarily to the sale of property in Daventry, England.
In 2004, the company began the process of liquidating one of its
inactive subsidiaries, British Timken, which is located in Duston,
England. The company recorded a non-cash charge of $16.2 million
on dissolution, which related primarily to the transfer of cumulative
foreign currency translation losses to the statement of income.
For 2004, “other expense, net” included losses on the disposal of
assets, losses from equity investments, foreign currency exchange
losses, donations, minority interests, and a non-cash charge for the
adoption of FASB Interpretation No. 46, “Consolidation of Variable
Interest Entities, an interpretation of Accounting Research Bulletin
No. 51” (FIN 46). For 2003, “other expense, net” included losses
from equity investments, losses on the disposal of assets, foreign
currency exchange gains, and minority interests.
During 2000, the company’s Steel Group invested in a joint venture,
PEL Technologies (PEL), to commercialize a proprietary technology
that converts iron units into engineered iron oxide for use in
pigments, coatings and abrasives. The company previously
accounted for its investment in PEL, which is a development stage
company, using the equity method. In the fourth quarter of 2003,
the company concluded that its investment in PEL was impaired
and recorded a non-cash impairment charge totaling $45.7 million.
Refer to Note 12 – Equity Investments in the notes to consolidated
financial statements for additional discussion.
230
Income Tax Expense:
2004
2003
$ Change
% Change
Income tax expense
Effective tax rate
$
Income tax expense for 2004 was positively impacted by tax
benefits relating to settlement of prior years’ liabilities, the changes
in the tax status of certain foreign subsidiaries, earnings of certain
subsidiaries being taxed at a rate less than 35%, benefits of tax
holidays in China and the Czech Republic, tax benefits from extraterritorial income exclusion, and the aggregate impact of certain
items of income that were not subject to income tax. These
benefits were partially offset by the establishment of a valuation
allowance against certain deferred tax assets associated with loss
carryforwards attributable to a subsidiary, which is in the process of
liquidation; state and local income taxes; and taxes incurred on
foreign remittances. Management does not anticipate that the
extent of the tax benefits relating to settlement of prior years’
liabilities, the tax benefit from changes in tax status of foreign
subsidiaries, and the tax charges associated with the establishment
of the valuation allowance attributable to the subsidiary that is
being liquidated will recur in the near future. The effective
tax rate for 2003 exceeded the U.S. statutory tax rate as a result
of state and local income taxes, withholding taxes on foreign
remittances, losses incurred in foreign jurisdictions that were not
64.1
32.1%
$
24.3
40.0%
$
39.8
-
163.8 %
(7.9)%
available to reduce overall tax expense, and the aggregate effect
of certain nondeductible expenses. The unfavorable tax rate
adjustments were partially mitigated by benefits from extraterritorial
income.
On October 22, 2004, the President signed the American Jobs
Creation Act of 2004 (the Jobs Act). The Jobs Act creates a
temporary incentive for U.S. corporations to repatriate accumulated
income earned abroad by providing an 85% dividends received
deduction for certain dividends from controlled foreign corporations. This deduction is subject to a number of limitations. As
such, the company is not yet in a position to decide on whether,
and to what extent, it might repatriate foreign earnings that have
not yet been remitted to the U.S. The company expects to finalize
its assessment by June 30, 2005. The Jobs Act also contains a
provision that will enable the company to deduct 3%, increasing to
9% by year 2010, of the income derived from certain manufacturing operations. Due to its net operating loss carryforward position,
the company does not anticipate achieving any benefit from this
provision in 2005.
22 I 23
Business Segments:
The primary measurement used by management to measure the
financial performance of each Group is adjusted EBIT (earnings
before interest and taxes, excluding the effect of amounts related
to certain items that management considers not representative of
ongoing operations such as impairment and restructuring, integration costs, one-time gains or losses on sales of assets, allocated
receipts received or payments made under the CDSOA, loss on the
dissolution of subsidiary, and acquisition-related currency exchange
gains). Refer to Note 14 – Segment Information in the notes to
consolidated financial statements for the reconciliation of adjusted
EBIT by Group to consolidated income before income taxes.
Automotive Group:
2004
2003
$ 1,582.2
$
15.9
1.0%
$ 1,396.1
$
15.7
1.1%
$ Change
% Change
Adjusted EBIT
The Automotive Group includes sales of bearings and other
products and services (other than steel) to automotive original
equipment manufacturers. The Automotive Group’s net sales in
2004 benefited from increased light vehicle penetration from new
products, strong medium and heavy truck production and favorable
foreign currency translation. Sales for light vehicle applications
increased, despite lower vehicle production in North America.
Medium and heavy truck demand continued to be strong primarily
due to a 37% increase in North American vehicle production.
$
$
186.1
0.2
-
13.3 %
1.3 %
(0.1)%
A portion of the net sales increase was attributable to the acquisition of Torrington. The Automotive Group’s profitability in 2004
benefited from higher sales and strong operating performance,
but was negatively impacted by higher raw material costs. The
Automotive Group expects to improve its ability to recover these
higher raw material costs in the future as multi-year contracts
mature. In 2005, the company expects that North American and
European vehicle production will be down slightly and medium and
heavy truck production will grow, but at a lower rate than in 2004.
231
Industrial Group:
2004
2003
$ 1,711.2
$
177.9
10.4%
$ 1,499.7
$ 128.0
8.5%
$ Change
% Change
Adjusted EBIT
Sales by the Industrial Group include global sales of bearings and
other products and services (other than steel) to a diverse customer
base, including: industrial equipment; construction and agriculture;
rail; and aerospace and defense customers. The Industrial Group
also includes aftermarket distribution operations for products other
than steel. The Industrial Group’s net sales in 2004 increased
due to higher demand, increased prices and favorable foreign currency translation. Many end markets recorded substantial growth,
especially construction, agriculture, rail, and general industrial
equipment. A portion of the net sales increase was attributable to
$
$
211.5
49.9
-
14.1%
39.0%
1.9%
the acquisition of Torrington. Sales to distributors increased slightly
in 2004, as distributors reduced their inventories of Torringtonbranded products. The company expects this inventory reduction
to continue in 2005. In addition to the increased sales volume,
profit for the Industrial Group benefited from operating cost
improvements and price increases. The company has seen a rapid
increase in industrial demand and anticipates strong demand
through 2005. The company continues to focus on increasing
capacity, improving customer service, and exploring global growth
initiatives.
Steel Group:
2004
2003
$ 1,383.6
$
54.8
4.0%
$ 1,026.5
$
(6.0)
(0.6)%
$ Change
% Change
The Steel Group’s products include steels of intermediate alloy, low
alloy and carbon grades in both solid and tubular sections, as well
as custom-made steel products, for both industrial and automotive
applications, including bearings. The increase in the Steel Group’s
net sales in 2004 resulted primarily from surcharges and price
increases, which were driven by higher raw material costs, as well
as increased volume. Demand increased across all steel customer
segments, led by strong industrial market growth. The strongest
customer segments for the Steel Group were oil production,
aerospace and general industrial customers. The Steel Group’s
profitability improved significantly in 2004 due to volume, raw
material surcharges and price increases. Raw material costs,
especially scrap steel prices, increased over 2003. The company
$
$
357.1
60.8
-
34.8%
-
recovered these cost increases primarily through surcharges. The
Steel Group operated at near capacity during much of 2004, which
the company expects to continue into 2005. Even though the
company anticipates raw material costs to remain high through
2005, the company expects improved earnings with price increases
in contracts effective for 2005.
During the second quarter of 2004, the company’s Faircrest steel
facility was shut down for 10 days to clean up contamination from
a material commonly used in industrial gauging. This material
entered the facility from scrap steel provided by one of its suppliers.
In 2004, the company recovered all of the clean-up, business
interruption and disposal costs in excess of $4 million of insurance
deductibles.
232
Overview:
2003
2002
$ Change
% Change
Net sales
Income before cumulative effect of change in accounting principle
Cumulative effect of change in accounting principle, net of tax
Net income
Earnings per share before cumulative effect of change in
accounting principle - diluted
Cumulative effect of change in accounting principle, net of tax
$ 3,788.1
$
36.5
$
$
36.5
$ 2,550.1
$
51.4
$
(12.7)
$
38.7
$
0.44
$
$
0.44
83,159,321
$
0.83
$
(0.21)
$
0.62
61,635,339
$ 1,238.0
$
(14.9)
$
12.7
$
(2.2)
48.6 %
(29.1)%
(5.9)%
$
$
$
(47.0)%
(29.0)%
34.9 %
(0.39)
0.21
(0.18)
-
In 2002, the cumulative effect of change in accounting principle related to the adoption of SFAS No. 142, "Goodwill and Other Intangible
Assets." The goodwill impairment charge related to the company’s Specialty Steel business.
Sales by Segment:
2003
2002
$ Change
% Change
Automotive Group
Industrial Group
Steel Group
Total company
$ 1,396.1
1,498.8
893.2
$ 3,788.1
The increases in net sales in 2003 for both the Automotive and the
Industrial Groups were primarily the result of the Torrington acquisition. The Automotive Group’s net sales further benefited from
the launch of new product platforms, the increasing demand in the
medium and heavy truck segments, and favorable foreign currency
translation. In addition to the effect of the Torrington acquisition,
$
752.8
971.5
825.8
$ 2,550.1
$
643.3
527.3
67.4
$ 1,238.0
85.5%
54.3%
8.2%
48.6%
the Industrial Group’s net sales increased in 2003 due to favorable
foreign currency translation and improved sales to industrial distributors. The increase in the Steel Group’s net sales in 2003 was due
primarily to penetration gains in industrial markets and increased
demand from automotive and industrial customers.
Gross Profit:
2003
2002
$ Change
% Change
Gross profit
Reorganization and integration charges included in cost of products sold
Gross profit increased in 2003, primarily due to the incremental
sales volume from the Torrington acquisition. Gross profit for the
Automotive Group benefited in 2003 from the additional sales
volume, resulting from the Torrington acquisition; however, it was
negatively impacted by additional costs associated with the restructuring of its manufacturing plants. During the last six months of
2003, the Automotive Group reduced employment by more than
750 associates. This action, along with others, improved the
Automotive Group’s productivity in the fourth quarter of 2003. In
addition to the increased sales volume from the Torrington acquisition, gross profit for the Industrial Group benefited in 2003 from
improved performance in Europe that was largely due to favorable
foreign currency exchange, exiting of low-margin businesses and
$
$
639.1
16.9%
3.4
$
469.6
18.4%
$
8.5
$
$
169.5
(5.1)
36.1 %
(1.5)%
(60.0)%
manufacturing cost reductions. Steel Group gross profit in 2003
was negatively impacted by extremely high costs for scrap steel,
natural gas and alloys, which more than offset increased sales, raw
material surcharges passed on to customers and higher capacity
utilization.
In 2003, reorganization and integration charges included in cost of
products sold related primarily to the integration of Torrington in the
amount of $9.3 million and costs incurred for the Duston, England
plant closure in the amount of $4.0 million. These charges were
partially offset by curtailment gains in the amount of $9.9 million,
resulting from the redesign of the company’s U.S.-based employee
benefit plans.
233
24 I 25
2003
2002
$ Change
% Change
Reorganization and integration charges included in selling,
administrative and general expenses
Selling, administrative and general expenses in 2003 increased
primarily due to the Torrington acquisition, costs incurred in
the integration of Torrington and currency exchange rates. Even
though the amount of selling, administrative and general expenses
in 2003 increased from 2002 as a result of higher net sales, selling,
administrative and general expenses as a percentage of net sales
decreased to 13.8% in 2003 from 14.1% in 2002.
$
521.7
13.8%
$
358.9
14.1%
$
162.8
-
45.4 %
(0.3)%
$
30.5
$
9.9
$
20.6
208.0 %
In 2003, reorganization and integration charges included in selling,
administrative and general expenses reflected integration costs for
the Torrington acquisition of $27.6 million and curtailment losses
resulting from the redesign of the company’s U.S.-based employee
benefit plans of $2.9 million.
2003
2002
$ Change
17.9
10.2
4.0
32.1
$
Impairment charges
Exit costs
Total
$
$
In 2003, impairment charges represented the write-off of
the remaining goodwill for the Steel Group in accordance with
SFAS No. 142, “Goodwill and Other Intangible Assets,” of
$10.2 million and impairment charges for the Columbus, Ohio
plant of $2.3 million. The severance and related benefit costs of
$2.9 million related to associates who exited the company as a
result of the integration of Torrington and other actions taken by
the company to reduce costs. The exit costs were comprised of
$3.0 million for the Columbus, Ohio plant and $0.7 million for the
12.5
2.9
3.7
19.1
$
$
$
(5.4)
(7.3)
(0.3)
(13.0)
Duston, England plant. The Duston and Columbus plants were
closed as part of the company’s MSI program in 2001. The additional costs that were incurred in 2003 for these two projects were the
result of changes in estimates. In 2002, the impairment charges
and exit costs were related to the Duston, England and Columbus,
Ohio plant closures. The severance and curtailment expenses
related primarily to a salaried workforce reduction throughout the
company.
2003
2002
$ Change
Interest expense
Interest income
$
$
48.4
1.1
$
$
31.5
1.7
$
$
16.9
(0.6)
The increase in interest expense in 2003 was due to the additional debt incurred as a result of the Torrington acquisition. Interest income
was not significant in either year.
234
2003
2002
$ Change
50.2
(13.4)
$
$
$
Other expense, net
$
$
$
CDSOA receipts are reported net of applicable expenses. In addition, amounts received in 2003 are net of a one-time repayment,
due to a miscalculation by the U.S. Treasury Department of funds
received by the company in 2002. The amounts received in 2003
related to the original Timken tapered roller, ball and cylindrical
bearing businesses and the Torrington tapered roller bearing
business. Pursuant to the terms of the agreement under which the
company purchased the Torrington business, Timken must deliver
to the seller of the Torrington business 80% of any CDSOA
payments received in 2003 and 2004 related to the Torrington
business.
During 2000, the company’s Steel Group invested in PEL to
commercialize a proprietary technology that converts iron units into
engineered iron oxide for use in pigments, coatings and abrasives.
The company previously accounted for its investment in PEL,
which is a development stage company, using the equity method.
In the fourth quarter of 2003, the company concluded that its
65.6
(45.7)
(10.0)
$
$
$
15.4
(45.7)
3.4
investment in PEL was impaired due to the following indicators
of impairment: history of negative cash flow and losses; 2004 operating plan with continued losses and negative cash flow; and the
continued required support from the company or another party.
Accordingly, the company recorded a non-cash impairment charge
totaling $45.7 million, which is comprised of the PEL indebtedness
that the company has guaranteed of $26.5 million and the write-off
of the advances to and investments in PEL that the company has
made of $19.2 million.
In 2003, “other expense, net” included losses from other equity
investments, losses from the sale of assets, foreign currency
exchange gains (including acquisition-related currency exchange
gains), and one-time net gains from the sales of non-strategic
assets. In 2002, “other expense, net” included foreign currency
exchange losses, losses on the disposal of assets and losses from
equity investments.
Income Tax Expense:
26 I 27
The effective tax rate was 40.0% for the years ended December
31, 2003 and 2002. The effective tax rate for both years exceeded
the U.S. statutory tax rate, as a result of taxes paid to state and
local jurisdictions, withholding taxes on foreign remittances,
recognition of losses in jurisdictions that were not available to
reduce overall tax expense, additional taxes on foreign income, and
the aggregate effect of other permanently non-deductible expenses.
The unfavorable tax rate adjustments were partially mitigated by
benefits from extraterritorial income.
235
Business Segments:
Automotive Group:
2003
2002
$ Change
752.8
11.1
1.5%
$
$
% Change
Adjusted EBIT
$ 1,396.1
$
15.7
1.1%
The Automotive Group includes sales of bearings and other products and services (other than steel) to automotive original equipment manufacturers. The increase in sales between years was
primarily the result of the acquisition of Torrington. Strengthening
medium and heavy truck markets, new product introductions and
favorable foreign currency exchange rates further benefited the
Automotive Group’s net sales. The Automotive Group’s results in
$
$
643.3
4.6
-
85.5 %
41.4 %
(0.4)%
2003 reflected higher costs due to issues in the execution of the
restructuring of its automotive plants and expenditures related to
new ventures in China and a U.S.-based joint venture, Advanced
Green Components. However, the Automotive Group began to see
some improvement from the rationalization initiatives in the fourth
quarter of 2003.
Industrial Group:
2003
2002
$ Change
971.5
73.0
7.5%
$
$
% Change
Adjusted EBIT
$ 1,499.7
$
128.0
8.5%
Sales by the Industrial Group include global sales of bearings and
other products and services (other than steel) to a diverse customer
base, including: industrial equipment; off-highway; rail; and aerospace and defense customers. The Industrial Group also includes
the financial results for Timken’s aftermarket distribution operations
for products other than steel. The sales increase between years
was primarily the result of the acquisition of Torrington. Many of
$
$
528.2
55.0
-
54.4%
75.2%
1.0%
the markets served by the Industrial Group remained relatively flat
during 2003. The Industrial Group benefited from improved
performance in Europe that was largely due to favorable foreign
currency exchange rates and improved results in the rail business,
strong aftermarket sales to industrial distributors, exiting of
low-margin business, and manufacturing cost reductions.
236
Steel Group:
2003
2002
$ Change
981.3
32.5
3.3%
$
$
% Change
$ 1,026.5
$
(6.0)
(0.6)%
The increase in the Steel Group’s net sales was primarily the result
of penetration gains in industrial markets and increased demand
from automotive and industrial customers, partially offset by lower
intersegment sales. The Steel Group’s results were negatively
$
$
45.2
(38.5)
-
4.6%
-
impacted by extremely high costs for scrap steel, natural gas and
alloys, partially offset by increased sales, higher capacity utilization,
implementation of new raw material surcharges and price increases.
The Balance Sheet
Total assets as shown on the Consolidated Balance Sheet at December 31, 2004 increased by $248.7 million from December 31, 2003.
This increase was due primarily to increased working capital required to support higher sales.
Current Assets:
12/31/04
12/31/03
$ Change
$
$
$
% Change
Accounts receivable, net
Inventories
51.0
717.4
90.1
874.8
$ 1,733.3
The increase in cash and cash equivalents in 2004 was partially due
to accumulated cash at certain debt-free foreign subsidiaries. Refer
to the Consolidated Statement of Cash Flows for further explanation. The increase in accounts receivable, net was due primarily to
sales being higher in the fourth quarter of 2004, compared to the
28.6
602.3
50.3
695.9
$ 1,377.1
$
22.4
115.1
39.8
178.9
356.2
78.3%
19.1%
79.1%
25.7%
25.9%
fourth quarter of 2003. The increase in deferred income taxes
related primarily to a reclassification of the benefit of certain
loss carryforwards from non-current deferred income taxes. The
increase in inventories was due primarily to increased volume and
higher raw material costs.
Property, Plant and Equipment – Net:
12/31/04
12/31/03
$ 3,622.2
(2,039.2)
$ 1,583.0
$ 3,503.8
(1,893.0)
$ 1,610.8
$ Change
% Change
Property, plant and equipment - cost
Property, plant and equipment - net
$
$
118.4
(146.2)
(27.8)
3.4 %
(7.7)%
(1.7)%
The decrease in property, plant and equipment – net in 2004 was due primarily to depreciation expense in excess of capital expenditures.
237
28 I 29
Other Assets:
12/31/04
12/31/03
$ Change
% Change
Goodwill
Intangible pension assets
Miscellaneous receivables and other assets
Total other assets
$
$
The increase in goodwill in 2004 was due primarily to the finalization of the purchase price allocation for the Torrington acquisition.
Goodwill resulting from the Torrington acquisition was $56.9 million
at December 31, 2004, compared to $47.0 million at December 31,
2003. During 2004, the Industrial Group completed two small
189.3
86.0
92.9
138.5
76.8
38.8
622.3
$
$
173.1
91.5
106.5
130.1
148.8
51.8
701.8
$
$
16.2
(5.5)
(13.6)
8.4
(72.0)
(13.0)
(79.5)
9.4 %
(6.0)%
(12.8)%
6.5 %
(48.4)%
(25.1)%
(11.3)%
acquisitions, which increased goodwill by $3.7 million. The
decrease in deferred income taxes related primarily to a reclassification of certain loss carryforwards to current deferred income
taxes.
12/31/04
12/31/03
$ Change
% Change
Short-term debt
Income taxes
$
157.4
520.2
343.4
19.0
1.3
$ 1,041.3
The increase in short-term debt in 2004 was due primarily to additional borrowings as a result of working capital requirements due to
increased volume and cash contributions to its U.S.-based pension
plans. The increase in accounts payable and other liabilities was
due primarily to an increase in trade accounts payable, resulting
from increased production volume. The decrease in salaries,
wages and benefits was due primarily to a decrease in the current
$
114.5
425.2
376.6
78.5
6.7
$ 1,001.5
$
$
42.9
95.0
(33.2)
(59.5)
(5.4)
39.8
37.5 %
22.3 %
(8.8)%
(75.8)%
(80.6)%
4.0 %
portion of accrued pension cost, based upon the company’s
estimate of contributions to its pension plans in the next twelve
months, partially offset by higher accruals for performance-based
compensation. The decrease in income taxes was due primarily to
the payment of capital gains tax, resulting from the 2003 sale of an
interest in a joint venture and the settlement of taxes from prior
year liabilities.
12/31/04
12/31/03
$ Change
% Change
Long-term debt
$
620.6
468.6
490.4
47.7
$ 1,627.3
The decrease in accrued pension cost in 2004 was due primarily to
plan contributions, partially offset by current year accruals for pension expense and an increase in the minimum pension liability.
$
613.4
477.5
477.0
30.8
$ 1,598.7
$
$
7.2
(8.9)
13.4
16.9
28.6
1.2 %
(1.9)%
2.8 %
54.9 %
1.8 %
Refer to Note 13 – Retirement and Postretirement Benefit Plans
in the notes to consolidated financial statements for additional
discussion.
238
12/31/04
12/31/03
$ Change
% Change
Common stock
Treasury shares
$
711.8
847.7
(289.5)
(0.2)
$ 1,269.8
Earnings invested in the business were increased in 2004 by net
income, partially offset by dividends declared. The decrease in
accumulated other comprehensive loss was due primarily to an
increase in the foreign currency translation adjustment, partially
offset by an increase in the minimum pension liability. The increase
in the foreign currency translation adjustment was due primarily to
the strengthening of the Euro, Polish Zloty, Romanian Leu, and the
Canadian Dollar relative to the U.S. Dollar and the write-off of the
$
689.3
758.9
(358.4)
(0.2)
$ 1,089.6
$
$
22.5
88.8
68.9
180.2
3.3%
11.7%
19.2%
16.5%
cumulative foreign currency translation adjustment loss, resulting
from the dissolution of one of the company’s inactive subsidiaries,
British Timken. During 2004, the American Institute of Certified
Public Accountants SEC Regulations Committee’s International
Practices Task Force concluded that Romania should come off
highly inflationary status no later than October 1, 2004. Effective
October 1, 2004, the company no longer accounted for Timken
Romania as highly inflationary.
Cash Flows
2004
2003
$ Change
Net cash (used) by investing activities
Net cash (used) provided by financing activities
Increase (decrease) in cash and cash equivalents
$
$
$
$
$
Net cash provided by operating activities was negatively impacted
by higher cash contributions to the company’s pension plans in
2004 of $197.0 million ($185.0 million for U.S.-based plans),
compared to $174.0 million ($168.9 million for U.S.-based plans) in
2003. Net cash provided by operating activities was also negatively impacted by cash used for other changes in operating assets and
liabilities of $90.1 million in 2004, compared to cash provided of
$65.5 million in 2003, which was primarily the result of working
capital requirements for increased sales volume and the payment
in 2004 of capital gains tax, resulting from the 2003 sale of an
interest in a joint venture. These net cash outflows were partially
offset by higher net income, adjusted for non-cash items equaling
$426.2 million in 2004, compared to $313.4 in 2003. The non-cash
items included depreciation and amortization expense, gain or loss
on disposals of assets, loss on dissolution of subsidiary, impairment
139.1
(108.6)
(20.4)
12.2
22.3
$ 204.9
$ (665.0)
$ 401.9
$
4.8
$
(53.4)
$
$
$
$
(65.8)
556.4
(422.3)
7.4
charges, deferred income tax provision, and common stock issued
in lieu of cash to employee benefit plans.
The decrease in net cash used by investing activities was the result
of the cash portion of the Torrington acquisition of $725.1 million in
2003. Proceeds from the sale of non-strategic assets were
$50.7 million and $152.3 million in 2004 and 2003, respectively.
Purchases of property, plant and equipment - net of $155.2 million
in 2004 increased from $118.5 million in 2003.
In 2004, net cash used by financing activities related primarily to
dividends paid, partially offset by net borrowings on the company’s
credit facilities. In 2003, net cash provided by financing activities
related primarily to the additional debt incurred and common stock
issued in connection with the Torrington acquisition and the public
equity offerings of the company’s common stock, partially offset by
dividends paid and net payments on the company’s credit facilities.
239
30 I 31
Total debt was $779.3 million at December 31, 2004, compared to
$734.6 million at December 31, 2003. Net debt was $728.4 million
at December 31, 2004, compared to $706.0 million at December
31, 2003. The net debt to capital ratio was 36.5% at December 31,
2004, compared to 39.3% at December 31, 2003. The company
expects that any cash requirements in excess of cash generated
from operating activities will be met by the availability under its
accounts receivable securitization facility and its senior credit
facility. At December 31, 2004, the company had outstanding
letters of credit totaling $71.0 million and borrowings of
$10.0 million under the $500 million senior credit facility, which
reduced the availability under that facility to $419.0 million. Also, at
December 31, 2004, the company had no outstanding borrowings
under the $125 million accounts receivable securitization facility.
The company believes it has sufficient liquidity to meet its
obligations through 2005.
Reconciliation of Total Debt to Net Debt and the Ratio of Net Debt to Capital:
Net debt:
12/31/04
12/31/03
Short-term debt
Long-term debt
Total debt
Net debt
$
$
157.4
1.3
620.6
779.3
(50.9)
728.4
$
$
114.5
6.7
613.4
734.6
(28.6)
706.0
Ratio of net debt to capital:
12/31/04
12/31/03
Net debt
$
728.4
1,269.8
$ 1,998.2
36.5%
The company presents net debt because it believes net debt is
more representative of the company’s indicative financial position
due to a temporary increase in cash and cash equivalents.
Under its $500 million senior credit facility, the company has three
financial covenants: consolidated net worth; leverage ratio; and
fixed charge coverage ratio. At December 31, 2004, the company
was in full compliance with the covenants under its senior credit
facility and its other debt agreements.
$
706.0
1,089.6
$ 1,795.6
39.3%
In January 2004, Standard & Poor’s Rating Services reaffirmed its
BBB- corporate credit rating on the company. In October 2003,
Moody’s Investors Services lowered its rating of the company’s
debt from Baa3 to Ba1. The ratings apply to the company’s senior
unsecured debt and senior implied and senior unsecured issuer
ratings. The impact of the lowered ratings by Moody’s on the
company’s earnings has been minimal, with only a slight increase in
the cost of the company’s senior credit facility.
240
Payments due by Period
Total
Less than
1 Year
1-3 Years
3-5 Years
$
$
$
More than
5 Years
Long-term debt
Short-term debt
Operating leases
Supply agreement
Total
$ 621.9
157.4
109.7
7.5
$ 896.5
$
1.3
157.4
19.3
5.2
183.2
$
101.2
33.9
2.3
137.4
$
27.3
23.3
50.6
$
$
492.1
33.2
525.3
The company expects to make cash contributions of $135.0 million
to its defined benefit pension plans in 2005. Refer to Note 13 –
Retirement and Postretirement Benefit Plans in the notes to
consolidated financial statements. 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, pursuant to which
the company purchases tooling, which expires on June 30, 2006.
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 its shares under this
plan in the near-term.
During 2004, the company did not purchase any shares of its
common stock as authorized under the company’s 2000 common
The company does not have any off-balance sheet arrangements
with unconsolidated entities or other persons.
32 I 33
241
Other Information
Recent Accounting Pronouncements:
In November 2004, the Financial Accounting Standards Board
(FASB) issued SFAS No. 151, “Inventory Costs, an amendment of
ARB 43, Chapter 4.” SFAS No. 151 requires certain inventory costs
to be recognized as current period expenses. SFAS No. 151 also
provides guidance for the allocation of fixed production costs. This
standard is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. Accordingly, the company will adopt
this standard in 2006. The company has not yet determined the
impact, if any, SFAS No. 151 will have on its results of operations,
cash flows and financial position.
In December 2004, the FASB issued SFAS No. 123R, “Share-Based
Payment.” SFAS No. 123R is a revision of SFAS No. 123,
“Accounting for Stock-Based Compensation,” which supersedes
Accounting Principles Board (APB) Opinion No. 25, “Accounting for
Stock Issued to Employees” and amends SFAS No. 95, “Statement
of Cash Flows.” Generally, the approach to accounting for sharebased payments in SFAS No. 123R is similar to the approach
described in SFAS No. 123. However, SFAS No. 123R requires all
share-based payments to employees, including grants of employee
stock options, to be recognized in the consolidated statement of
income based on their fair values. Pro forma disclosure is no longer
an alternative. SFAS No. 123R is effective for the first reporting
period, beginning after June 15, 2005. Early adoption is permitted.
The company expects to adopt the provisions of SFAS No. 123R,
effective July 1, 2005.
SFAS No. 123R permits public companies to adopt its requirements
using either the “modified prospective” method or “modified retrospective” method. Under the “modified prospective” method,
compensation cost is recognized, beginning with the effective date
(a) based on the requirements of SFAS No. 123R for all share-based
payments granted after the effective date and (b) based on the
requirements of SFAS No. 123 for all awards granted to employees
prior to the effective date of SFAS No. 123R that remain unvested
on the effective date. The “modified retrospective” method
includes the requirements of the “modified prospective” method,
but also permits entities to restate based on the amounts previously
recognized under SFAS No. 123 for purposes of pro forma
disclosures either all periods presented or prior interim periods of
the year of adoption. The company plans to adopt SFAS No. 123R
using the “modified prospective“ method.
As permitted by SFAS 123, the company currently accounts for
share-based payments to employees using APB Opinion No. 25’s
intrinsic value method and, as such, generally recognizes no
compensation cost for employee stock options. Accordingly, the
adoption of SFAS No. 123R’s fair value method may have a
significant impact on the company’s results of operations, although
it will have no impact on the company’s overall financial position.
The impact of adoption of SFAS No. 123R cannot be predicted at
this time because it will depend on levels of share-based payments
granted in the future. However, had the company adopted SFAS
No. 123R in prior periods, the impact of that standard would have
approximated the impact of SFAS No. 123 as described in the
disclosure of pro forma net income and earnings per share in Note
1 to the company’s consolidated financial statements. SFAS No.
123R also requires the benefits of tax deductions in excess of
recognized compensation cost to be reported as a financing cash
flow, rather than as an operating cash flow as required under
current literature. This requirement will reduce net operating cash
flows and increase net financing cash flows in periods after adoption. While the company cannot estimate what those amounts will
be in the future (because they depend on, among other things,
when employees exercise stock options), the amount of operating
cash flows recognized in prior periods for such excess tax
deductions were $3.1 million, $1.1 million and $0 in 2004, 2003 and
2002, respectively.
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.
The company’s revenue recognition policy is to recognize revenue
when title passes to the customer. This occurs at the shipping
242
point, except for certain exported goods, for which it occurs when
the goods reach their destination. Selling prices are fixed, based
on purchase orders or contractual arrangements. Write-offs of
accounts receivable historically have been low.
Goodwill:
SFAS No. 142, “Goodwill and Other Intangible Assets” requires
that goodwill and indefinite-lived intangible assets be tested for
impairment at least annually. Furthermore, goodwill is reviewed for
impairment whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. The company
engages an independent valuation firm and performs its annual
impairment test during the fourth quarter after the annual forecasting process is completed. In 2004, since the fair values of the
company’s reporting units exceeded their carrying values, no
impairment loss was recognized. However, in 2003 and 2002, the
carrying values of the company’s Steel reporting units exceeded
their fair values. As a result, impairment losses of $10.2 million and
$20.5 million, respectively, were recognized. Refer to Note 8 –
Goodwill and Other Intangible Assets in the notes to consolidated
financial statements.
For exit and disposal activities that are initiated after December 31,
2002, the company’s policy is to recognize restructuring costs in
accordance with SFAS No. 146, “Accounting for Costs Associated
with Exit or Disposal Activities” or Emerging Issues Task Force
Issue No. 94-3, “Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)” for exit and disposal
activities that are initiated prior to or on December 31, 2002, and
the SEC Staff Accounting Bulletin No. 100, “Restructuring and
Impairment Charges.” Detailed contemporaneous documentation
is maintained and updated on a monthly basis to ensure that
accruals are properly supported. If management determines that
there is a change in estimate, the accruals are adjusted to reflect
this change.
Benefit plans:
The company sponsors a number of defined benefit pension
plans, which cover eligible associates. The company also sponsors
several unfunded postretirement plans that provide health care and
life insurance benefits for eligible retirees and dependents. The
measurement of liabilities related to these plans is based
on management’s assumptions related to future events, including
discount rate, return on pension plan assets, rate of compensation
increases and health care cost trend rates. The discount rate is
determined using a model that matches corporate bond securities
against projected future pension and postretirement disbursements. Actual pension plan asset performance either reduces
or increases net actuarial gains or losses in the current year, which
ultimately affects net income in subsequent years.
For expense purposes in 2004, the company applied a discount rate
of 6.3% and an expected rate of return of 8.75% for the company’s
pension plan assets. For 2005 expense, the company reduced the
discount rate to 6.0%. The assumption for expected rate of return
on plan assets was not changed from 8.75% for 2005. The lower
discount rate will result in an increase in 2005 pretax pension
expense of approximately $5.0 million. A 0.25% reduction in the
discount rate would increase pension expense by approximately
$4.9 million for 2005. A 0.25% reduction in the expected rate
of return would increase pension expense by approximately
$3.9 million for 2005.
During 2003, the company made revisions, which became effective
on January 1, 2004, to certain of its benefit programs for its
U.S.-based employees resulting in a pretax curtailment gain of
$10.7 million. Depending on an associate’s combined age and
years of service with the company on January 1, 2004, defined
benefit pension plan benefits were reduced or replaced by a new
defined contribution plan. The company will no longer subsidize
retiree medical coverage for those associates who did not meet a
threshold of combined age and years of service with the company
on January 1, 2004.
For measurement purposes for postretirement benefits, the company assumed a weighted-average annual rate of increase in the
per capita cost (health care cost trend rate) for medical benefits of
10.0% for 2005, declining gradually to 5.0% in 2010 and thereafter;
and 12.75% for 2005, declining gradually to 6.0% in 2014 and thereafter for prescription drug benefits. 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
243
34 I 35
trend rate would have increased the 2004 total service and interest
components by $1.8 million and would have increased the postretirement obligation by $29.7 million. A one-percentage-point
decrease would provide corresponding reductions of $1.6 million
and $26.8 million, respectively.
The U.S. Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the Medicare Act) was signed into law
on December 8, 2003. The Medicare Act provides for prescription
drug benefits under Medicare Part D and contains a subsidy to plan
sponsors who provide “actuarially equivalent” prescription plans.
The company believes that it offers “actuarially equivalent”
prescription plans. In May 2004, the FASB issued FASB Staff
Position No. FAS 106-2, “Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003” (FSP 106-2). During the three months
ended September 30, 2004, the company adopted retroactively
FSP 106-2. The effect of the Medicare Act has been measured as
of December 31, 2003 and is now reflected in the company’s
consolidated financial statements and accompanying notes. The
effects of the Medicare Act are reductions to the accumulated
postretirement benefit obligation of $30.7 million and to the net
periodic postretirement benefit cost of $4.1 million. No Medicare
subsidies were received in 2004.
Income taxes:
differences resulting from the treatment of items for tax and
accounting purposes. These differences result in deferred tax
assets and liabilities that are included within the consolidated
balance sheet. Based on known and projected earnings information
and prudent tax planning strategies, the company then assesses
the likelihood that the deferred tax assets will be recovered. To the
extent that the company believes recovery is not likely, a valuation
allowance is established. In the event that the company
determines the realizability of deferred tax assets in the future is in
excess of the net recorded amount, an adjustment to the deferred
tax asset would increase income in the period in which such
determination was made. Likewise, if the company determines
that it is unlikely that all or part of the net deferred tax asset will be
realized in the future, an adjustment to the deferred tax asset would
be charged to expense in the period in which such determination
was made. Net deferred tax assets relate primarily to pension and
postretirement benefits and tax loss and credit carryforwards,
which the company believes will result in future tax benefits.
Significant management judgment is required in determining the
provision for income taxes, deferred tax assets and liabilities, and
any valuation allowance recorded against net deferred tax assets.
Historically, actual results have not differed significantly from those
determined using the estimates described above.
Other Matters:
SFAS No. 109, “Accounting for Income Taxes,” requires that a
valuation allowance be established when it is more likely than not
that all or a portion of a deferred tax asset will not be realized. The
company estimates actual current tax due and assesses temporary
Changes in short-term interest rates related to several separate
funding sources impact the company’s earnings. These sources are
borrowings under an accounts receivable securitization program,
borrowings under the $500 million senior credit facility, floating rate
tax-exempt U.S. municipal bonds with a weekly reset mode, and
short-term bank borrowings at international subsidiaries. The
company is also sensitive to market risk for changes in interest
rates as they influence $80 million of debt that has been hedged by
interest rate swaps. In the first quarter of 2004, the company
entered into interest rate swaps with a total notional value of
244
$80 million to hedge a portion of its fixed-rate debt. Under the
terms of the interest rate swaps, the company receives interest at
fixed rates and pays interest at variable rates. The maturity dates
of the interest rate swaps are January 15, 2008 and February 15,
2010. If the market rates for short-term borrowings increased by
1% around the globe, the impact would be an increase in interest
expense of $2.8 million with a corresponding decrease in income
before income taxes of the same amount. The amount was determined by considering the impact of hypothetical interest rates on
the company’s borrowing cost, year-end debt balances by category
and an estimated impact on the tax-exempt municipal bonds’
interest rates.
environmental expenses and has a well-established environmental
compliance audit program, which includes a proactive approach to
bringing its domestic and international units to higher standards of
environmental performance. This program measures performance
against local laws, as well as standards that have been established
for all units worldwide. It is difficult to assess the possible effect of
compliance with future requirements that differ from existing ones.
As previously reported, the company is unsure of the future
financial impact to the company that could result from the United
States Environmental Protection Agency’s (EPA’s) final rules
to tighten the National Ambient Air Quality Standards for fine
particulate and ozone.
Fluctuations in the value of the U.S. Dollar compared to foreign
currencies, predominately in European countries, also impact the
company’s earnings. The greatest risk relates to products shipped
between the company’s European operations and the United
States. Foreign currency forward contracts and options are used to
hedge these intercompany transactions. Additionally, hedges are
used to cover third-party purchases of product and equipment. As
of December 31, 2004, there were $130.8 million of hedges in
place. A uniform 10% weakening of the U.S. Dollar against all
currencies would have resulted in a charge of $12.5 million for
these hedges. In addition to the direct impact of the hedged
amounts, changes in exchange rates also affect the volume of
sales or foreign currency sales price as competitors’ products
become more or less attractive.
The company and certain of its U.S. subsidiaries have been
designated as potentially responsible parties by the United States
EPA for site investigation and remediation at certain sites under the
Comprehensive Environmental Response, Compensation and
Liability Act (Superfund). The claims for remediation have been
asserted against numerous other entities, which are believed to be
financially solvent and are expected to fulfill their proportionate
share of the obligation. Management believes any ultimate liability
with respect to all pending actions will not materially affect the
company’s results of operations, cash flows or financial position.
The company continues its efforts to protect the environment
and comply with environmental protection laws. Additionally, it has
invested in pollution control equipment and updated plant
operational practices. The company is committed to implementing
a documented environmental management system worldwide and
to becoming certified under the ISO 14001 standard to meet
or exceed customer requirements. By the end of 2004, 33 of
the company’s plants had obtained ISO 14001 certification. The
company believes it has established adequate reserves to cover its
On February 1, 2005, the company’s board of directors declared a
quarterly cash dividend of $0.15 per share. The dividend is payable
on March 2, 2005 to shareholders of record as of February 18, 2005.
This will be the 331st consecutive dividend paid on the common
stock of the company.
245
36 I 37
2004
2003
2002
$ 4,513,671
3,675,086
838,585
$ 3,788,097
3,148,979
639,118
$ 2,550,075
2,080,498
469,577
Operating Income
587,923
13,434
237,228
521,717
19,154
98,247
358,866
32,143
78,568
Interest expense
Interest income
Receipt of Continued Dumping & Subsidy Offset Act (CDSOA) payment
Income Before Income Taxes and Cumulative Effect
of Change in Accounting Principle
Income Before Cumulative Effect of Change
in Accounting Principle
Cumulative effect of change in accounting principle
(net of income tax benefit of $7,786)
Net Income
(50,834)
1,397
44,429
(32,441)
(48,401)
1,123
65,559
(55,726)
(31,540)
1,676
50,202
(13,388)
199,779
64,123
60,802
24,321
85,518
34,067
Net sales
Gross Profit
$
135,656
$
36,481
$
51,451
$
135,656
$
36,481
$
(12,702)
38,749
Earnings Per Share:
Income before cumulative effect of change
in accounting principle
Earnings Per Share
$ 1.51
$ 1.51
$ 0.44
$ 0.44
$ 0.84
(0.21)
$ 0.63
Earnings Per Share–Assuming Dilution:
Income before cumulative effect of change
Earnings Per Share–Assuming Dilution
$ 1.49
$ 1.49
$ 0.44
$ 0.44
$ 0.83
(0.21)
$ 0.62
See accompanying Notes to Consolidated Financial Statements on pages 42 through 61.
246
December 31
2004
2003
ASSETS
Current Assets
Accounts receivable, less allowances: 2004– $24,952; 2003–$23,957
Inventories:
Finished products
Total Inventories
$
$
28,626
602,262
50,271
58,357
423,808
392,668
874,833
1,733,291
42,052
323,439
330,455
695,946
1,377,105
648,646
2,973,542
3,622,188
2,039,231
1,582,957
601,108
2,902,697
3,503,805
1,892,957
1,610,848
189,299
178,844
138,466
76,834
38,809
622,252
$ 3,938,500
173,099
197,993
130,081
148,802
51,861
701,836
$ 3,689,789
Property, Plant and Equipment
Land and buildings
Other Assets
Goodwill
Miscellaneous receivables and other assets
Total Other Assets
Total Assets
50,967
717,425
90,066
38 I 39
Current Liabilities
Short-term debt
Income taxes
$
Long-term debt
Authorized–10,000,000 shares each class, none issued
Authorized–200,000,000 shares
Issued (including shares in treasury) (2004 – 90,511,833 shares;
2003 – 89,076,114 shares)
Stated capital
Treasury shares at cost (2004 – 7,501 shares; 2003 – 10,601 shares)
157,417
520,259
343,409
18,969
1,273
1,041,327
$
114,469
425,157
376,603
78,514
6,725
1,001,468
620,634
468,644
490,366
47,681
1,627,325
613,446
477,502
476,966
30,780
1,598,694
-
-
53,064
658,730
847,738
(289,486)
(198)
1,269,848
$ 3,938,500
53,064
636,272
758,849
(358,382)
(176)
1,089,627
$ 3,689,789
247
2004
2003
2002
$ 135,656
$ 36,481
$ 38,749
209,431
7,053
(17,110)
16,186
62,039
2,775
10,154
208,851
4,944
4,406
2,744
55,967
12,702
146,535
5,904
17,250
5,217
(13,564)
(114,264)
(130,407)
28,082
(73,218)
2,690
139,067
(27,543)
33,229
(27,975)
(83,982)
(2,234)
204,888
(43,679)
(50,611)
(3,198)
80,761
10,037
206,103
Purchases of property, plant and equipment–net
Proceeds from disposals of non-strategic assets
Acquisitions
(155,180)
5,268
50,690
(9,359)
(108,581)
(118,530)
26,377
152,279
(725,120)
(664,994)
(85,277)
12,616
(6,751)
(79,412)
Proceeds from issuance of common stock
Common stock issued to finance acquisition
Short-term debt activity–net
Net Cash (Used) Provided by Financing Activities
Increase (Decrease) In Cash and Cash Equivalents
(46,767)
198,000
(198,000)
339,547
(334,040)
20,860
(20,400)
12,255
22,341
28,626
$ 50,967
(42,078)
127,000
(127,000)
54,985
180,010(1)
629,800
(379,790)
(41,082)
401,845
4,837
(53,424)
82,050
$ 28,626
(31,713)
(37,296)
(11,498)
(80,507)
2,474
48,658
33,392
$ 82,050
Net income
Adjustments to reconcile net income to net cash
Loss on disposals of property, plant and equipment
Deferred income tax provision
Common stock issued in lieu of cash
Accounts receivable
Inventories
Other assets
Foreign currency translation loss (gain)
(1)
Excluding $140 million of common stock (9,395,973 shares) issued to the seller of the Torrington business, in conjunction with the acquisition.
248
Common Stock
Total
Other
Paid-In
Capital
Stated
Capital
Earnings
Invested
in the
Business
Accumulated
Other
Comprehensive
Loss
Treasury
Stock
(Thousands of dollars, except share data)
Net income
Change in fair value of derivative financial
instruments net of reclassifications
Total comprehensive loss
$ 781,735
38,749
Issuance of 3,186,470 shares from treasury
(1)
Issuance of 369,290 shares from authorized(1)
Net income
financial instruments net of
reclassifications
Issuance of 29,473 shares from treasury(1)
Issuance of 25,624,198 shares from authorized(1)(2)
Net income
financial instruments (net of
reclassifications)
(2)
53,064
$ 256,423
$ 757,410
38,749
$ (224,538) $ (60,624)
14,050
14,050
(254,318)
(254,318)
(871)
(202,390)
(31,713)
(871)
(31,713)
57,747
(2,138)
3,707
3,707
$ 609,086
$ 53,064
$ 257,992
36,481
59,885
$ 764,446
$ (465,677) $
75,062
75,062
31,813
31,813
420
143,776
(42,078)
420
1,104
301
(262)
377,438
377,438
$ 53,064
$ 636,272
135,656
563
$ 758,849
$ (358,382) $
(176)
135,656
105,736
105,736
(36,468)
(36,468)
(372)
204,552
(46,767)
(372)
(46,767)
3,068
3,068
(1,067)
(1,045)
20,435
20,435
$ 1,269,848
40 I 41
(42,078)
1,104
$1,089,627
(739)
36,481
Issuance of 3,100 shares from treasury(1)
(1)
$
$ 53,064
$ 658,730
(22)
$ 847,738
$ (289,486) $
(198)
Share activity was in conjunction with employee benefit and stock option plans. See accompanying Notes to Consolidated Financial Statements on pages 42 through 61.
Share activity includes the issuance of 22,045,973 shares in connection with the Torrington acquisition and an additional public equity offering of 3,500,000 shares in
October 2003.
249
Principles of Consolidation:
The consolidated financial
statements include the accounts and operations of the company
and its subsidiaries. All significant intercompany accounts and
transactions are eliminated upon consolidation. Investments in
affiliated companies are accounted for by the equity method.
Revenue Recognition: The company recognizes revenue when
title passes to the customer. This is FOB shipping point except for
certain exported goods, which is FOB destination. Selling prices
are fixed based on purchase orders or contractual arrangements.
Write-offs of accounts receivable historically have been low. Shipping
and handling costs are included in cost of products sold in the
consolidated statement of income.
Cash Equivalents: The company considers all highly liquid investments with a maturity of three months or less when purchased to
be cash equivalents.
Inventories: Inventories are valued at the lower of cost or market,
with 57% valued by the last-in, first-out (LIFO) method. If all
inventories had been valued at current costs, inventories would
have been $214,900 and $147,500 greater at December 31, 2004
and 2003, respectively. During 2002, inventory quantities were
reduced as a result of ceasing manufacturing operations in Duston,
England (see Note 6). This reduction resulted in a liquidation of
LIFO inventory quantities carried at lower costs prevailing in prior
years, compared to the cost of current purchases, the effect of
which increased income before cumulative effect of change in
accounting principle by approximately $5,700 or $0.09 per
diluted share.
Property, Plant and Equipment: Property, plant and equipment
is valued at cost less accumulated depreciation. Maintenance
and repairs are charged to expense as incurred. Provision for
depreciation is computed principally by the straight-line method
based upon the estimated useful lives of the assets. The useful
lives are approximately 30 years for buildings, 5 to 7 years for
computer software and 3 to 20 years for machinery and equipment.
Impairment of long-lived assets is recognized when events or
changes in circumstances indicate that the carrying amount of the
asset or related group of assets may not be recoverable. If the
expected future undiscounted cash flows are less than the carrying
amount of the asset, an impairment loss is recognized at that time
to reduce the asset to the lower of its fair value or its net book value.
Goodwill: The company tests goodwill and indefinite-lived intangible assets for impairment at least annually. The company engages
an independent valuation firm and performs its annual impairment
test during the fourth quarter after the annual forecasting process is
completed. Furthermore, goodwill is reviewed for impairment
whenever events or changes in circumstances indicate that the
carrying value may not be recoverable.
Income Taxes: Deferred income taxes are provided for the
temporary differences between the financial reporting basis and tax
basis of the company’s assets and liabilities.
Foreign Currency Translation:
Assets and liabilities of
subsidiaries, other than those located in highly inflationary
countries, 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 year. The 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 of subsidiaries in highly inflationary countries
are included in results of operations. The company recorded
foreign currency exchange losses of $7,687 in 2004, $2,666 in
2003, and $5,143 in 2002. During 2004, the American Institute of
Certified Public Accountants SEC Regulations Committee’s
International Practices Task Force concluded that Romania should
come off highly inflationary status no later than October 1, 2004.
Effective October 1, 2004, the company no longer accounted for
Timken Romania as highly inflationary.
Stock-Based Compensation: On December 31, 2002, the
Financial Accounting Standards Board (FASB) issued 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 alternative methods of
transition to SFAS No. 123’s fair value method of accounting for
stock-based compensation. SFAS No. 148 also amends the
disclosure requirements 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, if the exercise price of
the company’s stock options equals the market price of the
underlying common stock on the date of grant, no compensation
expense is required. Restricted stock rights are awarded to certain
employees and directors. The market price on the grant date is
charged to compensation expense ratably over the vesting period of
the restricted stock rights.
The effect on net income and earnings per share as if the company
had applied the fair value recognition provisions of SFAS No. 123 is
as follows for the years ended December 31:
Net income,
as reported
2004
2003
2002
$ 135,656
$ 36,481
$ 38,749
1,488
1,170
(7,305)
(6,786)
Add: Stock-based employee
compensation expense,
net of related taxes
1,884
Deduct: Stock-based
employee compensation
expense determined
under fair value based
methods for all awards,
net of related taxes
(6,751)
Pro forma net
income
$ 130,789
Earnings per share:
Basic – as reported
Basic – pro forma
Diluted – as reported
Diluted – pro forma
$ 30,664
$ 33,133
$1.51
$1.46
$0.44
$0.37
$0.63
$0.54
$1.49
$1.44
$0.44
$0.37
$0.62
$0.54
250
Earnings Per Share: Earnings per share are computed by dividing
net income by the weighted-average number of common shares
outstanding during the year. Earnings per share - assuming
dilution are computed by dividing net income by the weightedaverage number of common shares outstanding adjusted for the
dilutive impact of potential common shares for options.
Derivative Instruments: The company accounts for its derivative
instruments in accordance with SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended. The
company recognizes all derivatives on the balance sheet at fair
value. Derivatives that are not designated as hedges must be
adjusted to fair value through earnings. If the derivative is designated and qualifies as a hedge, depending on the nature of the hedge,
changes in the fair value of the derivatives are either offset against
the change in fair value of the hedged assets, liabilities, or firm
commitments through earnings or recognized in other
comprehensive income (loss) until the hedged item is recognized in
earnings. The company’s holdings of forward foreign exchange
contracts have been deemed derivatives pursuant to the criteria
established in SFAS No. 133, of which the company has designated certain of those derivatives as hedges. The critical terms, such
as the notional amount and timing of the forward contract and
forecasted transaction, coincide resulting in no significant hedge
ineffectiveness. In 2004, the company entered into interest rate
swaps to hedge a portion of its fixed-rate debt. The critical terms,
such as principal and notional amounts and debt maturity and swap
termination dates, coincide resulting in no hedge ineffectiveness.
These instruments qualify as fair value hedges. Accordingly, the
gain or loss on both the hedging instrument and the hedged item
attributable to the hedged risk are recognized currently in earnings.
Recent Accounting Pronouncements In November 2004, the
FASB issued SFAS No. 151, “Inventory Costs, an amendment of
ARB 43, Chapter 4.” SFAS No. 151 requires certain inventory costs
to be recognized as current period expenses. SFAS No. 151 also
provides guidance for the allocation of fixed production costs. This
standard is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The company has not yet
determined the impact, if any, SFAS No. 151 will have on its results
of operations, cash flows and financial position.
In December 2004, the FASB issued SFAS No. 123R, “Share-Based
Payment.” SFAS No. 123R is a revision of SFAS No. 123,
“Accounting for Stock-Based Compensation,” which supersedes
Accounting Principles Board (APB) Opinion No. 25, “Accounting for
Stock Issued to Employees” and amends SFAS No. 95, “Statement
of Cash Flows.” Generally, the approach to accounting for sharebased payments in SFAS No. 123R is similar to the approach
described in SFAS No. 123. However, SFAS No. 123R requires all
share-based payments to employees, including grants of employee
stock options, to be recognized in the consolidated statement of
income based on their fair values. Pro forma disclosure is no longer
an alternative. SFAS No. 123R is effective for the first reporting
period beginning after June 15, 2005. Early adoption is permitted.
The company expects to adopt the provisions of SFAS No. 123R
effective July 1, 2005.
SFAS No. 123R permits public companies to adopt its
requirements using either the “modified prospective” method or
“modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized beginning with the
effective date (a) based on the requirements of SFAS No. 123R for
all share-based payments granted after the effective date and (b)
based on the requirements of SFAS No. 123 for all awards granted
to employees prior to the effective date of SFAS No. 123R that
remain unvested on the effective date. The “modified retrospective” method includes the requirements of the “modified prospective” method, but also permits entities to restate based on the
amounts previously recognized under SFAS No. 123 for purposes
of pro forma disclosures either all periods presented or prior
interim periods of the year of adoption. The company plans to
adopt SFAS No. 123R using the “modified prospective” method.
As permitted by SFAS 123, the company currently accounts for
share-based payments to employees using APB Opinion No. 25’s
intrinsic value method and, as such, generally recognizes no
compensation cost for employee stock options. Accordingly, the
adoption of SFAS No. 123R’s fair value method may have a significant impact on the company’s results of operations, although it will
have no impact on the company’s overall financial position. The
impact of adoption of SFAS No. 123R cannot be predicted at this
time because it will depend on levels of share-based payments
granted in the future. However, had the company adopted SFAS
No. 123R in prior periods, the impact of that standard would have
approximated the impact of SFAS No. 123 as described in the
disclosure of pro forma net income and earnings per share. SFAS
No. 123R also requires the benefits of tax deductions in excess of
recognized compensation cost to be reported as a financing cash
flow, rather than as an operating cash flow as required under
current literature. This requirement will reduce net operating cash
flows and increase net financing cash flows in periods after
adoption. While the company cannot estimate what those
amounts will be in the future (because they depend on, among
other things, when employees exercise stock options), the amount
of operating cash flows recognized in prior periods for such
excess tax deductions were $3,068, $1,104, and $0 in 2004, 2003
and 2002, respectively.
Use of Estimates: The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States requires management to make estimates and
assumptions that affect the amounts reported in the financial
statements and accompanying notes. These estimates and
assumptions are reviewed and updated regularly to reflect recent
experience.
Reclassifications: Certain amounts reported in the 2003 and 2002
financial statements have been reclassified to conform to the
2004 presentation.
251
42 I 43
2 Acquisitions
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 for
approximately $840,000 plus $25,089 of acquisition costs incurred
in connection with the acquisition. IR’s Engineered Solutions
business, was comprised of certain operating assets and
subsidiaries, including The Torrington Company. With the strategic
acquisition of IR’s Engineered Solutions business, hereafter
referred to as Torrington, the company is able to expand its global
presence and market share as well as broaden its product base in
addition to reducing costs through realizing economies of scale,
rationalizing facilities and eliminating duplicate processes. The
company’s consolidated financial statements include the results of
operations of Torrington since the date of the acquisition.
The company paid IR $700,000 in cash, subject to post-closing
purchase price adjustments, and issued $140,000 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: $180,010, net of underwriting
discounts and commissions, from a public offering of
12,650,000 shares of common stock at $14.90 per common share;
$246,900, net of underwriting discounts and commissions, from a
public offering of $250,000 of 5.75% senior unsecured notes due
2010; $125,000 from its Asset Securitization facility; and
approximately $86,000 from its senior credit facility.
The final purchase price for the acquisition of Torrington was
subject to adjustment upward or downward based on the differences for both net working capital and net debt as of December 31,
2001 and February 15, 2003, both calculated in a manner as
set forth in The Stock and Asset Purchase Agreement. These
adjustments did not have a material effect on the company’s
financial statements.
The allocation of the purchase price has been performed based on
the assignment of fair values to assets acquired and liabilities
assumed. Fair values are based primarily on appraisals performed
by an independent appraisal firm. Items that affected the ultimate
purchase price allocation include finalization of integration initiatives
or plant rationalizations that qualified for accrual in the opening
balance sheet and other information that provided a better estimate
of the fair value of assets acquired and liabilities assumed. In
March 2003, the company announced the planned closing of its
plant in Darlington, England. This plant has ceased manufacturing
as of December 31, 2003. In July 2003, the company announced
that it would close its plant in Rockford, Illinois. As of December
31, this plant has closed, and the fixed assets have been either sold
or scrapped. The building has not yet been sold and is classified as
an “asset held for sale” in miscellaneous receivables and other
assets on the consolidated balance sheet. In October 2003, the
company announced that it reached an agreement in principle
with Roller Bearing Company of America, Inc. for the sale of the
company’s airframe business, which included certain assets at its
Standard plant in Torrington, Connecticut. This transaction closed
on December 22, 2003. In connection with the Torrington
integration efforts, the company incurred severance, exit and other
related costs of $22,602 for former Torrington associates, which
are considered to be costs of the acquisition and are included in the
purchase price allocation. Severance, exit and other related costs
associated with former Timken associates have been expensed
during 2004 and 2003 and are not included in the purchase price
allocation. Refer to footnote 6 for further discussion of impairment
and restructuring charges.
In accordance with FASB EITF Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” the
company recorded accruals for severance, exit and relocation costs in the purchase price allocation. A reconciliation of the beginning and
ending accrual balances is as follows:
Severance
Less: payments
$
8,536
(4,631)
Less: payments
3,905
287
(1,871)
$ 2,321
Exit
$
2,530
(205)
2,325
6,560
(8,885)
$
-
Relocation
$
Total
5,259
(3,362)
$
1,897
(570)
(1,327)
$
-
16,325
(8,198)
8,127
6,277
(12,083)
$ 2,321
252
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.
Accounts receivable
Inventory
Property, plant & equipment
In-process research and development
Intangible assets subject to amortization – (12-year weighted average useful life)
Goodwill
Equity investment in needle bearing joint venture
Other non-current assets, including deferred taxes
$
Total Assets Acquired
177,227
210,194
4,418
429,014
1,800
91,642
56,909
146,335
36,451
$ 1,153,990
Accounts payable and other current liabilities
Non-current liabilities, including accrued postretirement benefits cost
$
192,689
96,212
Total Liabilities Assumed
$
288,901
Net Assets Acquired
$
865,089
There is no tax basis goodwill associated with the Torrington
acquisition.
The $1,800 related to in-process research and development was
written off at the date of acquisition in accordance with FASB
Interpretation No. 4, "Applicability of FASB Statement No. 2 to
Business Combinations Accounted for by the Purchase Method."
The write-off is included in selling, administrative and general
expenses in the consolidated statement of income. The fair value
assigned to the in-process research and development was determined by an independent valuation using the discounted cash flow
method.
In July 2003, the company sold to NSK Ltd. its interest in a needle
bearing manufacturing venture in Japan that had been operated by
NSK and Torrington for $146,335 before taxes, which approximated
the carrying value at the time of the sale.
The following unaudited pro forma financial information presents
the combined results of operations of the company and Torrington
as if the acquisition had occurred at the beginning of the periods
presented. The unaudited pro forma financial information does 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:
Unaudited
Net sales
Net income
Earnings per share – assuming dilution:
Earnings per share – assuming dilution
2003
2002
$3,939,340
29,629
29,629
$3,756,652
104,993
92,291
$
$
0.36
-
$ 1.25
$ (0.15)
$
0.36
$ 1.10
Other Acquisitions in 2004 and 2002
During 2004 and 2002, the company finalized several acquisitions.
The total cost of these acquisitions amounted to $8,425 in 2004
and $6,751 in 2002. The purchase price was allocated to the assets
and liabilities acquired, based on their fair values at the dates of
acquisition. The fair value of the assets was $5,513 in 2004 and
$6,751 in 2002 and the fair value of the liabilities assumed was
$815 in 2004 and $6,751 in 2002. The excess of the purchase price
over the fair value of the net assets acquired was allocated to
goodwill. The company’s consolidated financial statements include
the results of operations of the acquired businesses for the periods
subsequent to the effective dates of the acquisitions. Pro forma
results of operations have not been presented because the effect
of these acquisitions was not significant.
253
44 I 45
The following table sets forth the reconciliation of the numerator and the denominator of earnings per share and earnings per share assuming dilution for the years ended December 31:
2004
Numerator:
Net income for earnings per share and earnings per share - assuming
dilution – income available to common shareholders
Denominator:
Denominator for earnings per share – weighted-average shares
Stock options and awards – based on the treasury stock method
Denominator for earnings per share - assuming dilution – adjusted
weighted-average shares
Earnings per share
The exercise prices for certain of the stock options that the company has awarded exceed the average market price of the company’s
common stock. Such stock options are antidilutive and were
not included in the computation of diluted earnings per share. The
antidilutive stock options outstanding were 2,316,988, 4,414,626
and 4,083,100 at December 31, 2004, 2003 and 2002, respectively.
Under the performance unit component of the company’s longterm incentive plan, the Compensation Committee of the Board of
2003
36,481
2002
$ 135,656
$
$
38,749
89,875,650
82,945,174
61,128,005
883,921
214,147
507,334
90,759,571
$ 1.51
$ 1.49
83,159,321
$ 0.44
$ 0.44
61,635,339
$ 0.63
$ 0.62
Directors can elect to make payments that become due in the
form of cash or shares of the company’s common stock (refer to
Note 9 - Stock Compensation Plans for additional discussion).
Performance units granted if fully earned would represent 443,372
shares of the company’s common stock at December 31, 2004.
These performance units have not been included in the calculation
of dilutive securities.
Accumulated other comprehensive loss consists of the following:
2004
Foreign currency translation adjustment
Fair value of open foreign currency cash flow hedges
In 2004, the company began the process of liquidating one of its
inactive subsidiaries, British Timken, which is located in Duston,
England. The company recorded a non-cash charge of $16,186 on
dissolution that related primarily to the transfer of cumulative foreign
$ 100,278
(387,750)
(2,014)
$ (289,486)
2003
2002
(5,458)
(351,282)
(1,642)
$ (358,382)
$ (80,520)
(383,095)
(2,062)
$ (465,677)
$
currency translation losses to the consolidated statement of income,
which was included in other expense - net.
During 2004, the company sold the real estate of this facility in
Duston, England, which ceased operations in 2002, for a gain of
$22,509, which was included in other expense - net on the consolidated statement of income.
2004
Variable-rate lines of credit for certain of the company’s European subsidiaries with
Variable-rate Ohio Water Development Authority revenue bonds for PEL
(2.07% and 1.35% at December 31, 2004 and 2003, respectively)
Other
Short-term debt
2003
$ 109,260
$
78,196
23,000
11,561
13,596
$ 157,417
23,000
13,273
$ 114,469
Refer to Note 7 – Contingencies and Note 12 – Equity Investments in the notes to consolidated financial statements for a discussion
of PEL’s debts, which are included above.
254
Fixed-rate Medium-Term Notes, Series A, due at various dates through
May 2028, with interest rates ranging from 6.20% to 7.76%
Variable-rate State of Ohio Air Quality and Water Development
Revenue Refunding Bonds, maturing on November 1, 2025
(1.98% at December 31, 2004)
Variable-rate State of Ohio Pollution Control Revenue Refunding
Bonds, maturing on June 1, 2033 (1.98% at December 31, 2004)
Variable-rate State of Ohio Water Development Revenue
Refunding Bonds, maturing on May 1, 2007 (2.00% at December 31, 2004)
Variable-rate State of Ohio Water Development Authority Solid Waste
Revenue Bonds, maturing on July 1, 2032 (2.02% at December 31, 2004)
Other
Long-term debt
The maturities of long-term debt for the five years subsequent to December 31, 2004, are as follows: 2005–$1,273; 2006–
$92,689; 2007–$8,526; 2008–$27,201; and 2009–$88.
Interest paid was approximately $52,000 in 2004, $43,000 in 2003
and $33,000 in 2002. This differs from interest expense due to
timing of payments and interest capitalized of $541 in 2004, $0 in
2003; and $436 in 2002. The weighted-average interest rate
on short-term debt during the year was 3.1% in 2004, 4.1% in
2003 and 4.8% in 2002. The weighted-average interest rate on
short-term debt outstanding at December 31, 2004 and 2003 was
3.4% and 2.8%, respectively.
In connection with the Torrington acquisition, the company entered
into new $875 million senior credit facilities on December 31, 2002,
with a syndicate of financial institutions, comprised of a five-year
revolving credit facility of up to $500 million and a one-year term
loan facility of up to $375 million. The one-year term loan facility
expired unused on February 18, 2003. The new revolving facility
replaced the company’s then existing senior credit facility.
Proceeds of the new senior credit facility were used to repay the
amounts outstanding under the then existing 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. At December 31, 2004, the company
was in full compliance with the covenants under its senior credit
facility and its other debt agreements. At December 31, 2004, the
company had outstanding letters of credit totaling $71.0 million and
borrowings of $10.0 million, which reduced the availability under
the $500 million senior credit facility to $419.0 million.
2004
2003
$ 286,832
$ 287,000
21,700
21,700
17,000
17,000
8,000
8,000
24,000
249,258
15,117
621,907
1,273
$ 620,634
24,000
250,000
12,471
620,171
6,725
$ 613,446
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 December 31, 2004 and 2003, there were no amounts outstanding under this facility. Any amounts outstanding under this facility
would be reported on the company’s consolidated balance sheet in
short-term debt. 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 statement of income. This rate was 2.57% and 1.56%, at December 31,
2004 and 2003, respectively.
The lines of credit for certain of the company’s European
subsidiaries provide for borrowings up to $134.3 million. At
December 31, 2004, the company had outstanding borrowings
of $109.3 million, which reduced the availability under these
facilities to $25.0 million.
The company and its subsidiaries lease a variety of real property
and equipment. Rent expense under operating leases amounted
to $19,550, $19,374, and $14,536 in 2004, 2003 and 2002, respectively. At December 31, 2004, future minimum lease payments
for noncancelable operating leases totaled $109,729 and are
payable as follows: 2005–$19,347; 2006–$18,287; 2007–$15,573;
2008–$12,373; 2009–$10,935; and $33,214 thereafter.
255
46 I 47
Impairment and restructuring charges are comprised of the following:
2004
2003
2002
Impairment charges
Exit costs
Total
$
$
In 2004, the impairment charge related primarily to the write
down of property, plant and equipment at one of the Steel
Group’s facilities based on the company’s estimate of its fair value.
The severance and related benefit costs related to associates who
exited the company as a result of the integration of Torrington. The
exit costs related primarily to facilities in the U.S.
In 2003, impairment charges represented the write-off of the
remaining goodwill for the Steel Group in accordance with
SFAS No. 142, “Goodwill and Other Intangible Assets,” of
$10.2 million and impairment charges for the Columbus, Ohio plant
8.5
4.2
0.7
13.4
$
$
12.5
2.9
3.7
19.1
$
$
17.9
10.2
4.0
32.1
of $2.3 million. The severance and related benefit costs of
$2.9 million related to associates who exited the company as a
result of the integration of Torrington and other actions taken by
the company to reduce costs. The exit costs were comprised of
$3.0 million for the Columbus, Ohio plant and $0.7 million for the
Duston, England plant as a result of changes in estimates for these
two projects. Manufacturing operations at Columbus and Duston
ceased in 2001 and 2002, respectively.
In 2002, the impairment charges and exit costs were related to
the Duston, England and Columbus, Ohio plant closures. The
severance and related benefit costs related primarily to a salaried
workforce reduction throughout the company.
Auto
Steel
Industrial
Total
Impairment charges
Exit costs
Total
$
$
1.7
1.7
$
8.5
8.5
8.5
4.2
0.7
$ 13.4
Steel
Total
2.3
2.2
3.0
7.5
$ 10.2
0.2
$ 10.4
$ 12.5
2.9
3.7
$ 19.1
Industrial
Steel
Total
3.8
3.8
$ 17.9
10.2
4.0
$ 32.1
$
2.5
0.7
3.2
$
$
$
Auto
Industrial
Impairment charges
Exit costs
Total
$
$
0.5
0.7
1.2
$
$
Auto
Impairment charges
Exit costs
Total
$ 14.2
0.9
3.9
$ 19.0
As of December 31, 2004, the remaining accrual balance for
severance and exit costs was $4.1 million. The activity for 2004
included expense accrued of $4.9 million, and payments of
$5.3 million. As of December 31, 2003, the accrual balance was
$4.5 million.
$
$
3.7
5.5
0.1
9.3
$
$
The activity for 2003 included expense accrued of $6.1 million,
payments of $6.5 million and accrual reversals of $1.1 million. In
2003, the accrual balance was reduced for severance that was
accrued, but not paid as a result of certain associates
retiring or finding other employment. As of December 31, 2002,
the accrual balance was $6.0 million.
256
7 Contingencies
The company and certain of its U.S. subsidiaries have been
designated as potentially responsible parties (PRPs) by the United
States Environmental Protection Agency for site investigation and
remediation under the Comprehensive Environmental Response,
Compensation and Liability Act (Superfund) with respect to certain
sites. The claims for remediation have been asserted against
numerous other entities which are believed to be financially
solvent and are expected to fulfill their proportionate share of the
obligation. In addition, the company is subject to various lawsuits,
claims and proceedings which arise in the ordinary course of its
business. The company accrues costs associated with environmental and legal matters when they become probable and
reasonably estimable. Accruals are established based on the
estimated undiscounted cash flows to settle the obligations and
are not reduced by any potential recoveries from insurance or
other indemnification claims. Management believes that any
ultimate liability with respect to these actions, in excess of
amounts provided, will not materially affect the company’s
consolidated operations, cash flows or financial position.
of credit was provided by the company to secure payment on Ohio
Water Development Authority revenue bonds held by PEL.
In case of default by PEL, the company agrees to pay existing
balances due as of the date of default. The letter of credit expires
on July 22, 2005. Also, the company provided a guarantee for a
$3,500 bank loan of PEL, which the company paid during 2004.
During 2003, the company recorded the amounts outstanding on
the debts underlying the guarantees, which totaled $26,500 and
approximated the fair value of the guarantees. Refer to Note 12 –
Equity Investments for additional discussion.
In connection with the Ashland plant sale, the company entered
into a four-year supply agreement with the buyer. The company
agrees to purchase a fixed amount each year ranging from $8,500
in the first year to $4,650 in year four or an aggregate total of
$25,900. The agreement also details the payment terms and
penalties assessed if the buyer does not meet the company’s
performance standards as outlined. This agreement expires on
June 30, 2006.
The company is also the guarantor of debt for PEL Technologies
LLC (PEL), an equity investment of the company. A $23,494 letter
48 I 49
257
SFAS No. 142 requires that goodwill and indefinite-lived intangible
assets be tested for impairment at least annually. The company
engages an independent valuation firm and performs its annual
impairment test during the fourth quarter after the annual forecasting process is completed. There was no impairment in 2004.
company’s Steel reporting unit. Accordingly, the company had
concluded that the entire amount of goodwill for its Steel reporting
unit was impaired. The company recorded a pretax impairment
loss of $10.2 million, which was reported in impairment and
restructuring charges.
In 2003, due to trends in the steel industry, the guideline company
values for the Steel reporting unit were revised downward. The
valuation which uses the guideline company method resulted in
a fair market value that was less than the carrying value for the
In fiscal 2002, upon adoption of SFAS No. 142, the company
recorded an impairment loss of $12.7 million, net of tax benefits of
$7.8 million, related to the Specialty Steel business as a cumulative
effect of change in accounting principle.
Beginning
Balance
Goodwill:
Automotive
Industrial
Totals
$
1,264
171,835
$ 173,099
Impairment
$
$
-
Acquisitions
$
$
13,774
13,774
Ending
Balance
Other
$
414
2,012
$ 2,426
$
1,678
187,621
$189,299
Beginning
Balance
Goodwill:
Automotive
Industrial
Steel
Totals
$
1,633
119,440
8,870
$ 129,943
Impairment
$
(10,237)
$ (10,237)
Acquisitions
$
$
46,951
46,951
Ending
Balance
Other
$
(369)
5,444
1,367
$ 6,442
$
1,264
171,835
$173,099
258
The following table displays other intangible assets as of December 31:
2004
2003
Gross
Amount Amortization
Intangible assets subject to amortization:
Automotive:
Land use rights
Patents
Technology use
Trademarks
Industrial:
Know-how transfer
Land use rights
Patents
Technology use
Trademarks
PMA licenses
Steel trademarks
Intangible assets not subject to amortization:
Goodwill
$
19,901
1,680
608
14,769
5,202
1,279
8,775
Gross
Amount Amortization
$
21,960
3,000
622
18,094
5,827
2,295
10,800
$ 21,960
3,000
659
18,442
5,535
2,176
10,800
$
15,209
2,000
486
4,484
878
5,548
1,507
7,200
1,412
633
$ 101,929
1,398
880
431
1,245
242
333
626
1,350
63
126
$ 17,052
13,811
1,120
55
3,239
636
5,215
881
5,850
1,349
507
$ 84,877
14,640
2,000
417
4,484
646
5,827
1,492
7,200
450
$ 99,754
$ 189,299
92,860
144
963
$ 283,266
$ 385,195
$ 17,052
$ 189,299
92,860
144
963
$ 283,266
$ 368,143
$ 173,099
106,518
115
959
$ 280,691
$ 380,445
Amortization expense for intangible assets was approximately
$8,800 and $7,900 for the years ended December 31, 2004 and
2003, and is estimated to be approximately $8,500 annually for the
next five years. The other intangible assets that are subject to
2,059
1,320
51
3,673
333
897
2,025
Net
Carrying
Amount
$
960
616
24
1,685
464
507
945
$
$
$
Net
Carrying
Amount
$
21,000
2,384
598
16,409
5,363
1,788
9,855
641
411
360
1,075
94
463
366
630
112
9,353
13,999
1,589
57
3,409
552
5,364
1,126
6,570
338
$ 90,401
9,353
$173,099
106,518
115
959
$280,691
$371,092
amortization acquired in the Torrington acquisition have useful lives
ranging from 2 to 20 years with a weighted-average useful life of
12 years.
259
50 I 51
Under the company’s stock option plans, shares of common stock
have been made available to grant at the discretion of the
Compensation Committee of the Board of Directors to officers and
key associates in the form of stock options, stock appreciation
rights, restricted shares, performance units, and deferred shares.
In addition, shares can be awarded to directors not employed by
the company. The options have a ten-year term and vest in
25% increments annually beginning twelve months after the
date of grant. Pro forma information regarding net income and
earnings per share is required by SFAS No. 123, and has been
determined as if the company had accounted for its associate
stock options under the fair value method of SFAS No. 123. The
fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model. For purposes of
pro forma disclosures, the estimated fair value of the options
granted under the plan is amortized to expense over the options’
vesting periods.
Following are the related assumptions under the Black-Scholes method:
Assumptions:
Dividend yield
Expected life - years
2004
2003
2002
4.29%
3.94%
3.69%
0.504
8
5.29%
3.57%
0.506
8
3.65%
0.401
8
A summary of activity related to stock options for the above plans is as follows for the years ended December 31:
2004
Options
Outstanding - beginning of year
Granted
Exercised
Canceled or expired
Outstanding - end of year
Options exercisable
2003
WeightedAverage
Exercise Price
8,334,920
702,250
(1,436,722)
(211,538)
7,388,910
$20.68
23.94
17.39
25.13
21.50
5,081,063
$21.95
The company sponsors a performance target option plan that is
contingent upon the company’s common shares reaching specified
fair market values. Under the plan, the number of shares awarded
were 25,000, 0 and 20,000 in 2004, 2003 and 2002, respectively.
No compensation expense was recognized in 2004, 2003 or 2002.
Exercise prices for options outstanding as of December 31, 2004,
range from $15.02 to $19.56, $21.99 to $26.44 and $33.75;
the number of options outstanding at December 31, 2004 that
correspond to these ranges are 3,964,410, 2,723,900 and
700,600, respectively; and the number of options exercisable at
December 31, 2004 that correspond to these ranges are
2,735,130, 1,645,333 and 700,600, respectively. The weightedaverage remaining contractual life of these options is 6 years. The
estimated weighted-average fair values of stock options granted
during 2004, 2003 and 2002 were $7.82, $6.78 and $10.36, respectively. At December 31, 2004, a total of 500,500 restricted
stock rights, restricted shares or deferred shares have been
awarded under the above plans and are not vested. The company
Options
7,310,026
1,491,230
(93,325)
(373,011)
8,334,920
5,771,810
2002
WeightedAverage
Exercise Price
$21.21
17.56
15.65
20.02
20.68
$21.53
Options
WeightedAverage
Exercise Price
6,825,412
1,118,175
(499,372)
(134,189)
7,310,026
4,397,590
$20.22
25.01
16.30
20.61
21.21
$22.39
distributed 73,025, 125,967 and 100,947 common shares in 2004,
2003 and 2002, respectively, as a result of awards of restricted
stock rights, restricted shares and deferred shares. The number of
restricted stock rights, restricted shares and deferred shares that
were awarded in 2004, 2003 and 2002 totaled 371,650, 38,500 and
256,000, respectively.
The company offers a performance unit component under its
long-term incentive plan to certain employees in which grants are
earned based on company performance measured by several
metrics over a three-year performance period. The Compensation
Committee of the Board of Directors can elect to make payments
that become due in the form of cash or shares of the company’s
common stock. 34,398, 48,225 and 44,375 performance units
have been granted in 2004, 2003 and 2002, respectively. 15,007
performance units were cancelled in 2004. Each performance unit
has a cash value of $100.
The number of shares available for future grants for all plans at
December 31, 2004, including stock options, is 5,075,782.
260
As a result of the company’s worldwide operating activities, it
is exposed to changes in foreign currency exchange rates,
which affect its results of operations and financial condition.
The company and certain subsidiaries enter into forward exchange
contracts to manage exposure to currency rate fluctuations,
primarily related to anticipated purchases of inventory and equipment. At December 31, 2004 and 2003, the company had forward
foreign exchange contracts, all having maturities of less than
eighteen months, with notional amounts of $130,794 and
$145,590, and fair values of $8,574 and $4,416, respectively. The
forward foreign exchange contracts were entered into primarily by
the company’s domestic entity to manage Euro exposures relative
to the U.S. Dollar and its European subsidiaries to manage Euro
and U.S. Dollar exposures. The realized and unrealized gains and
losses on these contracts are deferred and included in inventory or
property, plant and equipment, depending on the transaction.
These deferred gains and losses are reclassified from accumulated other comprehensive loss and recognized in earnings when the
future transactions occur, or through depreciation expense.
During 2004, the company entered into interest rate swaps with a
total notional value of $80 million to hedge a portion of its fixed-rate
debt. Under the terms of the interest rate swaps, the company
receives interest at fixed rates and pays interest at variable rates.
The maturity dates of the interest rate swaps are January 15, 2008
and February 15, 2010. The fair value of these swaps was $909 at
December 31, 2004. The critical terms, such as principal and
notional amounts and debt maturity and swap termination dates,
coincide resulting in no hedge ineffectiveness. These instruments
are designated and qualify as fair value hedges. Accordingly, the
gain or loss on both the hedging instrument and the hedged item
attributable to the hedged risk are recognized currently in earnings.
The carrying value of cash and cash equivalents, accounts
receivable, commercial paper, short-term borrowings and accounts
payable are a reasonable estimate of their fair value due to the
short-term nature of these instruments. The fair value of the
company's long-term fixed-rate debt, based on quoted market
prices, was $549,000 and $533,000 at December 31, 2004 and
2003, respectively. The carrying value of this debt was $539,000
and $546,000.
The company performs research and development under
company-funded programs and under contracts with the Federal
government and others. Expenditures committed to research and
development amounted to $58,500, $55,700 and $57,000 for
2004, 2003 and 2002, respectively. Of these amounts, $8,400,
$3,300 and $5,600, respectively were funded by others.
Expenditures may fluctuate from year to year depending on special
projects and needs.
The balances related to investments accounted for under the
equity method are reported in miscellaneous receivables and
other assets on the consolidated balance sheets, which were
approximately $29,800 and $34,000 at December 31, 2004 and
2003, respectively.
Equity investments are reviewed for impairment when circumstances (such as lower-than-expected financial performance or
change in strategic direction) indicate that the carrying 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 consolidated statement of income.
During 2000, the company’s Steel Group invested in a joint venture,
PEL, to commercialize a proprietary technology that converts iron
units into engineered iron oxides for use in pigments, coatings and
abrasives. In the fourth quarter of 2003, the company concluded
its investment in PEL was impaired due to the following indicators
of impairment: history of negative cash flow and losses; 2004
operating plan with continued losses and negative cash flow; and
the continued required support from the company or another party.
In the fourth quarter of 2003, the company recorded a non-cash
impairment loss of $45,700, which is reported in other expense-net
on the consolidated statement of income.
The company concluded that PEL is a variable interest entity and
that the company is the primary beneficiary. In accordance with
FASB Interpretation No. 46, “Consolidation of Variable Interest
Entities, an interpretation of Accounting Research Bulletin No. 51,”
(FIN 46), the company consolidated PEL effective March 31, 2004.
The adoption of FIN 46 resulted in a charge, representing the cumulative effect of change in accounting principle, of $948, which is
reported in other expense-net on the consolidated statement of
income. Also, the adoption of FIN 46 increased the consolidated
balance sheet as follows: current assets by $1,659; property, plant
and equipment by $11,333; short-term debt by $11,561; accounts
payable and other liabilities by $659; and other non-current liabilities
by $1,720. All of PEL’s assets are collateral for its obligations.
Except for PEL’s indebtedness for which the company is a guarantor, PEL’s creditors have no recourse to the general credit of the
company.
261
52 I 53
The company sponsors defined contribution retirement and
savings plans covering substantially all associates in the United
States and certain salaried associates at non-U.S. locations. The
company contributes Timken Company common stock to certain
plans based on formulas established in the respective plan agreements. At December 31, 2004, the plans had 12,411,755 shares
of Timken Company common stock with a fair value of $322,954.
Company contributions to the plans, including performance sharing, amounted to $22,801 in 2004; $21,029 in 2003; and $14,603
in 2002. The company paid dividends totaling $6,467 in 2004;
$6,763 in 2003; and $6,407 in 2002, to plans holding common
shares.
The company and its subsidiaries sponsor several unfunded
postretirement plans that provide health care and life insurance
benefits for eligible retirees and dependents. Depending on
retirement date and associate classification, certain health care
plans contain contributions and cost-sharing features such as
deductibles and coinsurance. The remaining health care and life
insurance plans are noncontributory.
The company and its subsidiaries sponsor a number of defined
benefit pension plans, which cover eligible associates.
As part of the Torrington purchase agreement, the company
agreed to prospectively provide former Torrington associates with
substantially comparable retirement benefits for a specified period
of time. The active Torrington associates became part of Timken’s
defined benefit pension plans, but prior service liabilities and
defined benefit plan assets remained with IR for the U.S.-based
pension plans; however, the company did assume prior service
liabilities for certain non-U.S.-based pension plans.
During 2003, the company made revisions, which became effective on January 1, 2004, to certain of its benefit programs for its
U.S.-based employees resulting in a pretax curtailment gain of
$10,720. Depending on an associate’s combined age and years of
service with the company, defined benefit pension plan benefits
were reduced or replaced by a new defined contribution plan. The
company will no longer subsidize retiree medical coverage for
those associates who do not meet a threshold of combined age
and years of service with the company.
262
The company uses a measurement date of December 31 to determine pension and other postretirement benefit measurements for the
pension plans and other postretirement benefit plans.
The following tables set forth the change in benefit obligation, change in plan assets, funded status and amounts recognized in the
consolidated balance sheet of the defined benefit pension and postretirement benefits as of December 31, 2004 and 2003:
Defined Benefit
Pension Plans
2004
2003
2004
2003
802,218
5,751
48,807
2
14,890
222
(51,295)
820,595
$ 720,675
6,765
49,459
(3,586)
20,228
65,516
479
(8,097)
(49,221)
$ 802,218
Service cost
Interest cost
Amendments
Actuarial losses
Acquisition
Benefits paid
$ 2,337,722
37,112
145,880
1,258
197,242
962
25,953
(159,983)
$ 2,586,146
$2,117,144
47,381
137,242
(2,350)
111,230
821
34,905
33,278
1,066
(142,995)
$2,337,722
Change in plan assets(1)
Acquisition
Benefits paid
$ 1,548,142
234,374
962
196,951
17,823
(157,386)
$ 1,840,866
$1,198,351
287,597
821
173,990
7,009
22,349
(141,975)
$1,548,142
$
(745,280)
739,079
(598)
95,820
89,021
$ (789,580)
657,781
(660)
109,421
$ (23,038)
$ (820,595)
303,244
(33,016)
$ (550,367)
$ (802,218)
307,003
(37,701)
$ (532,916)
(603,644)
92,860
$ (674,502)
106,518
$ (550,367)
-
$ (532,916)
-
544,946
(23,038)
$ (550,367)
$ (532,916)
Funded status
Projected benefit obligation in excess of plan assets
Prepaid (accrued) benefit cost
Amounts recognized in the consolidated balance sheet
Accrued benefit liability
Intangible asset
Minimum pension liability included in accumulated
other comprehensive loss
Net amount recognized
(1)
$
$
$
599,805
89,021
$
$
$
54 I 55
The current portion of accrued pension cost, which is included in
salaries, wages and benefits on the consolidated balance sheet,
was $135,000 and $197,000 at December 31, 2004 and 2003,
respectively. The current portion of accrued postretirement
benefit cost, which is included in salaries, wages and benefits on
the consolidated balance sheet, was $60,000 and $55,950 at
December 31, 2004 and 2003, respectively.
263
13 Retirement and Postretirement Benefit Plans (continued)
2004 solid investment performance, which primarily reflected
higher stock market returns, increased the company’s pension
fund asset values. At the same time, the company’s defined
benefit pension liability also increased as a result of lowering the
discount rate from 6.3% to 6.0%.
The accumulated benefit obligations at December 31, 2004
exceeded the market value of plan assets for the majority of the
company’s plans. For these plans, the projected benefit obligation
was $2,555,000; the accumulated benefit obligation was
$2,425,000; and the fair value of plan assets was $1,813,000 at
December 31, 2004.
In 2004, as a result of increases in the company’s defined benefit
pension liability, the company recorded additional minimum
pension liability of $54,859 and a non-cash after tax charge to
accumulated other comprehensive loss of $36,468.
For 2005 expense, the company’s discount rate has been reduced
from 6.3% to 6.0%. This change will result in an increase in 2005
pretax pension expense of approximately $5,000.
On September 10, 2002, the company issued 3,000,000 shares of
its common stock to The Timken Company Collective Investment
Trust for Retirement Trusts (Trust) as a contribution to three
company-sponsored pension plans. The fair market value of the
3,000,000 shares of common stock contributed to the Trust was
approximately $54,500, which consisted of 2,766,955 shares of
the company’s treasury stock and 233,045 shares issued from
authorized common stock. As of December 31, 2004, the
company’s defined benefit pension plans held 1,313,000 common
shares with fair value of $34,164. The company paid dividends
totaling $927 in 2004 to plans holding common shares.
The following table summarizes the assumptions used by the consulting actuary and the related benefit cost information:
Pension Benefits
Assumptions
Discount rate
Expected long-term return on plan assets
Components of net periodic benefit cost
Service cost
Interest cost
2004
2003
2002
2004
2003
2002
6.0%
3% to 4%
8.75%
6.3%
3% to 4%
8.75%
6.6%
3% to 4%
9.5%
6.0%
6.3%
6.6%
$ 37,112
145,880
(146,199)
15,137
33,075
(106)
$ 84,899
$ 47,381
137,242
(133,474)
18,506
19,197
560
(574)
$ 88,838
$ 36,115
132,846
(135,179)
19,725
473
6,706
(1,143)
$ 59,543
5,751
48,807
(4,683)
17,628
$ 67,503
$ 6,765
49,459
(5,700)
14,997
(8,856)
$ 56,665
$ 4,357
47,505
(6,408)
11,827
871
$ 58,152
For measurement purposes, the company assumed a weightedaverage annual rate of increase in the per capita cost (health care
cost trend rate) for medical benefits of 10.0% for 2005, declining
gradually to 5.0% in 2010 and thereafter; and 12.75% for 2005,
declining gradually to 6.0% in 2014 and thereafter for prescription
drug benefits.
$
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 increase the
2004 total service and interest cost components by $1,807 and
would increase the postretirement benefit obligation by
$29,662. A one-percentage-point decrease would provide
corresponding reductions of $1,616 and $26,759, respectively.
264
On December 8, 2003, the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (the Act) was signed
into law. The Act provides for prescription drug benefits under
Medicare Part D and contains a subsidy to plan sponsors who provide “actuarially equivalent” prescription plans. The company
believes that it offers “actuarially equivalent” prescription plans. In
accordance with FASB Staff Position 106-1, as updated by 106-2, all
measures of the APBO or net periodic postretirement benefit cost in
the financial statements or accompanying notes reflect the effects of
the Act on the plan for the entire fiscal year.
For the year 2004, the effect on the accumulated postretirement
benefit obligation attributed to past service as of January 1, 2004 is
a reduction of $30,663 and the effect on the amortization of
actuarial losses, service cost, and interest cost components of net
periodic benefit cost is a reduction of $4,148. No Medicare
subsidies were received in 2004.
Plan Assets:
The company’s pension asset allocation at December 31, 2004 and 2003, and target allocation are as follows:
Current Target
Allocation
Percentage of Pension Plan
Assets at December 31
Asset Category
2005
Equity securities
Debt securities
Total
60% to 70%
30% to 40%
100%
The company recognizes its overall responsibility to ensure that
the assets of its various pension plans are managed effectively and
prudently and in compliance with its policy guidelines and all
applicable laws. Preservation of capital is important; however, the
company also recognizes that appropriate levels of risk are
necessary to allow its investment managers to achieve satisfactory
long-term results consistent with the objectives and the fiduciary
2004
68%
32%
100%
2003
70%
30%
100%
character of the pension funds. Asset allocation is established in a
manner consistent with projected plan liabilities, benefit payments
and expected rates of return for various asset classes. The expected rate of return for the investment portfolio is based on expected
rates of return for various asset classes as well as historical asset
class and fund performance.
56 I 57
Cash Flows:
2003
2004
2005 (expected)
$ 173,990
$ 196,951
$ 135,000
Benefit Payments
Pension Benefits
Gross
2005
2006
2007
2008
2009
2010-2014
$
$
$
$
$
$
154,034
155,267
157,066
160,036
163,258
884,177
$ 59,732
$ 63,181
$ 65,620
$ 67,696
$ 69,595
$ 349,879
$
$
$
$
$
$
Expected
Medicare
Subsidies
Net Including
Medicare
Subsidies
2,179
2,340
2,493
2,619
14,091
$ 59,732
$ 61,002
$ 63,280
$ 65,203
$ 66,976
$ 335,788
The accumulated benefit obligation was $2,451,345 and $2,227,003 at December 31, 2004 and 2003, respectively.
265
Description of types of products and services from which each
reportable segment derives its revenues
The company’s reportable segments are business units that
target different industry segments. Each reportable segment is
managed separately because of the need to specifically address
customer needs in these different industries. The company has
three reportable segments: Automotive, Industrial and Steel
Groups.
steel products, including precision steel components. A significant
portion of the company’s steel is consumed in its bearing
operations. In addition, sales are made to other anti-friction
bearing companies and to aircraft, automotive, forging, tooling, oil
and gas drilling industries and steel service centers. Tool steels are
sold through the company’s distribution facilities.
Beginning in the first quarter of 2003, 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 manages 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. Emerging market sales to automotive
original equipment manufacturers are now included in the
Automotive Group.
The Automotive Group includes sales of bearings and other
products and services (other than steel) to automotive original
equipment manufacturers for passenger cars, trucks and trailers.
The Industrial Group includes sales of bearings and other products
and services (other than steel) to a diverse customer base,
including: industrial equipment; off-highway; rail; and aerospace
and defense customers. The company’s bearing products are used
in a variety of products and applications including passenger cars,
trucks, aircraft wheels, locomotive and railroad cars, machine tools,
rolling mills and farm and construction equipment, in aircraft,
missile guidance systems, computer peripherals and medical
instruments.
Steel Group includes sales of intermediate alloy, vacuum
processed alloys, tool steel and some carbon grades. These are
available in a wide range of solid and tubular sections with a
variety of finishes. The company also manufactures custom-made
The company evaluates performance and allocates resources
based on return on capital and profitable growth. 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, integration costs, one-time gains or losses on sales
of assets, allocated receipts received or payments made under the
CDSOA, loss on dissolution of subsidiary, acquisition-related currency
exchange gains, and other items similar in nature). The accounting
policies of the reportable segments are the same as those
described in the summary of significant accounting policies.
Intersegment sales and transfers are recorded at values based on
market prices, which creates intercompany profit on intersegment
sales or transfers.
Factors used by management to identify the enterprise’s
reportable segments
In the previous years’ Segment Information note to consolidated
financial statements, the company reported net sales by geographic
area based on the location of its selling subsidiary. In 2004, the
company changed its reporting of net sales by geographic area to
be more reflective of how the company operates its segments,
which is by the destination of net sales. Net sales by geographic
area for 2003 and 2002 have been reclassified to conform to the
2004 presentation. Non-current assets by geographic area are
reported by the location of the subsidiary.
United
States
Europe
Other
Countries
Consolidated
2004
Net sales
Non-current assets
$ 3,114,138
1,536,859
$ 784,778
410,407
$ 614,755
257,943
$ 4,513,671
2,205,209
2003
Net sales
Non-current assets
$ 2,673,007
1,753,221
$ 648,412
365,969
$ 466,678
193,494
$ 3,788,097
2,312,684
2002
Net sales
Non-current assets
$ 1,876,696
1,472,680
$ 347,220
223,348
$ 326,159
84,036
$ 2,550,075
1,780,064
266
2004
2003
2002
$ 1,582,226
78,100
15,919
73,385
1,280,979
$ 1,396,104
82,958
15,685
71,294
1,180,537
$ 752,763
33,866
11,095
34,948
663,864
$ 1,709,770
1,437
71,352
177,913
49,721
1,680,175
$ 1,498,832
837
61,018
128,031
33,724
1,617,898
$ 971,534
45,429
73,040
32,178
1,105,684
$ 1,221,675
161,941
59,979
54,756
23,907
977,346
$ 893,161
133,356
64,875
(6,043)
24,297
891,354
$ 825,778
155,500
67,240
32,520
23,547
978,808
$ 4,513,671
209,431
248,588
147,013
3,938,500
$ 3,788,097
208,851
137,673
129,315
3,689,789
$ 2,550,075
146,535
116,655
90,673
2,748,356
$
44,429
22,509
(16,186)
(5,399)
(948)
(719)
(50,834)
1,397
(1,865)
$ 137,673
(19,154)
(33,913)
1,996
65,559
1,696
(45,730)
(48,401)
1,123
(47)
$ 116,655
(32,143)
(18,445)
50,202
(31,540)
1,676
(887)
199,779
$
$
Automotive Group
EBIT as adjusted
Industrial Group
Intersegment sales
EBIT, as adjusted
Steel Group
Intersegment sales
EBIT (loss), as adjusted
58 I 59
Total
EBIT, as adjusted
Reconciliation to Income Before Income Taxes
Integration/Reorganization expenses
(Loss) gain on sale of assets
CDSOA net receipts, net of expenses
Acquisition-related unrealized currency exchange gains
Impairment charge for investment in PEL
Gain on sale of real estate
Loss on sale of business
Other
Interest expense
Interest income
Income before income taxes and cumulative effect of change
$
248,588
(13,434)
(27,025)
(734)
60,802
85,518
267
15 Income Taxes
For financial statement reporting purposes, income before income
taxes, based on geographic location of the operation to which such
earnings are attributable, is provided below. The Timken Company
has elected to treat certain foreign entities as branches for US
income tax purposes, therefore pretax income by location is not
directly related to pretax income as reported to the respective taxing
jurisdictions.
United States
Non- United States
2004
2003
2002
$165,392
$ 34,387
$199,779
$ 53,560
$ 7,242
$ 60,802
$191,105
$(105,587)
$ 85,518
The provision (credit) for income taxes consisted of the following:
2004
Current
United States:
Federal
State and local
Foreign
2003
Deferred
$ (12,976) $ 53,646
4,078
1,063
10,982
7,330
$ 2,084 $ 62,039
Current
$
1,020
18,895
$ 19,915
2002
Deferred
$
$
48
1,271
3,087
4,406
Current
Deferred
$
5,220
3,936
7,661
$ 16,817
$ 17,808
(1,682)
1,124
$ 17,250
The company made income tax payments of approximately $49,758 and $13,830 in 2004 and 2003, respectively. During
2002, the company received income tax refunds of approximately $27,000. Taxes paid differ from current taxes provided,
primarily due to the timing of payments.
Following is the reconciliation between the provision for income taxes and the amount computed by applying U.S. federal income tax rate
of 35% to income before income taxes:
Income tax at the statutory federal rate
Adjustments:
Foreign Jurisdictions with different tax rates
Extraterritorial Income Benefit
Tax Holiday
Settlements of prior year liabilities
Other items
In connection with various investment arrangements, the Company
has a “holiday” from income taxes in the Czech Republic and
China. These agreements were new to the Company in 2003 and
2004
2003
2002
$ 69,922
$ 21,281
$ 29,931
3,743
4,164
28,630
(6,123)
(2,013)
(2,308)
(4,505)
(12,673)
(11,954)
(2,760)
$ 64,123
32.1%
1,489
1,465
3,027
2,225
8,866
3,598
(2,824)
664
(1,975)
(2,137)
(8,626)
(980)
(2,166)
500
2,548
4,749
(3,247)
$ 24,321 $ 34,067
40%
40%
expire in 2010 and 2007, respectively. In total, the agreements
reduced income tax expenses by $4,500 in 2004 and $2,200 in
2003. These savings resulted in an increase to earnings per
diluted share of $0.05 in 2004 and $0.03 in 2003.
268
The effect of temporary differences giving rise to deferred tax assets and liabilities at December 31, 2004 and 2003 were as follows:
Inventory
Benefit accruals
Other–net
Valuation allowance
Deferred tax liability – depreciation & amortization
The company has U.S. loss carryforwards with tax benefits totaling
$79,800. These losses will start to expire in 2021. In addition,
the company has loss carryforward tax benefits in various foreign
jurisdictions of $62,100 with various expiration dates and state and
local loss carryforward tax benefits of $15,100, which will begin to
expire in 2014. The company has provided a $100,800 valuation
against certain U.S. and foreign loss carryforward tax benefits, a
$12,200 valuation against other deferred tax assets of certain
foreign subsidiaries, and a $12,200 valuation against the state and
local loss carryforward tax benefits.
The company has a research tax credit carryforward of $3,400, an
AMT credit carryforward of $5,200 and state income tax credits of
$4,900. The research tax credits will expire annually between 2019
and 2023 and the AMT credits do not have any expiration date. The
state income tax credits will expire at various intervals beginning in
2004 and have a $4,100 valuation against them.
2004
2003
$ 198,210
166,525
27,832
14,479
170,799
17,302
(129,328)
465,819
(298,918)
$ 166,901
$192,860
145,451
16,660
22,908
205,086
10,539
(100,851)
492,653
(293,580)
$199,073
Prior to the American Jobs Creation Act of 2004, the company
planned to reinvest undistributed earnings of all non-U.S. subsidiaries. The amount of undistributed earnings for this purpose
was approximately $185,000 at December 31, 2004.
On October 22, 2004, the President signed the American Jobs
Creation Act of 2004 (the Act). The Act creates a temporary
incentive for U.S. corporations to repatriate accumulated income
earned abroad by providing an 85 percent dividends received
deduction for certain dividends from controlled foreign corporations. This deduction is subject to a number of limitations. As
such, the company is not yet in a position to decide on whether,
and to what extent, it might repatriate foreign earnings that have
not yet been remitted to the U.S. The company expects to finalize
its assessment by June 30, 2005.
269
60 I 61
Repor t of Management on Internal Control
Over Financial Repor ting
reporting for the company. Timken’s internal control system was
designed to provide reasonable assurance regarding the preparation and fair presentation of published financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Based on our assessment under COSO’s
“Internal Control-Integrated Framework,” management believes
that, as of December 31, 2004, Timken’s internal control over
financial reporting is effective.
Timken management assessed the effectiveness of the company’s
internal control over financial reporting as of December 31, 2004.
In making this assessment, it used the criteria set forth by the
James W. Griffith
Glenn A. Eisenberg
President and
Chief Executive Officer
Executive Vice President –
Finance and Administration
Ernst & Young LLP, independent registered public accounting firm,
has issued an audit report on our assessment of Timken’s internal
control over financial reporting. This report appears on page 63.
Management Cer tifications
James W. Griffith, President and Chief Executive Officer of Timken,
has certified to the New York Stock Exchange that he is not aware
of any violation by Timken of New York Stock Exchange corporate
governance standards.
Section 302 of the Sarbanes-Oxley Act of 2002 requires Timken’s
principal executive officer and principal financial officer to file certain
certifications with the Securities and Exchange Commission relating
to the quality of Timken’s public disclosures. These certifications are
filed as exhibits to Timken’s Annual Report on Form 10-K.
Repor t of Independent Registered Public
Accounting Firm
To the Board of Directors and Shareholders
The Timken Company
We have audited the accompanying consolidated balance sheets
of The Timken Company and subsidiaries as of December 31, 2004
and 2003, and the related consolidated statements of income,
shareholders’ equity, and cash flows for each of the three years in
the period ended December 31, 2004. These financial statements
are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
The Timken Company and subsidiaries at December 31, 2004 and
2003, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31,
2004, in conformity with U.S. generally accepted accounting
principles.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of The Timken Company’s internal control over
financial reporting as of December 31, 2004, based on criteria
established in Internal Control – Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 28, 2005 expressed an
unqualified opinion thereon.
Cleveland, Ohio
February 28, 2005
270
Repor t of Independent Registered Public
Accounting Firm
To the Board of Directors and Shareholders
The Timken Company
We have audited management’s assessment, included in the
accompanying Report of Management on Internal Control Over
Financial Reporting, that The Timken Company maintained
effective internal control over financial reporting as of December
31, 2004, based on criteria established in Internal Control –
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria).
The Timken Company’s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s
assessment and an opinion on the effectiveness of the company’s
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal
control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s
assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial
reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of
the company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could
have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
In our opinion, management’s assessment that The Timken
Company maintained effective internal control over financial
reporting as of December 31, 2004, is fairly stated, in all material
respects, based on the COSO criteria. Also, in our opinion, The
Timken Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2004,
based on the COSO criteria.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of The Timken Company as of
December 31, 2004 and 2003, and the related consolidated
statements of income, shareholders’ equity, and cash flows for
each of the three years in the period ended December 31, 2004 of
The Timken Company and our report dated February 28, 2005
expressed an unqualified opinion thereon.
Cleveland, Ohio
February 28, 2005
271
62 I 63
Forward-Looking Statements
Certain statements set forth in this annual report (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. In particular the Corporate Profile on
pages 3 through 4 and Management’s Discussion and
Analysis on pages 19 through 37 contain numerous forwardlooking statements. 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 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.
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 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 the rapid improvement in the
industrial market, 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; higher cost and availability of raw materials
and energy; the company’s ability to mitigate the impact
of higher material costs through surcharges and/or price
increases; changes resulting from inventory management
and cost reduction initiatives and different levels of
customer demands; the effects of unplanned work stoppages; and changes in the cost of labor and benefits.
f) the success of the company's operating plans, including
its ability to achieve the benefits from its 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) the success of the company’s plans concerning the
transfer of bearing production from Canton, including the
possibility that the transfer of production will not achieve
the desired results, the possibility of disruption in the
supply of bearings during the process, and the outcome of
the company’s discussions with the union that represents
company associates at the affected facilities.
h) 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.
i) 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.
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.
272
Net
Sales
2004
Gross
Profit
Net
Income
(Loss)
Impairment &
Restructuring
Earnings per Share(1)
Basic
Diluted
Dividends
per
Share
Q1
$ 1,098,785
730
$ 28,470
Q2
1,130,287
$
205,587
329
25,341
.28
Q3
1,096,724
184,045
2,939
17,463
.19
.19
.13
Q4
1,187,875
246,430
9,436
64,382(2)(5)
.71
.71
.13
$ 4,513,671
202,523
$
$
.32
$
.32
$
.28
.13
.13
$
838,585
$
13,434
$ 135,656
$ 1.51
$ 1.49
$
.52
$
137,762(3)
$
-
$ 11,339
$
$
$
.13
2003
Q1
$ 838,007
Q2
990,253
158,069
853
Q3
938,012
147,610
1,883
Q4
1,021,825
195,677
16,418
$ 3,788,097
$
639,118(3)
$
19,154
.15
.15
3,921
.05
.05
.13
(1,275)
(.01)
(.01)
.13
22,496(2)(4)
$ 36,481
.26
$
.44
.25
$
.44
.13
$
.52
(1)
Annual earnings per share do not equal the sum of the individual quarters due to differences in the average number of shares outstanding during the respective periods.
(2)
Includes receipt (net of expenses) of $44.4 million and $65.6 million in 2004 and 2003 resulting from the U.S. Continued Dumping and Subsidy Offset Act.
(3)
Gross profit for 2003 includes a reclassification of $7.5 million from cost of products sold to selling administrative and general expenses for Torrington engineering and
research and development expenses to be consistent with the company’s 2004 cost classification methodology.
(4)
Includes $45.7 million for write-off of investment in joint venture, PEL.
(5)
Includes $17.1 million for the gain on sale of non-strategic assets and $16.2 million for the loss on dissolution of a subsidiary.
64 I 65
2004 Stock Prices
2003 Stock Prices
High
Low
High
Low
Q1 $24.70
$18.74
Q1 $20.46
$14.88
Q2
26.49
20.81
Q2
18.50
15.59
Q3
26.49
22.50
Q3
19.25
14.55
Q4
27.50
22.82
Q4
20.32
15.31
273
2004
2003
$ 1,582,226
1,709,770
3,291,996
1,221,675
4,513,671
$ 1,396,104
1,498,832
2,894,936
893,161
3,788,097
2002
2001
Net sales:
Automotive Bearings
Industrial Bearings
Total Bearings
Steel
Total net sales
Gross profit
Operating income (loss)
Other income (expense) - net
Earnings before interest and taxes (EBIT)(1)
Interest expense
Income (loss) before cumulative effect of
accounting changes
Net income (loss)
Balance Sheets
Inventory
Working capital
Property, plant and equipment – net
Total assets
Total debt:
Commercial paper
Short-term debt
Long-term debt
Total debt
Net debt:
Total debt
Net debt(5)
Total liabilities
Capital:
Net debt
Capital
Net income (loss) / Total assets
Net income (loss) / Net sales
EBIT / Net sales
EBIT / Beginning invested capital (2)
Beginning invested capital:
Total assets
Current portion of deferred income taxes
Long term portion of deferred income taxes
Income taxes
Beginning invested capital
Capital expenditures / Net sales
Dividends per share
Earnings per share - assuming dilution (4)
Number of associates at year-end
838,585
587,923
13,434
237,228
11,988
249,216
50,834
$
$
135,656
135,656
874,833
691,964
1,582,957
3,938,500
$
$
$
$
$
$
$
$
36,481
36,481
695,946
375,637
1,610,848
3,689,789
752,763
971,534
1,724,297
825,778
2,550,075
$
469,577
358,866
32,143
78,568
36,814
115,382
31,540
639,118(6)
521,717(6)
19,154
98,247
9,833
108,080
48,401
157,417
1,273
620,634
779,324
779,324
(50,967)
728,357
2,668,652
$ 1,269,848
$
$
$
114,469
6,725
613,446
734,640
51,451
38,749
488,923
334,222
1,226,244
2,748,356
642,943
990,365
1,633,308
813,870
2,447,178
400,720
363,683
54,689
(17,652)
22,061
4,409
33,401
$
$
8,999
78,354
23,781
350,085
461,219
(41,666)
(41,666)
429,231
187,224
1,305,345
2,533,084
1,962
84,468
42,434
368,151
497,015
734,640
(28,626)
706,014
2,600,162
$ 1,089,627
461,219
(82,050)
379,169
2,139,270
$
609,086
497,015
(33,392)
463,623
1,751,349
$
781,735
728,357
1,269,848
1,998,205
706,014
1,089,627
1,795,641
379,169
609,086
988,255
463,623
781,735
1,245,358
3.4%
3.0%
5.5%
9.7%
1.0%
1.0%
2.9%
5.6%
1.4%
1.5%
4.5%
6.0%
(1.6)%
(1.7)%
0.2%
0.2%
2,748,356
(82,050)
(36,003)
(169,051)
(296,543)
(222,546)
(3,847)
1,938,316
172.0
129,315
208,851
3.4%
0.52
0.44
0.44
39.3%
26,073
42,184
2,533,084
(33,392)
(42,895)
(27,164)
(258,001)
(254,291)
1,917,341
139.0
90,673
146,535
3.6%
0.52
0.63
0.62
38.4%
17,963
44,057
2,564,105
(10,927)
(43,094)
(239,182)
(137,320)
(1,527)
2,132,055
124.8
102,347
152,467
4.2%
0.67
(0.69)
(0.69)
37.2%
18,735
39,919
3,689,789
(28,626)
(50,271)
(148,802)
(425,157)
(376,603)
(78,514)
2,581,816
173.6
147,013
209,431
3.3%
0.52
1.51
1.49
36.5%
25,931
42,484
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
(1)
EBIT is defined as operating income plus other income (expense) - net.
The company uses EBIT/Beginning invested capital as a type of ratio that indicates return on capital. EBIT is defined as operating income plus other income (expense) - net. Beginning
invested capital is calculated as total assets less the following balance sheet line items: cash and cash equivalents; the current and long-term portions of deferred income taxes; accounts
payable and other liabilities; salaries, wages and benefits; and income taxes.
(3)
Based on the average number of associates employed during the year.
(4)
Based on the average number of shares outstanding during the year and includes the cumulative effect of accounting change in 2002, which related to the adoption of SFAS No. 142.
(5)
The company presents net debt because it believes net debt is more representative of the company's indicative financial position due to temporary changes in cash and cash equivalents.
(2)
274
2000
$
839,838(7)
923,477(7)
1,763,315
879,693
2,643,008
1999
$
500,873
367,499
27,754
105,620
(6,580)
99,040
31,922
$
$
45,888
45,888
489,549
311,090
1,363,772
2,564,105
$
$
(8)
1998
$
(8)
1997
$
(8)
1996
$
(8)
1995
$
(8)
(8)
(8)
(8)
(8)
(8)
1,759,871
735,163
2,495,034
1,797,745
882,096
2,679,841
1,718,876
898,686
2,617,562
1,598,040
796,717
2,394,757
1,524,728
705,776
2,230,504
492,668
359,910
132,758
(9,638)
123,120
27,225
581,655
356,672
224,983
(16,117)
208,866
26,502
612,188
332,419
279,769
6,005
286,766
21,432
566,363
319,458
246,905
(3,747)
242,304
17,899
507,041
304,046
202,995
(10,229)
197,957
19,813
62,624
62,624
446,588
348,455
1,381,474
2,441,318
$
$
114,537
114,537
457,246
359,914
1,349,539
2,450,031
$
$
171,419
171,419
445,853
275,607
1,220,516
2,326,550
$
$
138,937
138,937
419,507
265,685
1,094,329
2,071,338
$
$
112,350
112,350
367,889
247,895
1,039,382
1,925,925
76,930
105,519
26,974
305,181
514,604
35,937
81,296
5,314
327,343
449,890
29,873
96,720
17,719
325,086
469,398
71,566
61,399
23,620
202,846
359,431
46,977
59,457
30,396
165,835
302,665
5,037
54,727
314
151,154
211,232
514,604
(10,927)
503,677
1,559,423
$ 1,004,682
449,890
(7,906)
441,984
1,395,337
$ 1,045,981
469,398
(320)
469,078
1,393,950
$ 1,056,081
359,431
(9,824)
349,607
1,294,474
$ 1,032,076
302,665
(5,342)
297,323
1,149,110
$
922,228
211,232
(7,262)
203,970
1,104,747
$
821,178
503,677
1,004,682
1,508,359
441,984
1,045,981
1,487,965
469,078
1,056,081
1,525,159
349,607
1,032,076
1,381,683
297,323
922,228
1,219,551
203,970
821,178
1,025,148
1.8%
1.7%
3.7%
4.9%
2.6%
2.5%
4.9%
6.0%
4.7%
4.3%
7.8%
11.4%
7.4%
6.5%
11.0%
17.7%
6.7%
5.8%
10.1%
16.9%
5.8%
5.0%
8.9%
14.1%
2,441,318
(7,906)
(39,706)
(236,602)
(120,295)
(5,627)
2,031,182
127.9
162,717
151,047
6.2%
0.72
0.76
0.76
33.4%
20,474
42,661
2,450,031
(320)
(42,288)
(20,409)
(221,823)
(106,999)
(17,289)
2,040,903
119.1
173,222
149,949
6.9%
0.72
1.01
1.01
29.7%
20,856
42,907
2,326,550
(9,824)
(42,071)
(26,605)
(253,033)
(134,390)
(22,953)
1,837,674
127.5
258,621
139,833
9.7%
0.72
1.84
1.82
30.8%
21,046
45,942
2,071,338
(5,342)
(54,852)
(3,803)
(237,020)
(86,556)
(18,724)
(19,746)
(29,072)
1,616,223
130.5
229,932
134,431
8.8%
0.66
2.73
2.69
25.3%
20,994
46,394
1,925,925
(7,262)
(50,183)
(31,176)
(229,096)
(76,460)
(43,241)
(22,765)
(30,723)
1,435,019
132.4
155,925
126,457
6.5%
0.60
2.21
2.19
24.4%
19,130
31,813
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
1,858,734
(12,121)
(49,222)
(45,395)
(216,568)
(68,812)
(29,502)
(21,932)
(13,198)
1,401,984
134.2
131,188
123,409
5.9%
0.56
1.80
1.78
19.9%
17,034
26,792
(6)
Gross profit for 2003 included a reclassification of $7.5 million from cost of products sold to selling, administrative and general expenses for Torrington engineering and research and
development expenses to be consistent with the company’s 2004 cost classification methodology.
It is impractical for Timken to reflect 2000 segment financial information related to the 2003 reorganization of its Automotive and Industrial Groups, as this structure was not in place
at the time.
(8)
It is impracticable for the company to restate prior year segment financial information into Automotive Bearings and Industrial Bearings as this structure was not in place until 2000.
(9)
Includes an estimated count of shareholders having common stock held for their accounts by banks, brokers and trustees for benefit plans.
(7)
275
66 I 67
Board of Directors
W.R. Timken, Jr.
James W. Griffith
Robert W. Mahoney
Frank C. Sullivan
Ward J. Timken
Phillip R. Cox
Jay A. Precourt
Jacqueline F. Woods
Ward J. Timken, Jr.
John M. Timken, Jr.
Joseph F. Toot, Jr.
John A. Luke, Jr.
276
W.R. Timken, Jr., Director since 1965
Chairman – Board of Directors
The Timken Company
Phillip R. Cox, Director since 2004 (A)
President and Chief Executive Officer
Cox Financial Corporation (Cincinnati, Ohio)
James W. Griffith, Director since 1999
The Timken Company
Jerry J. Jasinowski, Director since 2004 (C, N)
President
The Manufacturing Institute (Washington, D.C.)
John A. Luke, Jr., Director since 1999 (C, N)
Chairman and Chief Executive Officer
MeadWestvaco (New York, New York)
Robert W. Mahoney, Director since 1992 (A, N)
Retired Chairman
Diebold, Incorporated (North Canton, Ohio)
Frank C. Sullivan, Director since 2003 (A)
RPM International Inc. (Medina, Ohio)
Jay A. Precourt, Director since 1996 (A)
Chairman and Chief Executive Officer
ScissorTail Energy (Vail, Colorado)
Hermes Consolidated Inc. (Denver, Colorado)
John M. Timken, Jr., Director since 1986 (A)
Private Investor (Old Saybrook, Connecticut)
Ward J. Timken, Director since 1971
President
Timken Foundation
Joseph W. Ralston, Director since 2003 (A, C)
Vice Chairman
The Cohen Group (Washington, D.C.)
68 I 69
Ward J. Timken, Jr., Director since 2002
Executive Vice President and President – Steel
The Timken Company
Joseph F. Toot, Jr., Director since 1968
Retired President and Chief Executive Officer
The Timken Company
Jacqueline F. Woods, Director since 2000 (C, N)
Retired President
SBC Ohio (Cleveland, Ohio)
(A) Member of Audit Committee
(C) Member of Compensation Committee
(N) Member of Nominating and Corporate Governance Committee
Joseph W. Ralston
Jerry J. Jasinowski
277
Officers and Executives
Automotive Group
James W. Griffith*
Jacqueline A. Dedo*
President – Automotive Group
Glenn A. Eisenberg*
Executive Vice President –
Finance and Administration
Sallie B. Bailey*
Senior Vice President – Finance and Controller
Jerry C. Begue
Managing Director – Europe
William R. Burkhart*
Charles M. Byrnes, Jr.
Vice President – Purchasing
Richard D. Adams
Vice President – Automotive –
Global Business Development
H. Roger Ellis
Vice President – Operations – Automotive
Robert W. Logston
Vice President – Automotive – Powertrain
Marc A. Weston
Vice President – Automotive – Chassis
Industrial Group
Christopher A. Coughlin
Senior Vice President – Project ONE
Michael C. Arnold*
President – Industrial Group
Donna J. Demerling
Senior Vice President – Supply Chain
Transformation
Michael J. Connors
Vice President – Industrial Equipment
Jon T. Elsasser
Senior Vice President
and Chief Information Officer
Thomas O. Dwyer
Vice President – Off-Highway
Mathew W. Happach
Vice President – Rail
Robert J. Lapp
Vice President – Government Affairs
Michael J. Hill
Vice President – Manufacturing – Industrial
Roger W. Lindsay
Senior Vice President – Asia Pacific
Debra L. Miller
Senior Vice President – Communications
and Community Affairs
Salvatore J. Miraglia, Jr.*
Senior Vice President – Technology
J. Ron Menning
Vice President – Aerospace, Consumer
and Super Precision
Daniel E. Muller
Vice President – Distribution Management
Steel Group
Donald J. Remboski
Vice President – Product Innovation
Mark J. Samolczyk
Senior Vice President – Corporate Planning
and Development
Scott A. Scherff
Corporate Secretary
and Assistant General Counsel
Ward J. Timken, Jr.*
Executive Vice President and President –
Steel Group
Hans J. Sack
President – Specialty Steel
Cengiz S. Kurkcu
President – Precision Steel Components
Michael T. Schilling
Vice President – Corporate Development
Nicholas P. Luchitz
Vice President – Steel Manufacturing
John C. Skurek
Vice President – Treasury
Linn B. Osterman
Vice President – Sales and Marketing –
Alloy Steel
Burkhard Stumpf
Vice President – Process and Advanced
Process Technologies
Dennis R. Vernier
Vice President – Auditing
*Required to file reports under Section 16 of the
Securities Exchange Act of 1934.
Donald L. Walker
Senior Vice President – Human Resources
and Organizational Advancement
278
Corporate Offices
The Timken Company
330-438-3000
www.timken.com
Annual Meeting of Shareholders
Tuesday, April 19, 2005, 10 a.m., Corporate Offices.
Direct meeting inquiries to Scott A. Scherff, corporate
secretary and assistant general counsel, at 330-471-4226.
Dividends on common stock are generally payable in
March, June, September and December.
The Timken Company offers an open enrollment dividend
reinvestment and stock purchase plan through its transfer
agent. This program allows current shareholders and new
investors the opportunity to purchase shares of common
stock without a broker.
Independent Auditors
Shareholders of record may increase their investment
in the company by reinvesting their dividends at no cost.
Shares held in the name of a broker must be transferred
to the shareholder’s name to permit reinvestment.
Stock Listing
Please direct inquiries to:
Publications
National City Bank Reinvestment Services
P.O. Box 94946
The Annual Meeting Notice, Proxy Statement
and Proxy Card are mailed to shareholders
in March.
Inquiries concerning dividend payments, change of
address or lost certificates should be directed to
National City Bank at 1-800-622-6757.
Copies of Forms 10-K and 10-Q may be
obtained from the company’s Web site,
www.timken.com/investors,
or by written request at no charge from:
Transfer Agent and Registrar
The Timken Company
Shareholder Relations, GNE-04
P.O. Box 6928
National City Bank Shareholder Services
P.O. Box 92301
www.nationalcitystocktransfer.com
Ernst & Young LLP
1300 Huntington Building
925 Euclid Ave.
New York Stock Exchange trading symbol, “TKR.”
Abbreviation used in most newspaper stock
listings is “Timken.”
70 I 71
Trademarks
AP-2™, Spexx® and Timken® are trademarks
of The Timken Company.
Printed on Recycled Paper
279
X.
AVAILABLE INFORMATION / DOCUMENTS ON DISPLAY
All Participants of TISOP will receive copies (in English) of all reports, proxy statements and other
communications distributed to the Company’s shareholders in general. These materials will be sent to
the Participants not later than the time at which the materials are sent to the Company’s shareholders.
Copies of the following documents or reports will be furnished to Participants without charge upon
written or oral request to Stephen Penrod, Principal – Global Retirement Income Benefits, The
Timken Company, 1835 Dueber Avenue, S.W., Canton, Ohio 44706-2798, USA, phone +1-330-4383000:

The Company’s Annual Report to shareholders for the latest two fiscal years;

All other recent reports, proxy statements and other communications distributed to the Company’s
shareholders in general; and

The most recent restatement of the Company's Amended Articles of Incorporation.
Documents on Display
Timken's Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8K, the amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and proxy statements are available, free of charge, on Timken's
website at www.timken.com as soon as reasonably practicable after electronically filing such material
with the US Securities and Exchange Commission.
This prospectus is published at Timken's website at www.timken.com.
280
Signature Page
Canton, Ohio/USA
April 25, 2007
THE TIMKEN COMPANY
By /s/ Glenn A. Eisenberg
____________________________________________
Glenn A. Eisenberg
Executive Vice President – Finance and Administration
281