10-K 1 tkr10k123115.htm 10-K 10-K


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2015
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from______to_______            
Commission file number: 1-1169
THE TIMKEN COMPANY
(Exact name of registrant as specified in its charter)
Ohio
 
34-0577130
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
4500 Mt. Pleasant St. NW, North Canton, Ohio
 
44720-5450
(Address of principal executive offices)
 
(Zip Code)
234.262.3000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Shares, without par value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
    Yes  x    No  o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  o    No  x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   
 Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   
 Yes  x    No  o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of June 30, 2015, the aggregate market value of the registrant’s common shares held by non-affiliates of the registrant was $2,734,145,335 based on the closing sale price as reported on the New York Stock Exchange.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at January 29, 2016
Common Shares, without par value
 
80,030,053 shares
DOCUMENTS INCORPORATED BY REFERENCE
Document
 
Parts Into Which Incorporated
Proxy Statement for the Annual Meeting of Shareholders to be held on or about May 10, 2016 (Proxy Statement)
 
Part III




THE TIMKEN COMPANY
INDEX TO FORM 10-K REPORT
 
 
 
PAGE
I.
 
 
 
Item 1.
 
Item 1A.
 
Item 1B.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 4A.
II.
 
 
 
Item 5.
 
Item 6.
 
Item 7.
 
Item 7A.
 
Item 8.
 
Item 9.
 
Item 9A.
 
Item 9B.
III.
 
 
 
Item 10.
 
Item 11.
 
Item 12.
 
Item 13.
 
Item 14.
IV.
 
 
 
Item 15.




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 engineers, manufactures and markets bearings, transmissions, gearboxes, belts, chain and related products and offers a spectrum of power system rebuild and repair services around the world. The Company’s growing product and services portfolio features many strong industrial brands, including Timken, Fafnir, Philadelphia Gear, Carlisle, Drives and Interlube.

The Company was founded in 1899 by Henry Timken, who received two patents on the design of a tapered roller bearing. Timken later became, and continues to be, the world's largest manufacturer of tapered roller bearings, leveraging its expertise to develop a full portfolio of industry-leading products and services. Timken built its reputation as a global leader by applying its knowledge of metallurgy, friction management and mechanical power transmission to increase the reliability and efficiency of its customers' equipment across a diverse range of industries. Today, the Company's global footprint consists of 63 manufacturing facilities/service centers, 12 technology and engineering centers and 26 distribution centers and warehouses, supported by a team comprised of more than 14,000 employees. Timken operates in 28 countries and territories around the globe.

Industry Segments and Geographical Financial Information:
Information required by this Item is incorporated herein by reference to Note 16 - Segment Information in the Notes to the Consolidated Financial Statements.

Major Customers:
The Company sells products and services to a diverse customer base globally, including customers in the following market sectors: industrial equipment, construction, agriculture, rail, aerospace and defense, automotive, heavy truck and energy. No single customer accounts for 5% or more of total net sales.

Products:
Timken manufactures and manages global supply chains for multiple product lines including anti-friction bearings and mechanical power transmission products designed to operate in demanding environments. The Company leverages its technical knowledge, research expertise, and production and engineering capabilities across all of its products and end markets to deliver high-performance products and services to its customers. Differentiation in these product lines is achieved by either: (1) product type or (2) the targeted applications utilizing the product.

Engineered Bearings:
The Timken® bearing portfolio features a broad range of anti-friction bearing products, including tapered, spherical and cylindrical roller bearings; thrust and ball bearings; and housed units. Timken is a leading authority on tapered roller bearings, and leverages its position by applying engineering know-how and technology across its entire bearing portfolio.

A bearing is a mechanical device that reduces friction between moving parts. The purpose of a bearing is to carry a load while allowing a machine shaft to rotate freely. The basic elements of the bearing include two rings, called races; a set of rollers that rotate around the bearing raceway; and a cage to separate and guide the rolling elements. Bearings come in a number of designs, featuring tapered, spherical, cylindrical or ball rolling elements. The various bearing designs accommodate radial and/or thrust loads differently, making certain bearing types better suited for specific applications.

Selection and development of bearings for customer applications and demand for high reliability require sophisticated engineering and analytical techniques. High precision tolerances, proprietary internal geometries and quality materials provide Timken bearings with high load-carrying capacity, excellent friction-reducing qualities and long service lives. The uses for bearings are diverse and can be found in transportation applications that include passenger cars and trucks, heavy trucks, helicopters, airplanes and trains. Ranging in size from precision bearings the size of a pencil eraser to those roughly three meters in diameter, Timken components are also used in a wide variety of industrial applications: paper and steel mills, mining, oil and gas extraction and production, machine tools, gear drives, health and positioning control, wind turbines and food processing.


1


Tapered Roller Bearings. Timken tapered roller bearings can increase power density and can include customized geometries, engineered surfaces and specialized sealing solutions. The Company’s tapered roller bearing line comes in thousands of combinations in single-, double- and four-row configurations. Tapered roller designs permit ready absorption of both radial and axial load combinations, which makes them particularly well-adapted to reducing friction where shafts, gears or wheels are used.

Spherical and Cylindrical Roller Bearings. Timken also produces spherical and cylindrical roller bearings that are used in large gear drives, rolling mills and other industrial and infrastructure development applications. These products are sold worldwide to original equipment manufacturers and industrial distributors serving major end-market sectors, including construction and mining, natural resources, defense, pulp and paper production, rolling mills and general industrial goods.

Ball Bearings. Timken radial, angular and precision ball bearings are used by customers in a variety of market sectors, including aerospace, agriculture, construction, health, machine tool and general industries. Radial ball bearings are designed to tolerate relatively high-speed operation under a range of load conditions. These bearing types consist of an inner and outer ring with a cage containing a complement of precision balls. Angular contact ball bearings are designed for a combination of radial and axial loading. Precision ball bearings are manufactured to tight tolerances and come in miniature and instrument, thin section and ball screw support designs.

Housed Units. Timken markets among the broadest range of bearing housed units in the industry. These products deliver durable, heavy-duty components designed to protect spherical, tapered and ball bearings in debris-filled, contaminated or high-moisture environments. Common housed unit applications include material handling and processing equipment.

Mechanical Power Transmission:
Belts. Timken makes and markets a full line of Carlisle® belts used in industrial, commercial and consumer applications. The portfolio features more than 20,000 parts designed for demanding applications, which are sold to original equipment and aftermarket customers. Carlisle® belts are engineered for maximum performance and durability, with products available in wrap molded, raw edge, v-ribbed and synchronous belt designs. Common applications include agriculture, construction, industrial machinery, outdoor power equipment and powersports.

Chains. Timken manufactures precision Drives® roller chain, pintle chain, agricultural conveyor chain, engineering class chain and oil field roller chain. These highly engineered products are used in a wide range of mobile and industrial machinery applications, including agriculture, oil and gas, aggregate and mining, primary metals, forest products and other heavy industries. These products are also utilized in the food and beverage and packaged goods sectors, which often require high-end, specialty products, including stainless-steel and corrosion-resistant roller chain.

Lubrication Systems. The Company offers 27 formulations of grease, leveraging its knowledge of tribology and anti-friction bearings to enable smooth equipment operation. Interlube® automated lubrication delivery systems dispense precise amounts of Timken grease, saving users from having to manually apply lubrication. These multifaceted delivery systems are used by the commercial vehicle, construction, mining, and heavy and general industries.

Aerospace Products. The Company's portfolio of parts, systems and services for the aerospace market sector includes products used in helicopters and fixed-wing aircraft for the military and commercial aviation industries.  Timken designs, manufactures and tests a wide variety of power transmission and drive train components, including bearings, transmissions, turbine engine components, gears and rotor-head assemblies and housings. In addition to original equipment, Timken provides aftermarket component repair for bearings and compressor cases. Timken inspects and reconditions main engine, gearbox and APU bearings on a wide range of platforms, such as engines, transmissions and gearboxes.

Industrial Gearboxes. The Company’s Philadelphia Gear® line of low- and high-speed gear drive designs are used in large-scale industrial applications. These gear drive configurations are custom-made to meet user specifications, offering a wide-array of size, footprint and gear arrangements. Low-speed drives are commonly used in crushing and pulverizing equipment, cooling towers, conveyors and pumps. High-speed drives are typically used by power generation, oil and gas, marine and pipeline industries.




2


Other Products. The Company also offers a full line of seals, couplings, augers and other mechanical power transmission components. Timken industrial sealing solutions come in a variety of types and material options that are used in manufacturing, food processing, mining, power generation, chemical processing, primary metals, pulp and paper, and oil and gas industry applications. Timken couplings, another mechanical power transmission component, are commonly found in gear drives, motors and pump applications. The Company also designs and manufactures Drives helicoid and sectional augers for agricultural applications, like conveying, digging and combines.

Services:
Power Systems. Timken services components in the industrial customer's drive train, including switch gears, electric motors and generators, gearboxes, bearings, couplings and central panels. The Company’s Philadelphia Gear services for gear drive applications include onsite technical services; inspection, repair and upgrade capabilities; and manufacturing of parts to OEM specifications. In addition, the Company’s Wazee, Smith Services, Schulz, Standard Machine and H&N service centers provide customers with services that include motor and generator rewind and repair and uptower wind turbine maintenance and repair. Timken Power Systems commonly serves customers in the power, wind energy, hydro and fossil fuel, water management, paper, mining and general manufacturing sectors.

Bearing Repair. Timken bearing repair services return worn bearings to like-new specifications, which increases bearing service life and can often restore bearings in less time than required to manufacture new. Bearing remanufacturing is available for any bearing type or brand - including competitor products - and is well-suited to heavy industrial applications such as paper, metals, mining, power generation and cement; railroad locomotives, passenger cars and freight cars; and aerospace engines and gearboxes.

Services accounted for approximately 7% of the Company’s net sales for the year ended December 31, 2015.

Sales and Distribution:
Timken products are sold principally by its own internal sales organizations. A portion of each segment's sales are made through authorized distributors.

Customer collaboration is central to the Company's sales strategy. Therefore, Timken goes where its customers need them, with sales engineers primarily working in close proximity to customers rather than at production sites. In some cases, Timken may co-locate with a customer at their facility to ensure optimized collaboration. The Company's sales force constantly updates the team's training and knowledge regarding all friction management products and market sector trends, and Timken employees assist customers during development and implementation phases and provide ongoing service and support.

The Company has a joint venture in North America focused on joint logistics and e-business services. This joint venture, CoLinx, LLC, includes five equity members: Timken, SKF Group, the Schaeffler Group, ABB Group and Gates Corporation. The e-business service focuses on information and business services for authorized distributors in the Process Industries segment.

Timken has entered into individually negotiated contracts with some of its customers. These contracts may extend for one or more years and, if a price is fixed for any period extending beyond current shipments, customarily include a commitment by the customer to purchase a designated percentage of its requirements from Timken. Timken does not believe that there is any significant loss of earnings risk associated with any given contract.

Competition:
The anti-friction bearing business is highly competitive in every country where Timken sells products. Timken competes primarily based on total value, including price, quality, timeliness of delivery, product design and the ability to provide engineering support and service on a global basis. The Company competes with domestic manufacturers and many foreign manufacturers of anti-friction bearings, including SKF Group, the Schaeffler Group, NTN Corporation, JTEKT Corporation and NSK Ltd.

Joint Ventures:
Investments in affiliated companies accounted for under the equity method were approximately $2.6 million and $1.8 million, respectively, at December 31, 2015 and 2014. The amount at December 31, 2015 was reported in other non-current assets on the Consolidated Balance Sheets.




3




Backlog:
The following table provides the backlog of orders of the Company's domestic and overseas operations at December 31, 2015 and 2014:
  
December 31,
(Dollars in millions)
2015
2014
Segment:
 
 
Mobile Industries
$
587.1

$
838.5

Process Industries
356.1

450.6

Total Company
$
943.2

$
1,289.1


Approximately 90% of the Company’s backlog at December 31, 2015, is scheduled for delivery in the succeeding twelve months. Actual shipments depend upon customers' ever-changing production schedules. Accordingly, Timken does not believe that its backlog data and comparisons thereof, as of different dates, reliably indicate future sales or shipments.

Raw Materials:
The principal raw material used by the Company to make anti-friction bearings is special bar quality (SBQ) steel. SBQ steel is produced around the world by various suppliers. SBQ steel is purchased in bar, tube and wire forms. The primary inputs to SBQ steel include scrap metal, iron ore, alloys, energy and labor. The availability and price of SBQ steel are subject to changes in supply and demand, commodity prices for ferrous scrap, ore, alloy, electricity, natural gas, transportation fuel, and labor costs. The Company manages price variability of commodities by using surcharge mechanisms on some of its contracts with its customers that provides for partial recovery of these cost increases in the price of bearing products.
Any significant increase in the cost of steel could materially affect the Company’s earnings. Disruptions in the supply of SBQ steel could temporarily impair the Company’s ability to manufacture bearings for its customers, or require the Company to pay higher prices in order to obtain SBQ, which could affect the Company’s revenues and profitability. The availability of bearing quality tubing is relatively limited, and the Company is taking steps to diversify its processes to limit its exposure to this particular form of SBQ steel. Overall, the Company believes that the number of suppliers of SBQ steel is adequate to support the needs of global bearing production, and, in general, the Company is not dependent on any single source of supply.
Research:
Timken operates a network of technology and engineering centers to support its global customers with sites in North America, Europe and Asia. This network develops and delivers innovative friction management and mechanical power transmission solutions and technical services. Timken's largest technical center is located at the Company's world headquarters in North Canton, Ohio. Other sites in the United States include Manchester, Connecticut; Fulton, Illinois; Springfield, Missouri; Keene and Lebanon, New Hampshire; and King of Prussia, Pennsylvania. Within Europe, the Company has technology facilities in Plymouth, England; Colmar, France; and Ploiesti, Romania. In Asia, Timken operates technology and engineering facilities in Bangalore, India and Shanghai, China.

Expenditures for research and development amounted to approximately $32.6 million, $38.8 million and $39.3 million in 2015, 2014 and 2013, respectively. Of these amounts, approximately $0.3 million and $0.4 million were funded by others in 2014 and 2013, respectively. None was funded by others in 2015.


4


Environmental Matters:
The Company continues its efforts to protect the environment and comply with environmental protection laws. Additionally, it has invested in pollution control equipment and updated plant operational practices. The Company is committed to implementing a documented environmental management system worldwide and to becoming certified under the ISO 14001 standard where appropriate to meet or exceed customer requirements. As of the end of 2015, 16 of the Company’s plants had obtained ISO 14001 certification.

The Company believes it has established appropriate reserves to cover its environmental expenses and has a well-established environmental compliance audit program for its domestic and international units. This program measures performance against applicable laws, as well as against internal standards that have been established for all units worldwide. It is difficult to assess the possible effect of compliance with future requirements that differ from existing requirements.

The Company and certain of its U.S. subsidiaries previously have been and could in the future be identified as potentially responsible parties for investigation and remediation at off-site disposal or recycling facilities under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), known as the Superfund, or state laws similar to CERCLA. In general, such claims for investigation and remediation have also been asserted against numerous other entities.

Management believes any ultimate liability with respect to pending actions will not materially affect the Company’s operations, cash flows or consolidated financial position. The Company is also conducting environmental investigation and/or remediation activities at a number of current or former operating sites. The costs of such investigation and remediation activities, in the aggregate, are not expected to be material to the operations or financial position of the Company.

New laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean-up requirements may require Timken to incur costs or become the basis for new or increased liabilities that could have a materially adverse effect on the Company's business, financial condition or results of operations.

Patents, Trademarks and Licenses:
Timken owns numerous U.S. and foreign patents, trademarks and licenses relating to certain products. While Timken regards these as important, it does not deem its business as a whole, or any industry segment, to be materially dependent upon any one item or group of items.

Employment:
At December 31, 2015, Timken had more than 14,000 employees. Approximately 7% of Timken’s U.S. employees are covered under collective bargaining agreements.

Available Information:
The Company uses its Investor Relations website at www.timken.com/investors, as a channel for routine distribution of important information, including news releases, analyst presentations and financial information. The Company posts filings as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (the SEC), including its annual, quarterly and current reports on Forms 10-K, 10-Q and 8-K; its proxy statements; and any amendments to those reports or statements. All such postings and filings are available on the Company’s website free of charge. In addition, this website allows investors and other interested persons to sign up to automatically receive e-mail alerts when the Company posts news releases and financial information on the Company’s website. The SEC also maintains a website, www.sec.gov, which contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The content on any website referred to in this Annual Report on Form 10-K is not incorporated by reference into this Annual Report unless expressly noted.


5


Item 1A. Risk Factors

The following are certain risk factors that could affect our business, financial condition and results of operations. The risks that are described 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.

Risk Relating to our Business

The bearing industry is highly competitive, and this competition results in significant pricing pressure for our products that could affect our revenues and profitability.

The global bearing industry is highly competitive. We compete with domestic manufacturers and many foreign manufacturers of anti-friction bearings, including SKF Group, the Schaeffler Group, NTN Corporation, JTEKT Corporation and NSK Ltd. Due to the competitiveness within the bearing industry, we may not be able to increase prices for our products to cover increases in our costs. In many cases we face pressure from our customers to reduce prices, which could adversely affect our revenues and profitability. In addition, our customers may choose to purchase products from one of our competitors rather than pay the prices we seek for our products, which could adversely affect our revenues and profitability.


Our business is capital intensive, and if there are downturns in the industries that we serve, we may be forced to significantly curtail or suspend operations with respect to those industries, which could result in our recording asset impairment charges or taking other measures that may adversely affect our results of operations and profitability.

Our business operations are capital intensive, and we devote a significant amount of capital to certain industries. Our 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. If there are downturns in the industries that we serve, we may be forced to significantly curtail or suspend our operations with respect to those industries, including laying-off employees, reducing production, recording asset impairment charges and other measures, which may adversely affect our results of operations and profitability.


Weakness in global economic conditions or in any of the industries or geographic regions in which we or our customers operate, as well as the cyclical nature of our customers' businesses generally or sustained uncertainty in financial markets, could adversely impact our revenues and profitability by reducing demand and margins.

Our results of operations may be materially affected by the conditions in the global economy generally and in global capital markets. There has been significant volatility in the capital markets and in the end markets and geographic regions in which we and our customers operate, which has negatively affected our revenues. Our revenues may also be negatively affected by changes in customer demand, changes in the product mix and negative pricing pressure in the industries in which we operate. Margins in those industries are highly sensitive to demand cycles, and our customers in those industries historically have tended to delay large capital projects, including expensive maintenance and upgrades, during economic downturns. As a result, our revenues and earnings are impacted by overall levels of industrial production.


6


Our results of operations may be materially affected by conditions in global financial markets or in any of the geographic regions in which we, our customers and our suppliers, operate. If an end user cannot obtain financing to purchase our products, either directly or indirectly contained in machinery or equipment, demand for our products will be reduced, which could have a material adverse effect on our financial condition and earnings.

Global financial markets have experienced volatility in recent years, including volatility in securities prices and diminished liquidity and credit availability. Our access to the financial markets cannot be assured and is dependent on, among other things, market conditions and company performance. Accordingly, we may be forced to delay raising capital, issue shorter tenors than we prefer or pay unattractive interest rates, which could increase our interest expense, decrease our profitability and significantly reduce our financial flexibility.

If a customer becomes insolvent or files for bankruptcy, our ability to recover accounts receivable from that customer would be adversely affected and any payment we received during the preference period prior to a bankruptcy filing may be potentially recoverable by the bankruptcy estate. Furthermore, if certain of our customers liquidate in bankruptcy, we may incur impairment charges relating to obsolete inventory and machinery and equipment. In addition, financial instability of certain companies in the supply chain could disrupt production in any particular industry. A disruption of production in any of the industries where we participate could have a material adverse effect on our financial condition and earnings.
 
If any of our suppliers are unable or unwilling to provide the products or services that we require or materially increase their costs, our ability to offer and deliver our products on a timely and profitable basis could be impaired. We cannot assure you that any or all of our relationships will not be terminated or that such relationships will continue as presently in effect. Furthermore, if any of our suppliers were to become subject to bankruptcy, receivership or similar proceedings, we may be unable to arrange for alternate or replacement relationships on favorable terms, which could harm our sales and operating results.


Any change in raw material prices or the availability or cost of raw materials could adversely affect our results of operations and profit margins.
 
We require substantial amounts of raw materials, including steel, to operate our business.  Our supply of raw materials could be interrupted for a variety of reasons, including availability and pricing.  Prices for raw materials necessary for production have fluctuated significantly in the past and could do so in the future.  We generally attempt to manage these fluctuations by passing along increased raw material prices to our customers in the form of price increases; however, we may be unable to increase the price of our products due to pricing pressure, contract terms or other factors, which could adversely impact our revenue and profit margins. 
 
Moreover, future disruptions in the supply of our raw materials 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 from other sources. Any significant increase in the prices for such raw materials could adversely affect our results of operations and profit margins.


Warranty, recall, quality 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. If we fail to meet customer specifications for their products, we may be subject to product quality costs and claims. A successful warranty or product liability claim against us, or a requirement that we participate in a product recall, could have a material adverse effect on our earnings.


We may incur further impairment and restructuring charges that could materially affect our profitability.

We have taken $180.7 million in impairment and restructuring charges in the aggregate during the last five years. Changes in business or economic conditions, or our business strategy, may result in additional restructuring programs and may require us to take additional charges in the future, which could have a material adverse effect on our earnings.



7


Environmental laws and regulations impose substantial costs and limitations on our operations and environmental compliance may be more costly than we expect.

We are subject to the risk of substantial environmental liability and limitations on our operations due to environmental laws and regulations. We are subject to extensive federal, state, local and foreign environmental, health and safety laws and regulations concerning matters such as air emissions, wastewater discharges, solid and hazardous waste handling and disposal and the investigation and remediation of contamination. The risks of substantial costs and liabilities related to compliance with these laws and regulations are an inherent part of our business, and future conditions may develop, arise or be discovered that create substantial environmental compliance or remediation liabilities and costs.
 
Compliance with environmental, health and safety legislation and regulatory requirements may prove to be more limiting and costly than we anticipate. To date, we have committed significant expenditures in our efforts to achieve and maintain compliance with these requirements at our facilities, and we expect that we will continue to make significant expenditures related to such compliance in the future. From time to time, we may be subject to legal proceedings brought by private parties or governmental authorities with respect to environmental matters, including matters involving alleged noncompliance with or liability under environmental, health and safety laws, property damage or personal injury. New laws and regulations, including those that 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.


The Company may be subject to risks relating to its information technology systems.

The Company relies on information technology systems to process, transmit and store electronic information and manage and operate its business. A breach in security could expose the Company and its customers and suppliers to risks of misuse of confidential information, manipulation and destruction of data, production downtimes and operations disruptions, which in turn could adversely affect the Company's reputation, competitive position, business or results of operations.

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 foreign 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.
 



8


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 original equipment manufacturers (OEMs), distributors and dealers;
import and export licensing requirements;
compliance with a variety of foreign laws and regulations, including unexpected changes in taxation and environmental or other regulatory requirements, which could increase our operating and other expenses and limit our operations;
disadvantages of competing against companies from countries that are not subject to U.S. laws and regulations, including the Foreign Corrupt Practices Act (FCPA);
difficulty in staffing and managing geographically diverse operations; and
tax exposures related to cross-border intercompany transfer pricing and other tax risks unique to international operations.

These and other risks may also increase the relative price of our products compared to those manufactured in other countries, reducing the demand for our products in the markets in which we operate, which could have a material adverse effect on our revenues and earnings.


The funded status of our defined benefit and other postretirement plans has caused and may in the future cause a reduction in our shareholders' equity.
 
We may be required to record charges related to pension and other postretirement liabilities as a result of asset returns, discount rate changes or other actuarial adjustments. These charges may be significant and would cause a reduction in our shareholders' equity.


Expenses and contributions related to our defined benefit plans are affected by factors outside our control, including the performance of plan assets, interest rates, actuarial data and experience, and changes in laws and regulations.

Our future expense and funding obligations for the defined benefit pension plans depend upon a number of factors, including the level of benefits provided for by the plans, the future performance of assets set aside in trusts for these plans, the level of interest rates used to determine the discount rate to calculate the amount of liabilities, actuarial data and experience and any changes in government laws and regulations. In addition, if the various investments held by our pension trusts do not perform as expected or the liabilities increase as a result of discount rates and other actuarial changes, our pension expense and required contributions would increase and, as a result, could materially adversely affect our business. We may be legally required to make contributions to the pension plans in the future in excess of our current expectations, and those contributions could be material.

 
Future actions involving our defined benefit and other postretirement plans, such as annuity purchases, lump sum payouts, and/or plan terminations could cause us to incur significant pension and postretirement settlement and curtailment charges.

We have purchased annuities and offered lump sum payouts to defined benefit plan and other postretirement plan participants and retirees in the past. If we were to take similar actions in the future, we could incur significant pension settlement and curtailment charges related to the reduction in pension and postretirement obligations from annuity purchases, lump sum payouts of benefits to plan participants, and/or plan terminations.


9


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, or at facilities of one or more of our suppliers, could have a material adverse effect on our business, financial condition and results of operations. Also, if one or more of our customers were to experience a work stoppage, that customer would likely halt or limit purchases of our products, which could have a material adverse effect on our business, financial condition and results of operations.


We are subject to a wide variety of domestic and foreign laws and regulations that could adversely affect our results of operations, cash flow or financial condition.

We are subject to a wide variety of domestic and foreign laws and regulations, and legal compliance risks, including securities laws, tax laws, employment and pension-related laws, competition laws, U.S. and foreign export and trading laws, and laws governing improper business practices. We are affected by new laws and regulations, and changes to existing laws and regulations, including interpretations by courts and regulators.
 
In addition, we could be adversely affected by violations of the FCPA and similar worldwide anti-bribery laws as well as export controls and economic sanction laws. The FCPA and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. Recently, there has been a substantial increase in the global enforcement of anti-corruption laws. We operate in many parts of the world that have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices. Our policies mandate compliance with these laws, but we cannot assure you that our internal controls and procedures will always protect us from the improper acts committed by our employees or agents. If we are found to be liable for FCPA, export control or sanction violations, we could suffer from criminal or civil penalties or other sanctions, including loss of export privileges or authorization needed to conduct aspects of our international business, which could have a material adverse effect on our business.

Compliance with the laws and regulations described above or with other applicable foreign, federal, state, and local laws and regulations currently in effect or that may be adopted in the future could materially adversely affect our competitive position, operating results, financial condition and liquidity.


If we are unable to attract and retain key personnel our business could be materially adversely affected.

Our business substantially depends on the continued service of key members of our management. The loss of the services of a significant number of members of our management could have a material adverse effect on our business. Our future success will also depend on our ability to attract and retain highly skilled personnel, such as engineering, finance, marketing and senior management professionals. Competition for these types of employees is intense, and we could experience difficulty from time to time in hiring and retaining the personnel necessary to support our business. If we do not succeed in retaining our current employees and attracting new high quality employees, our business could be materially adversely affected.


We may not realize the improved operating results that we anticipate from past and future acquisitions and we may experience difficulties in integrating acquired businesses.

We seek to grow, in part, through strategic acquisitions and joint ventures, which are intended to complement or expand our businesses, and expect to continue to do so in the future. These acquisitions involve challenges and risks. In the event that we do not successfully integrate these acquisitions into our existing operations so as to realize the expected return on our investment, our results of operations, cash flow or financial condition could be adversely affected.


10


Our operating results depend in part on continued successful research, development and marketing of new and/or improved products and services, and there can be no assurance that we will continue to successfully introduce new products and services.

The success of new and improved products and services depends on their initial and continued acceptance by our customers. Our businesses are affected, to varying degrees, by technological change and corresponding shifts in customer demand, which could result in unpredictable product transitions or shortened life cycles. We may experience difficulties or delays in the research, development, production, or marketing of new products and services which may prevent us from recouping or realizing a return on the investments required to bring new products and services to market. The end result could be a negative impact on our operating results.


If our internal controls are found to be ineffective, our financial results or our stock price may be adversely affected.

Our most recent evaluation resulted in our conclusion that, as of December 31, 2015, our internal control over financial reporting was effective. We believe that we currently have adequate internal control procedures in place for future periods, including processes related to newly acquired businesses; however, increased risk of internal control breakdowns generally exists in a business environment that is decentralized. In addition, if our internal control over financial reporting is found to be ineffective, investors may lose confidence in the reliability of our financial statements, which may adversely affect our stock price.


Risks Relating to the Spinoff of TimkenSteel

Potential indemnification liabilities to TimkenSteel Corporation (TimkenSteel) pursuant to the separation and distribution agreement and other agreements entered into in connection with the tax-free spinoff of TimkenSteel into a separate independent publicly traded company on June 30, 2014 (the Spinoff), could materially and adversely affect our business, financial condition, results of operations and cash flows.

In connection with the Spinoff, we entered into a separation and distribution agreement, an employee matters agreement and a tax sharing agreement, all with TimkenSteel, which provide for, among other things, the principal corporate transactions required to effect the Spinoff, certain conditions to the Spinoff and provisions governing the relationship between the Company and TimkenSteel with respect to and resulting from the Spinoff. Among other things, the separation and distribution agreement provides for indemnification obligations designed to make us financially responsible for substantially all liabilities that may exist relating to our continuing business operations, whether incurred prior to or after the Spinoff, as well as those obligations of TimkenSteel assumed by us pursuant to the separation and distribution agreement. If we are required to indemnify TimkenSteel under the circumstances set forth in the separation and distribution agreement, we could be subject to substantial liabilities.


In connection with the Spinoff, TimkenSteel has agreed to indemnify us for certain liabilities related to its steel business operations, but if it is unable to fulfill such obligations, it could adversely affect our business, financial condition, results of operations and cash flows.

Pursuant to the separation and distribution agreement, the employee matters agreement and the tax sharing agreement, TimkenSteel has agreed to indemnify us for certain liabilities related to its steel business operations. However, third parties could seek to hold us responsible for any of the liabilities that TimkenSteel has agreed to retain, and there can be no assurance that the indemnity from TimkenSteel will be sufficient to protect us against the full amount of such liabilities, or that TimkenSteel will be able to fully satisfy its indemnification obligations. In particular, if TimkenSteel is unable to pay any prior period taxes for which it is responsible, the Company could be required to pay the entire amount of such taxes. If TimkenSteel becomes insolvent or files for bankruptcy, our ability to recover amounts that TimkenSteel has agreed to indemnify us for would be adversely affected. Moreover, even if we ultimately succeed in recovering from TimkenSteel any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves. If TimkenSteel is unable to satisfy its indemnification obligations, the underlying liabilities could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 


11


If the Spinoff does not qualify as a tax-free transaction, the Company and its shareholders could be subject to substantial tax liabilities.

The Spinoff was conditioned on our receipt of an opinion from Covington & Burling LLP, special tax counsel to the Company, that the distribution of TimkenSteel common shares in the Spinoff qualified as tax-free (except for cash received by shareholders in lieu of fractional shares) to the Company, TimkenSteel and the Company’s shareholders for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) and related provisions of the Code. The opinion relied on, among other things, various assumptions and representations as to factual matters made by the Company and TimkenSteel, which, if inaccurate or incomplete in any material respect, could jeopardize the conclusions reached by such counsel in its opinion. We are not aware of any facts or circumstances that would cause the assumptions or representations that were relied on in the opinion of counsel to be inaccurate or incomplete in any material respect. The opinion is not binding on the Internal Revenue Service, or IRS, or the courts, and there can be no assurance that the qualification of the Spinoff as a transaction under Sections 355 and 368(a) of the Code will not be challenged by the IRS or by others in court, or that any such challenge would not prevail. If the Spinoff is determined to be taxable for U.S. federal income tax purposes, the Company and its shareholders that are subject to U.S. federal income tax could incur significant U.S. federal income tax liabilities, as each U.S. holder of the Company’s common shares that received TimkenSteel common shares in the Spinoff would generally be treated as having received a taxable distribution of property in an amount equal to the fair market value of the TimkenSteel common shares received.


Certain members of our Board of Directors and management may have actual or potential conflicts of interest because of their ownership of shares of TimkenSteel or their relationships with TimkenSteel following the Spinoff.

Certain members of our Board of Directors and management own shares of TimkenSteel and/or options to purchase shares of TimkenSteel, which could create, or appear to create, potential conflicts of interest when our directors and executive officers are faced with decisions that could have different implications for us and TimkenSteel. Two of our directors, Ward J. Timken, Jr. and John P. Reilly, are also directors of TimkenSteel and, in the case of Mr. Timken, Chairman, President and Chief Executive Officer of TimkenSteel. This may create, or appear to create, potential conflicts of interest if these directors are faced with decisions that could have different implications for TimkenSteel then the decisions have for us.

Item 1B. Unresolved Staff Comments
None.


12


Item 2. Properties
Timken has manufacturing facilities at multiple locations in the United States and in a number of countries outside the United States. The aggregate floor area of these facilities worldwide is approximately 10.6 million square feet, all of which, except for approximately 2.1 million 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. The Company believes all buildings are in satisfactory operating condition to conduct business.

Timken’s Mobile Industries segment's manufacturing facilities and service centers in the United States are located in Bucyrus, Canton and New Philadelphia, Ohio; Los Alamitos, California; Manchester, Connecticut; Carlyle, Illinois; Lenexa, Kansas; Keene and Lebanon, New Hampshire; Iron Station, North Carolina; Gaffney and Honea Path, South Carolina; Pulaski and Knoxville, Tennessee; Ogden, Utah and Altavista, Virginia. These facilities, including warehouses at plant locations and a technology and wind center in North Canton, Ohio have an aggregate floor area of approximately 3.6 million square feet.

Timken’s Mobile Industries segment’s manufacturing plants and service centers outside the United States are located in Benoni, South Africa; Villa Carcina, Italy; Colmar, France; Cheltenham, Northampton, Plymouth, and Wolverhampton, England; Belo Horizonte, Curtiba and Sorocaba, Brazil; Jamshedpur, India; Sosnowiec, Poland; and Yantai, China. These facilities, including warehouses at plant locations, have an aggregate floor area of approximately 2.4 million square feet.

Timken's Process Industries segment's manufacturing plants and service centers in the United States are located in Hueytown, Alabama; Sante Fe Springs, California; Broomfield and Denver, Colorado; New Haven, Connecticut; New Castle, Delaware; Fulton and Mokena, Illinois; Mishawaka, Indiana; Fort Scott, Kansas; Augusta and Portland, Maine; Springfield, Missouri; Randleman, and Rutherfordton, North Carolina; Union, South Carolina; Ferndale and Pasco, Washington; Princeton, West Virginia; and Casper and Rock Springs, Wyoming. These facilities, including warehouses at plant locations and a technology center in North Canton, Ohio have an aggregate floor area of approximately 2.6 million square feet.

Timken's Process Industries segment's manufacturing plants and service centers outside the United States are located in Chengdu, Jiangsu and Wuxi, China; Chennai and Durg, India; Dudley, England; Saskatoon and Prince George, Canada; and Ploiesti, Romania. These facilities, including warehouses at plant locations have an aggregate floor area of approximately 2.0 million square feet.

In addition to the manufacturing and distribution facilities discussed above, Timken owns or leases warehouses and distribution facilities in the United States, Brazil, Canada, France, Mexico, Singapore, Argentina, Australia, and China.

The extent to which the Company uses its properties varies by property and from time to time.  The Company believes that its capacity levels are adequate for its present and anticipated future needs.  Most of the Company’s manufacturing facilities remain capable of handling additional volume increases.

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.

In October 2014, the Brazilian government antitrust agency announced that it had opened an investigation of alleged antitrust violations in the bearing industry. The Company’s Brazilian subsidiary, Timken do Brasil Comercial Importadora Ltda, was included in the investigation. While the Company is unable to predict the ultimate length, scope or results of the investigation, management believes that the outcome will not have a material effect on the Company’s consolidated financial position; however, any such outcome may be material to the results of operations of any particular period in which costs, if any, are recognized. Based on current facts and circumstances, the low end of the range for potential penalties, if any, would be immaterial to the Company.

Item 4. Mine Safety Disclosures
Not applicable.


13


Item 4A. Executive Officers of the Registrant
The executive officers are elected by the Board of Directors normally for a term of one year and until the election of their successors. All executive officers have been employed by Timken or by a subsidiary of the Company during the past five-year period. The executive officers of the Company as of February 12, 2016 are as follows:

Name
 
Age    
 
Current Position and Previous Positions During Last Five Years
William R. Burkhart
 
50
 
2014 Executive Vice President, General Counsel and Secretary
 
 
 
 
2000 Senior Vice President and General Counsel
Christopher A. Coughlin
 
55
 
2014 Executive Vice President, Group President
 
 
 
 
2012 Group President
 
 
 
 
2011 President - Process Industries
Philip D. Fracassa
 
47
 
2014 Executive Vice President and Chief Financial Officer
 
 
 
 
2012 Senior Vice President - Planning and Development
 
 
 
 
2010 Senior Vice President and Controller - B&PT
Richard G. Kyle
 
50
 
2014 President and Chief Executive Officer; Director
 
 
 
 
2013 Chief Operating Officer - B&PT; Director
 
 
 
 
2012 Group President
 
 
 
 
2011 President - Mobile Industries & Aerospace
J. Ted Mihaila
 
61
 
2006 Senior Vice President and Controller

14


PART II.

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common shares are traded on the New York Stock Exchange under the symbol “TKR.” The estimated number of record holders of the Company’s common shares at December 31, 2015 was 4,411. The estimated number of beneficial shareholders at December 31, 2015 was 40,257.
The following table provides information about the high and low sales prices for the Company’s common shares and dividends paid for each quarter for the last two fiscal years.
 
 
2015
 
2014
 
Stock prices
Dividends
 
Stock prices
Dividends
 
High
Low
per share
 
High
Low
per share
First quarter
$
43.56

$
37.65

$
0.25

 
$
61.37

$
52.51

$
0.25

Second quarter
$
43.06

$
36.24

$
0.26

 
$
69.51

$
57.69

$
0.25

Third quarter
$
36.95

$
26.31

$
0.26

 
$
49.96

$
42.34

$
0.25

Fourth quarter
$
32.89

$
26.84

$
0.26

 
$
44.30

$
37.62

$
0.25


Issuer Purchases of Common Shares:
The following table provides information about purchases of its common shares by the Company during the quarter ended December 31, 2015.
 
Period
Total number
of shares purchased (1)
Average
price paid per share (2)
Total number of
shares purchased as
part of publicly
announced
plans or programs
Maximum number
of shares that may
yet be purchased
under the
plans or programs (3)(4)
10/1/2015 - 10/31/2015
424,530

$
29.08

424,292

2,603,623

11/1/2015 - 11/30/2015
866,944

31.34

866,495

1,737,128

12/1/2015 - 12/31/2015
1,445,352

29.23

1,445,000

292,128

Total
2,736,826

$
29.88

2,735,787


 
(1)
Of the shares purchased in October, November and December, 238, 449 and 352, respectively, represent common shares of the Company that were owned and tendered by employees to exercise stock options, and to satisfy withholding obligations in connection with the exercise of stock options and vesting of restricted shares.
(2)
For shares tendered in connection with the vesting of restricted shares, the average price paid per share is an average calculated using the daily high and low of the Company’s common shares as quoted on the New York Stock Exchange at the time of vesting. For shares tendered in connection with the exercise of stock options, the price paid is the real-time trading share price at the time the options are exercised.
(3)
On February 10, 2012, the Board of Directors of the Company approved a share purchase plan pursuant to which the Company may purchase up to ten million of its common shares in the aggregate. On June 13, 2014, the Board of Directors of the Company authorized an additional ten million common shares for repurchase under this plan. This share purchase plan expired on December 31, 2015.
(4)
On January 29, 2016, the Board of Directors of the Company approved a new share purchase plan pursuant to which the Company may purchase up to five million of its common shares, in the aggregate. This share purchase plan expires on January 31, 2017. The Company may purchase shares from time to time in open market purchases or privately negotiated transactions. The Company may make all or part of the purchases pursuant to accelerated share repurchases or Rule 10b5-1 plans.



15


Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities (continued)

 

*Total return assumes reinvestment of dividends. Fiscal years ending December 31.


 
2011
2012
2013
2014
2015
Timken
$
88

$
104

$
122

$
134

$
93

S&P 500
102

118

157

178

181

S&P 400 Industrials
99

120

173

176

170

 
The line graph compares the cumulative total shareholder returns over five years for The Timken Company, the S&P 500 Stock Index and the S&P 400 Industrials Index. The graph assumes, in each case, an initial investment of $100 on January 1, 2011, in Timken common shares, S&P 500 Index and S&P 400 Industrials Index, based on market prices at the end of each fiscal year through and including December 31, 2015, and reinvestment of dividends (and taking into account the value of the TimkenSteel common shares distributed in the Spinoff).



16


Item 6. Selected Financial Data

Summary of Operations and Other Comparative Data:
(Dollars in millions, except per share and per employee data)
2015
2014
2013
2012
2011
Statements of Income
 
 
 
 
 
Net sales
$
2,872.3

$
3,076.2

$
3,035.4

$
3,359.5

$
3,333.6

Gross profit
793.9

898.0

868.4

1,028.0

1,018.0

Selling, general and administrative expenses
494.3

542.5

546.6

554.5

540.6

Impairment and restructuring charges
14.7

113.4

8.7

29.5

14.4

Operating (loss) income (1)
(151.4
)
208.4

305.9

444.0

463.0

Other (expense) income, net
(7.5
)
19.9

6.7

102.0

(0.4
)
Interest expense, net
30.7

24.3

22.5

28.2

31.2

(Loss) income from continuing operations
(68.0
)
149.3

175.5

331.5

280.8

Income from discontinued operations, net of income taxes

24.0

87.5

164.4

175.8

Net (loss) income attributable to The Timken Company
$
(70.8
)
$
170.8

$
262.7

$
495.5

$
454.3

Balance Sheets
 
 
 
 
 
Inventories, net
$
543.2

$
585.5

$
582.6

$
611.5

$
669.6

Property, plant and equipment, net
777.8

780.5

855.8

834.1

868.6

Total assets
2,785.3

3,001.4

4,477.9

4,244.2

4,327.4

Total debt:
 
 
 
 
 
Short-term debt
62.0

7.4

18.6

14.3

22.0

Current portion of long-term debt
15.1

0.6

250.7

9.6

5.8

Long-term debt
580.6

522.1

176.4

424.9

448.6

Total debt
$
657.7

$
530.1

$
445.7

$
448.8

$
476.4

Net debt (cash)
 
 
 
 
 
Total debt
657.7

530.1

445.7

448.8

476.4

Less: cash and cash equivalents and restricted cash
(129.8
)
(294.1
)
(399.7
)
(601.5
)
(468.4
)
 Net debt (cash): (2)
$
527.9

$
236.0

$
46.0

$
(152.7
)
$
8.0

Total liabilities
1,440.7

1,412.3

1,829.3

1,997.6

2,284.9

Shareholders’ equity
$
1,344.6

$
1,589.1

$
2,648.6

$
2,246.6

$
2,042.5

Capital:
 
 
 
 
 
Net debt (cash)
527.9

236.0

46.0

(152.7
)
8.0

Shareholders’ equity
1,344.6

1,589.1

2,648.6

2,246.6

2,042.5

Net debt (cash) + shareholders’ equity (capital)
$
1,872.5

$
1,825.1

$
2,694.6

$
2,093.9

$
2,050.5

Other Comparative Data
 
 
 
 
 
(Loss) income from continuing operations / Net sales
(2.4
%)
4.9
%
5.8
%
9.9
%
8.4
%
Net (loss) income attributable to The Timken Company / Net sales
(2.5
%)
5.6
%
8.7
%
14.7
%
13.6
%
Return on equity (3)
(5.1
%)
9.4
%
6.6
%
14.8
%
13.7
%
Net sales per employee (4)
$
197.5

$
210.9

$
203.1

$
218.0

$
218.8

Capital expenditures
105.6

126.8

133.6

118.3

105.5

Depreciation and amortization
130.8

137.0

142.4

149.6

146.7

Capital expenditures / Net sales
3.7
%
4.1
%
4.4
%
3.5
%
3.2
%
Dividends per share
$
1.03

$
1.00

$
0.92

$
0.92

$
0.78

Basic (loss) earnings per share - continuing operations (5)
$
(0.84
)
$
1.62

$
1.84

$
3.41

$
2.84

Diluted (loss) earnings per share - continuing operations (5)
$
(0.84
)
$
1.61

$
1.82

$
3.38

$
2.81

Basic (loss) earnings per share (6)
$
(0.84
)
$
1.89

$
2.76

$
5.11

$
4.65

Diluted (loss) earnings per share (6)
$
(0.84
)
$
1.87

$
2.74

$
5.07

$
4.59

Net debt (cash) to capital (2)
28.2
%
12.9
%
1.7
%
(7.3
%)
0.4
%
Number of employees at year-end (7)
14,709

14,378

14,794

15,093

15,722

Number of shareholders (8)
40,257

44,271

52,218

50,783

44,238

(1)
Operating (loss) income included pension settlement charges of $465.0 million during 2015.
(2)
The Company presents net debt (cash) because it believes net debt (cash) is more representative of the Company’s financial position than total debt due to the amount of cash and cash equivalents.
(3)
Return on equity is defined as (loss) income from continuing operations divided by ending shareholders’ equity.
(4)
Based on average number of employees employed during the year.
(5)
Based on average number of shares outstanding during the year.
(6)
Based on average number of shares outstanding during the year and includes discontinued operations for all periods presented.
(7)
Adjusted to exclude temporary employees for all periods.
(8)
Includes an estimated count of shareholders having common shares held for their accounts by banks, brokers and trustees for benefit plans.

17


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Dollars in millions, except per share data)

OVERVIEW

Introduction:

The Timken Company engineers, manufactures and markets bearings, transmissions, gearboxes, belts, chain and related products and offers a spectrum of power system rebuild and repair services. The Company’s growing product and services portfolio features many strong industrial brands, such as Timken, Fafnir, Philadelphia Gear, Carlisle, Drives and Interlube. Timken today applies its deep knowledge of metallurgy, friction management and mechanical power transmission across the broad spectrum of bearings and related systems to improve the reliability and efficiency of machinery and equipment all around the world. Known for its quality products and collaborative technical sales model, Timken focuses on providing value to diverse markets worldwide through both original equipment manufacturers (OEMs) and aftermarket channels. With more than 14,000 people operating in 28 countries, Timken makes the world more productive and keeps industry in motion. The Company operates under two reportable segments: (1) Mobile Industries and (2) Process Industries. The following further describes these business segments:

Mobile Industries serves OEM customers that manufacture off-highway equipment for the agricultural, mining and construction markets; on-highway vehicles including passenger cars, light trucks, and medium- and heavy-duty trucks; rail cars and locomotives; and rotorcraft and fixed-wing aircraft. Beyond service parts sold to OEMs, aftermarket sales to individual end users, equipment owners, operators and maintenance shops are handled through the Company's extensive network of authorized automotive and heavy-truck distributors.

Process Industries serves OEM and end-user customers in industries that place heavy demands on the fixed operating equipment they make or use in heavy and other general industrial sectors. This includes metals, cement and aggregate production; coal and wind power generation; oil and gas extraction and refining; pulp and paper and food processing; and health and critical motion control equipment. Other applications include marine equipment, gear drives, cranes, hoists and conveyors. This segment also supports aftermarket sales and service needs through its global network of authorized industrial distributors.

Timken creates value by understanding customer needs and applying its know-how in attractive market sectors. Timken’s business strengths include its channel mix and end-market diversity, serving a broad range of customers and industries across the globe. The Company collaborates with OEMs to improve equipment efficiency with its engineered products and captures subsequent equipment replacement cycles by selling through independent channels in the aftermarket. Timken focuses its international efforts and footprint in regions of the world where strong macroeconomic factors such as urbanization, infrastructure development and sustainability create demand for our products and services.


18


The Timken Business Model is the specific framework for how the Company evaluates opportunities and differentiates itself in the market.
The Company’s Strategy is to apply the Timken Business Model and leverage the Company’s competitive differentiators and strengths to create customer value and drive increased growth and profitability by:

Capturing Opportunities and Expanding Reach. The Company intends to expand into new and existing markets by leveraging its collective knowledge of metallurgy, friction management and mechanical power transmission to create value for Timken customers. Using a highly collaborative technical selling approach, the Company places particular emphasis on creating unique solutions for challenging and/or demanding applications. The Company intends to grow in attractive market sectors around the world, emphasizing those spaces that are highly fragmented, demand high service and value the reliability and efficiency offered by Timken products. The Company also targets those applications that offer significant aftermarket demand, thereby providing product and services revenue throughout the equipment’s lifetime.

Performing With Excellence. Timken operates with a relentless drive for exceptional results and a passion for superior execution. The Company embraces a continuous improvement culture that is charged with increasing efficiency, lowering costs, eliminating waste, encouraging organizational agility and building greater brand equity to fuel future growth. This requires the Company’s ongoing commitment to attract, retain and develop the best talent across the world.

Driving Effective Capital Deployment. The Company is intently focused on providing the highest returns for shareholders through its capital allocation framework, which includes (1) investing in the core business through capital expenditures, research and development and organic growth initiatives like DeltaX; (2) pursuing strategic acquisitions to broaden our portfolio and capabilities, with an focus on bearings, adjacent power transmission products and related services; and (3) returning capital to shareholders through share repurchases and dividends. As part of this framework, the Company may also restructure, reposition or divest underperforming product lines or assets.

19


The following items highlight certain of the Company's more significant strategic accomplishments in 2015:

Product and Global Manufacturing Footprint Expansion

On December 4, 2015, the Company launched the 6000 series line of metric deep groove ball bearings and introduced a new line of Drives® Leaf Chain in North America, completing the global rollout of the series as an element of the Company's DeltaX growth initiative. DeltaX is a multi-year initiative designed to accelerate product development and line expansion.

On November 19, 2015, the Company announced plans to build a 161,000-square-foot manufacturing plant in Romania. The new plant will produce ISO and inch-sized Timken® tapered roller bearings up to 12 inches outside diameter for global power transmission, off-highway and distribution customers. The Company broke ground on the new plant in early February 2016, with projected start-up in 2017.

On April 28, 2015, the Company expanded its product offering of high performance spherical roller bearings. The new product line includes medium bore high performance spherical roller bearings featuring either steel or brass cages in a variety of sizes. The new offering of spherical roller bearings includes several new features that are expected to contribute to longer bearing life and to run cooler than other comparable products.

On April 10, 2015, the Company launched the Timken® UC-series ball bearing housed unit product line, an extension of the Company’s housed unit bearing portfolio.

On March 19, 2015, the Company unveiled its new 27,000-square-foot, state-of-the-art gear drive manufacturing facility in Houston, Texas. This facility serves customers in the power generation, oil and gas exploration, refining and pipeline/pumping industries that require reliable, high-speed enclosed gearboxes to keep pumps, compressors and generators operating in harsh conditions.

Financing Agreements and Pension Plan Transactions

On November 30, 2015, the Company amended its $100 million Asset Securitization Agreement (Accounts Receivable Facility) to, among other things, extend the maturity to November 30, 2018.

On November 30, 2015, the Company entered into an agreement pursuant to which one of its U.S. defined benefit pension plans purchased a group annuity contract from Prudential Insurance Company of America (Prudential) that requires Prudential to pay and administer future pension benefits for approximately 3,400 U.S. Timken retirees. The purchase was funded by existing pension plan assets and required no cash contribution from the Company to Prudential in this transaction. As a result of the purchase of the group annuity contract, the Company incurred non-cash pension settlement charges of $241.8 million in the fourth quarter of 2015. Coupled with the group annuity contract purchased in January discussed below, the Company transferred a total of approximately $1.1 billion of pension obligations to Prudential in 2015, which reduced the Company's total projected benefit obligation by approximately 50%.

On June 19, 2015, the Company amended and restated its five-year $500 million Senior Credit Facility to, among other things, extend the maturity to June 19, 2020.

On January 23, 2015, the Company entered into an agreement pursuant to which another of its U.S. defined benefit pension plans purchased a group annuity contract from Prudential that requires Prudential to pay and administer future pension benefits for approximately 5,000 U.S. Timken salaried retirees. The purchase was funded by existing pension plan assets and required no cash contribution from the Company to Prudential in this transaction. As a result of the purchase of the group annuity contract as well as lump-sum distributions to new retirees, the Company incurred pension settlement charges of $215.2 million in the first quarter of 2015.


20


Acquisitions and Divestitures
 
On October 21, 2015, the Company completed the sale of all of the outstanding stock of Timken Alcor Aerospace Technologies, Inc. (Alcor), located in Mesa, Arizona. Alcor was engaged in the design, engineering, sourcing, manufacture and sale of parts and components used in gas turbine engines and helicopter drivetrain applications and filing applications for and obtaining certificates reflecting a Parts Manufacturer Approval (PMA) issued by the United States Federal Aviation Administration (FAA) for such parts and components. For the twelve months ending September 30, 2015, Alcor had sales of $20.6 million. The results of the operations of Alcor prior to the sale were reported in the Mobile Industries segment. The Company recognized a gain on the sale of Alcor of approximately $29 million.

On September 1, 2015, the Company acquired all the membership interests of Carlstar Belt LLC (the Belts business). The Belts business is a leading North American manufacturer of belts used in industrial, commercial and consumer applications. Based in Springfield, Missouri, the Belts business had sales of approximately $140 million for the twelve months ending June 30, 2015. The results of the operations of the Belts business are reported in the Mobile Industries and Process Industries segments based on the customers served.






21


RESULTS OF OPERATIONS
2015 vs. 2014

Overview: 
 
2015
2014
$ Change
% Change
Net sales
$
2,872.3

$
3,076.2

$
(203.9
)
(6.6
%)
(Loss) income from continuing operations
(68.0
)
149.3

(217.3
)
(145.5
%)
Income from discontinued operations

24.0

(24.0
)
(100.0
%)
Income attributable to noncontrolling interest
2.8

2.5

0.3

12.0
%
Net (loss) income attributable to The Timken Company
$
(70.8
)
$
170.8

$
(241.6
)
(141.5
%)
Diluted (loss) earnings per share:
 
 
 


Continuing operations
$
(0.84
)
$
1.61

$
(2.45
)
(152.2
%)
Discontinued operations

0.26

(0.26
)
(100.0
%)
Diluted (loss) earnings per share
$
(0.84
)
$
1.87

$
(2.71
)
(144.9
%)
Average number of shares—diluted
84,631,778

91,224,328


(7.2
%)
The decrease in sales was primarily due to the impact of foreign currency exchange rate changes and lower end market demand, partially offset by the benefit of acquisitions. The Company's net income from continuing operations in 2015 was lower compared to 2014 due to non-cash pension settlement charges recorded in 2015, the impact of lower volume across most end market sectors, unfavorable price/mix and foreign currency exchange rate changes. These factors were partially offset by lower selling, general and administrative expenses, lower material and operating costs and a lower provision for income taxes. The decrease in income from discontinued operations in 2015 compared with 2014 was due to the spinoff of TimkenSteel that was completed on June 30, 2014.

Outlook:

The Company expects 2016 full-year sales to decline 4% to 5% compared with 2015, driven by lower demand across most market sectors and the estimated impact of foreign currency exchange rate changes, partially offset by the impact of acquisitions. The Company's earnings from continuing operations are expected to be higher in 2016 than 2015, primarily due to the absence of material pension settlement charges in 2016, lower raw material costs, and lower selling, general and administrative expenses, partially offset by the impact of lower volume and price/mix, higher impairment and restructuring charges and the impact of foreign currency exchange rate changes.

The Company expects to generate operating cash from continuing operations of approximately $300 million in 2016, a decrease from 2015 of approximately $75 million or 20.0%, as the Company anticipates lower income, excluding non-cash impairment and pension settlement charges. Pension contributions are expected to be approximately $15 million in 2016, compared with $10.8 million in 2015. The Company expects capital expenditures to be approximately 4.5% of sales in 2016, compared with 3.7% of sales in 2015.




22


THE STATEMENTS OF INCOME

Sales:
 
2015
2014
$ Change
% Change    
Net sales
$
2,872.3

$
3,076.2

$
(203.9
)
(6.6
%)
Net sales decreased in 2015 compared with 2014 primarily due to the effect of foreign currency exchange rates of $152 million and lower organic sales of $90 million, partially offset by the benefit of acquisitions of $39 million. The decrease in organic sales volume was driven by lower demand across most of the Company's end market sectors, partially offset by growth in the wind, military marine, rail and automotive sectors.


Gross Profit:
 
2015
2014
$ Change
Change
Gross profit
$
793.9

$
898.0

$
(104.1
)
(11.6
%)
Gross profit % to net sales
27.6
%
29.2
%

(160) bps

Rationalization expenses included in cost of products sold
$
6.4

$
3.6

$
2.8

77.8
%
Gross profit decreased in 2015 compared with 2014, primarily due to the impact of lower volume of $40 million, unfavorable price/mix of $37 million and the impact of foreign currency exchange rate changes of $63 million. These factors were partially offset by the impact of inventory valuation adjustments that occurred during 2014 of $20 million, lower raw material and operating costs net of manufacturing underutilization and the impact of acquisitions.


Selling, General and Administrative Expenses:
 
2015
2014
$ Change
Change
Selling, general and administrative expenses
$
494.3

$
542.5

$
(48.2
)
(8.9%
)
Selling, general and administrative expenses % to net sales
17.2
%
17.6
%

(40) bps

The decrease in selling, general and administrative expenses in 2015 compared with 2014 was primarily due to lower incentive compensation expense of $28 million and the impact of foreign currency exchange rate changes of $20 million. The benefits of cost reduction initiatives were largely offset by the impact of acquisitions, higher pension and bad debt expense and costs associated with ongoing growth initiatives.


Impairment and Restructuring Charges:
 
2015
2014
$ Change
Impairment charges
$
3.3

$
98.9

$
(95.6
)
Severance and related benefit costs
7.7

10.7

(3.0
)
Exit costs
3.7

3.8

(0.1
)
Total
$
14.7

$
113.4

$
(98.7
)
Impairment and restructuring charges of $14.7 million in 2015 were primarily due to severance and related benefit costs associated with initiatives to reduce headcount, impairment charges of $3.0 million related to the Company's service center in Niles, Ohio and exit costs of approximately $3.0 million related to the Company's termination of its relationship with one of its third-party sales representatives in Colombia. Impairment and restructuring charges of $113.4 million in 2014 were primarily due to goodwill and other intangible impairment charges of $96.2 million that were recorded in the third quarter of 2014.
 

23


Pension Settlement Charges:
 
2015
2014
$ Change
Pension settlement charges
$
465.0

$
33.7

$
431.3

Pension settlement charges in 2015 were primarily due to the purchase of group annuity contracts from Prudential by two of the Company's U.S. defined benefit pension plans. The two group annuity contracts require Prudential to pay and administer future pension benefits for approximately 8,400 U.S. Timken retirees in the aggregate. The Company transferred a total of approximately $1.1 billion of its pension obligations and a total of approximately $1.2 billion of pension assets to Prudential in these transactions. In addition to the purchase of the group annuity contracts, the Company made lump-sum distributions of $37 million to new retirees. The Company also incurred pension settlement and curtailment charges related to one of its Canadian defined benefit pension plans. As a result of the group annuity contracts, lump-sum distributions as well as pension settlement and curtailment charges related to the Canadian pension plan, the Company incurred total pension settlement and curtailment charges of $465.0 million, including professional fees of $2.6 million, in 2015.

Pension settlement charges recorded in 2014 were primarily the result of the settlement of approximately $110 million of the Company's pension obligations related to its defined benefit pension plan in the United States as a result of lump sum distributions to new retirees and certain deferred vested plan participants in 2014.


Gain on Divestiture:
 
2015
2014
$ Change
Gain on divestiture
$
28.7

$

$
28.7

Gain on divestiture in 2015 was primarily related to the gain on the sale of Alcor of $29.0 million in the fourth quarter of 2015, partially offset by a loss on the sale of the Company's repair business in Niles, Ohio of $0.3 million in the second quarter of 2015.


Interest Income (Expense):
 
2015
2014
$ Change
% Change
Interest (expense)
$
(33.4
)
$
(28.7
)
$
(4.7
)
16.4
%
Interest income
2.7

4.4

(1.7
)
(38.6
%)
Interest expense for 2015 increased compared with 2014 primarily due to lower capitalized interest and higher average debt, partially offset by lower average interest rates. Interest income decreased for 2015 compared with 2014 primarily due to lower interest income recognized on the deferred payments related to the sale of real estate in Sao Paulo, Brazil (Sao Paulo). The last of the deferred payments was received during the fourth quarter of 2015.

Other (Expense) Income:
 
2015
2014
$ Change
% Change
Gain on sale of real estate
$

$
22.6

$
(22.6
)
(100.0
%)
Fixed asset write-off
(9.7
)

(9.7
)
NM

Other income (expense), net
2.2

(2.7
)
4.9

(181.5
%)
Total
$
(7.5
)
$
19.9

$
(27.4
)
(137.7
%)
During 2014, the Company recognized a gain of $22.6 million related to the sale of real estate in Sao Paulo.

During the fourth quarter of 2015, the Company wrote-off $9.7 million that remained in construction in process (CIP) after the related assets were placed into service.  The majority of these assets were placed into service between 2008 and 2012.  This item was identified during an examination of aged balances in the CIP account. Management of the Company concluded that the correction of this error in the fourth quarter of 2015 and the presence of this error in prior periods was immaterial to all periods presented.

24


Income Tax Expense:
 
2015
2014
$ Change
Change
Income tax (benefit) expense
$
(121.6
)
$
54.7

$
(176.3
)
(322.3%
)
Effective tax rate
64.1
%
26.8
%

3,730
 bps
The effective tax rate for 2015 was 64.1%, which reflects a tax benefit on pretax loss. The tax benefit rate of 64.1% was greater than the U.S. statutory rate of 35% primarily due to the tax benefits of reversals of certain valuation allowances in foreign jurisdictions, U.S. foreign tax credits, earnings in certain foreign jurisdictions where the effective tax rate was less than 35%, reversals of reserves for uncertain tax positions, state and local taxes, the U.S. manufacturing deduction, the U.S. research tax credit and other U.S. tax benefits. These factors were offset by U.S. taxation of foreign earnings, recording of deferred tax liabilities related to foreign branch operations, and losses at certain foreign subsidiaries where no tax benefit could be recorded.
The effective tax rate on pretax income for 2014 was favorable relative to the U.S. federal statutory rate primarily due to U.S. foreign tax credits, earnings in certain foreign jurisdictions where the effective tax rate was less than 35%, adjustments to tax accruals for undistributed foreign earnings, the U.S. manufacturing deduction, the U.S. research tax credit and other U.S. tax benefits. These factors were partially offset by U.S. taxation of foreign income, losses at certain foreign subsidiaries where no tax benefit could be recorded, non-deductible intangible asset impairment charges recorded in the Mobile Industries segment and accruals for uncertain tax positions.
The following is the reconciliation between the provision/(benefit) for income taxes and the amount computed by applying income tax rate of 35% to income before taxes:
 
2015
2014
Income tax at the U.S. federal statutory rate
$
(66.4
)
$
71.4

Adjustments:
 
 
Reversal of valuation allowance
(34.7
)

U.S. foreign tax credit
(22.4
)
(15.1
)
Foreign earnings taxed at different rates including tax holidays
(11.0
)
(15.7
)
Tax expense related to undistributed earnings of subsidiaries

(8.7
)
Accruals and settlements related to tax audits
(5.9
)
12.8

State and local income taxes, net of federal tax benefit
(4.9
)
(0.3
)
U.S. domestic manufacturing deduction
(4.5
)
(6.6
)
U.S. research tax credit
(1.1
)
(1.0
)
Other items (net)
(1.5
)
(6.0
)
Tax on foreign remittances and U.S. tax on foreign income
13.8

19.6

Deferred taxes related to branch operations
11.6


Foreign losses without current tax benefits
5.4

4.3

(Benefit) provision for income taxes
$
(121.6
)
$
54.7

Effective tax rate
64.1
%
26.8
%


Discontinued Operations:
 
2015
2014
$ Change
Net sales
$

$
786.2

$
(786.2
)
Income before income taxes

40.0

(40.0
)
Income taxes

16.0

(16.0
)
Operating results, net of tax
$

$
24.0

$
(24.0
)
On June 30, 2014, the Company completed the spinoff of TimkenSteel. The operating results, net of tax, included one-time transaction costs of $57.1 million during 2014. These costs included consulting and professional fees associated with preparing for and executing the spinoff of TimkenSteel.


25


BUSINESS SEGMENTS

The Company's reportable segments are business units that target different industry sectors. While the segments often operate using a shared infrastructure, each reportable segment is managed to address specific customer needs in these diverse market segments. The primary measurement used by management to measure the financial performance of each segment is earnings before interest and taxes (EBIT). Refer to Note 16 - Segment Information in the Notes to the Consolidated Financial Statements for the reconciliation of EBIT by segment to consolidated income before income taxes.

The presentation of segment results below includes a reconciliation of the changes in net sales for each segment reported in accordance with U.S. GAAP to net sales adjusted to remove the effects of acquisitions and divestitures completed in 2015 and 2014 and foreign currency exchange rate changes. The effects of acquisitions, divestitures and foreign currency exchange rate changes on net sales are removed to allow investors and the Company to meaningfully evaluate the percentage change in net sales on a comparable basis from period to period.

The following items highlight the Company's acquisitions and divestitures completed in 2015 and 2014:
During the fourth quarter of 2015, the Company sold all of the outstanding stock of Alcor. Results for Alcor were reported in the Mobile Industries segment.
During the third quarter of 2015, the Company acquired the Belts business. Results for the Belts business are reported in the Mobile Industries and Process Industries segments based on the customers served.
During the fourth quarter of 2014, the Company acquired substantially all of the assets of Revolvo Ltd. (Revolvo). Results for Revolvo are reported in the Process Industries segment.
During the fourth quarter of 2014, the Company sold its aerospace engine overhaul business. Results for the aerospace engine overhaul business were reported in the Mobile Industries segment.
During the second quarter of 2014, the Company acquired substantially all of the assets of Schulz Group (Schulz). Results for Schulz are reported in the Process Industries segment.


Mobile Industries Segment:
 
2015
2014
$ Change
Change
Net sales
$
1,558.3

$
1,685.4

$
(127.1
)
(7.5%
)
EBIT
$
173.3

$
65.6

$
107.7

164.2%

EBIT margin
11.1
%
3.9
%

720 bps

 
 
 
 
 
 
 
 
 
 
  
2015
2014
$ Change
% Change
Net sales
$
1,558.3

$
1,685.4

$
(127.1
)
(7.5%
)
Less: Acquisitions
21.8


21.8

NM

         Divestitures
(13.2
)

(13.2
)
NM

         Currency
(88.1
)

(88.1
)
NM

Net sales, excluding the impact of acquisitions, divestitures and currency
$
1,637.8

$
1,685.4

$
(47.6
)
(2.8%
)
The Mobile Industries segment's net sales, excluding the effects of acquisitions, divestitures and foreign currency exchange rate changes, decreased $47.6 million or 2.8% in 2015 compared with 2014. The decrease in net sales was primarily due to lower volume in the off-highway (primarily agriculture) and aerospace end market sectors, partially offset by organic growth in the rail and automotive sectors. EBIT increased in 2015 compared with 2014 primarily due to the impact of goodwill impairment and inventory valuation adjustments of $118 million recorded in 2014, a gain on the sale of Alcor of $29 million recorded in 2015, the benefit of lower raw material and operating costs net of manufacturing underutilization, lower selling, general and administrative expenses and the impact of acquisitions. These factors were partially offset by a gain on the sale of real estate in Brazil of $23 million recorded in 2014, lower volume of $20 million and unfavorable price/mix of $14 million and the negative impact of foreign currency exchange rate changes of $18 million.


26


Full-year sales for the Mobile Industries segment are expected to be down approximately 5% in 2016 compared with 2015. This reflects lower expected volume in the rail, off-highway and aerospace end market sectors and the estimated impact of foreign currency exchange rate changes, partially offset by organic growth in the automotive end market sector and the benefit of acquisitions. EBIT for the Mobile Industries segment is expected to decrease in 2016 compared with 2015 as a result of the gain from the sale of Alcor in 2015, the impact of lower volume and the impact of foreign currency exchange rate changes, partially offset by lower raw material and operating costs, selling, general and administrative expenses and the benefit of acquisitions.


Process Industries Segment:
 
2015
2014
$ Change
Change
Net sales
$
1,314.0

$
1,390.8

$
(76.8
)
(5.5%
)
EBIT
$
190.2

$
267.1

$
(76.9
)
(28.8%
)
EBIT margin
14.5
%
19.2
%

(470) bps

 
 
 
 
 
 
 
 
 
 
  
2015
2014
$ Change
% Change
Net sales
$
1,314.0

$
1,390.8

$
(76.8
)
(5.5%
)
Less: Acquisitions
30.2


30.2

NM

         Currency
(63.5
)

(63.5
)
NM

Net sales, excluding the impact of acquisitions and currency
$
1,347.3

$
1,390.8

$
(43.5
)
(3.1%
)
The Process Industries segment's net sales, excluding the effects of acquisitions and foreign currency exchange rate changes, decreased $43.5 million or 3.1% in 2015 compared with 2014 primarily due to lower volume in the industrial distribution, services and heavy industries end market sectors, partially offset by organic growth in the wind energy and military marine sectors. EBIT was lower in 2015 compared with 2014 primarily due to the impact of lower volume of $21 million, unfavorable price/mix of $24 million, the impact of unfavorable foreign currency exchange rate changes of $25 million and higher impairment and restructuring charges. These factors were partially offset by lower selling, general and administrative expenses, the impact of lower material and operating costs net of manufacturing underutilization and the impact of acquisitions. EBIT also included a charge of $8.2 million in the fourth quarter of 2015 related to the write-off of certain CIP balances.  Refer to Note 8 - Property, Plant and Equipment for additional information.

Full-year sales for the Process Industries segment are expected to be down approximately 4% in 2016 compared with 2015. This reflects lower expected volume in the industrial distribution, services and heavy industries end market sectors and the negative impact of foreign currency exchange rate changes, partially offset by the benefit of acquisitions. EBIT for the Process Industries segment is expected to increase in 2016 compared with 2015 primarily due to lower selling, general and administrative expenses, raw material and operating costs, partially offset by foreign currency exchange rate changes and the impact of lower volume and price/mix.


Unallocated Corporate:
 
2015
2014
$ Change
Change
Corporate expenses
$
57.4

$
71.4

$
(14.0
)
(19.6 %
)
Corporate expenses % to net sales
2.0
%
2.3
%

(30) bps

Corporate expenses decreased in 2015 compared with 2014 primarily due to lower incentive compensation expenses and the impact of cost reduction initiatives.

27


RESULTS OF OPERATIONS:
2014 vs. 2013

Overview:
 
2014
2013
$ Change
% Change
Net sales
$
3,076.2

$
3,035.4

$
40.8

1.3
%
Income from continuing operations
149.3

175.5

(26.2
)
(14.9
%)
Income from discontinued operations
24.0

87.5

(63.5
)
(72.6
%)
Income attributable to noncontrolling interest
2.5

0.3

2.2

NM

Net income attributable to The Timken Company
$
170.8

$
262.7

$
(91.9
)
(35.0
%)
Diluted earnings per share:
 
 
 
 
Continuing operations
$
1.61

$
1.82

$
(0.21
)
(11.5
%)
Discontinued operations
0.26

0.92

(0.66
)
(71.7
%)
Diluted earnings per share
$
1.87

$
2.74

$
(0.87
)
(31.8
%)
Average number of shares - diluted
91,224,328

95,823,728


(4.8
%)
The increase in sales in 2014 compared with 2013 was primarily due to higher volume across most end market sectors, partially offset by planned program exits that concluded in 2013. The Company's net income from continuing operations in 2014, compared with 2013, was lower due to higher impairment and restructuring charges, the impact of planned program exits that concluded at the end of 2013 and pension settlement charges, partially offset by the impact of higher volume, lower manufacturing cost and the gain on the sale of real estate in Sao Paulo. Income from continuing operations also benefited from a lower effective tax rate. Impairment and restructuring charges primarily related to goodwill impairment. Income from discontinued operations was lower in 2014 compared with 2013 due to the spinoff of TimkenSteel on June 30, 2014.


THE STATEMENTS OF INCOME

Sales:
 
2014
2013
$ Change
% Change
Net sales
$
3,076.2

$
3,035.4

$
40.8

1.3
%
Net sales increased in 2014 compared with 2013, primarily due to higher volume of $150 million, as well as the benefit of acquisitions of $25 million. These factors were partially offset by planned program exits which concluded in 2013, of approximately $110 million and the impact of foreign currency rate changes of $30 million.


Gross Profit:
 
2014
2013
$ Change
Change
Gross profit
$
898.0

$
868.4

$
29.6

3.4
 %
Gross profit % to net sales
29.2
%
28.6
%

60
 bps
Rationalization expenses included in cost of products sold
$
3.6

$
5.9

$
(2.3
)
(39.0
 %)
Gross profit increased in 2014 compared with 2013, primarily due to the impact of higher volume of $64 million and lower manufacturing and material costs of $33 million. These factors were partially offset by planned program exits which concluded in 2013 of $35 million, the impact of inventory valuation adjustments of $19 million and the impact of lower price/mix of $15 million.






28


Selling, General and Administrative Expenses:
 
2014
2013
$ Change
Change
Selling, general and administrative expenses
$
542.5

$
546.6

$
(4.1
)
(0.8 %
)
Selling, general and administrative expenses % to net sales
17.6
%
18.0
%

(40) bps

The decrease in selling, general and administrative expenses in 2014 compared with 2013 was primarily due to the benefit of cost-reduction initiatives of $24 million, partially offset by higher expense related to incentive compensation plans of $13 million and the impact of acquisitions of $6 million.


Impairment and Restructuring Charges:
 
2014
2013
$ Change
Impairment charges
$
98.9

$
0.1

$
98.8

Severance and related benefit costs
10.7

9.2

1.5

Exit costs
3.8

(0.6
)
4.4

Total
$
113.4

$
8.7

$
104.7

Impairment and restructuring charges of $113.4 million in 2014 were primarily due to goodwill and other intangible impairment charges of $96.2 million for two of the Company's aerospace reporting units within the Mobile Industries segment that were recorded in 2014. Impairment and restructuring charges for 2013 were primarily due to severance and related benefit costs of $6 million due to cost-reduction initiatives relating to reductions in headcount in the bearings and power transmission business and the recognition of severance and related benefits of $3 million related to the closure of the manufacturing facility in St. Thomas, Ontario, Canada (St. Thomas).


Pension Settlement Charges:
 
2014
2013
$ Change
Pension settlement charges
$
33.7

$
7.2

$
26.5

Pension settlement charges recorded in 2014 were primarily due to the settlement of approximately $110 million of the Company's pension obligations related to its defined benefit pension plan in the United States as a result of the lump sum distributions to new retirees and certain deferred vested plan participants in 2014. Pension settlement charges in 2013 primarily related to the settlement of pension obligations for the Company's Canadian defined pension plans as a result of the closure of the Company's manufacturing facility in St. Thomas.


Interest Income and (Expense):
 
2014
2013
$ Change
% Change
Interest (expense)
$
(28.7
)
$
(24.4
)
$
(4.3
)
17.6
%
Interest income
$
4.4

$
1.9

$
2.5

131.6
%
Interest expense for 2014 increased compared with 2013 primarily due to higher average debt and lower capitalized interest. Interest income increased for 2014 compared with 2013 primarily due to interest income recognized on the deferred payments related to the sale of the Company's former manufacturing site in Sao Paulo.










29


Other Income (Expense):
 
2014
2013
$ Change
% Change
Gain on sale of real estate
$
22.6

$
5.4

$
17.2

318.5
%
Other income (expense), net
(2.7
)
1.3

(4.0
)
(307.7
%)
Total
$
19.9

$
6.7

$
13.2

197.0
%
During 2014, the Company recognized a gain of $22.6 million, compared with $5.4 million in 2013, related to the sale of its former manufacturing site in Sao Paulo.

The Company reported other expense, net in 2014 compared with other income, net in 2013 primarily due to higher charitable donations in 2014. The Company also incurred higher foreign currency exchange rate changes in 2014 compared with 2013.


Income Tax Expense:
 
2014
2013
$ Change
Change
Income tax expense
$
54.7

$
114.6

$
(59.9
)
(52.3 %
)
Effective tax rate
26.8
%
39.5
%

(1,270) bps

The effective tax rate on pretax income for 2014 was favorable relative to the U.S. federal statutory rate primarily due to U.S. foreign tax credits, earnings in certain foreign jurisdictions where the effective tax rate was less than 35%, the U.S. manufacturing deduction, the U.S. research tax credit and certain discrete tax benefits. These factors were partially offset by U.S. taxation of foreign income, losses at certain foreign subsidiaries where no tax benefit could be recorded, non-deductible intangible asset impairment charges recorded in the Mobile Industries segment and U.S. state and local taxes.

The effective tax rate on pretax income for 2013 was unfavorable relative to the U.S. federal statutory rate primarily due to U.S. taxation of foreign income including cash repatriation, losses at certain foreign subsidiaries where no tax benefit could be recorded and U.S. state and local taxes. These factors were partially offset by earnings in certain foreign jurisdictions where the effective tax rate was less than 35%, U.S. foreign tax credits, the U.S. manufacturing deduction and certain discrete U.S. tax benefits.

The change in the effective tax rate in 2014 compared with 2013 was primarily due to lower U.S. taxation of foreign income, lower losses at certain foreign subsidiaries where no tax benefit could be recorded and lower U.S. state and local taxes, partially offset by lower U.S. foreign tax credits, lower U.S. manufacturing deduction, non-deductible intangible asset impairment charges recorded in the Mobile Industries segment and the net effect of other discrete items.


Discontinued Operations:
 
2014
2013
$ Change
% Change
Net sales
$
786.2

$
1,305.8

$
(519.6
)
(39.8%
)
Income before income taxes
40.0

127.1

(87.1
)
(68.5%
)
Income taxes
16.0

39.6

(23.6
)
(59.6%
)
Operating results, net of tax
$
24.0

$
87.5

$
(63.5
)
(72.6%
)
On June 30, 2014, the Company completed the Spinoff. The operating results, net of tax, included one-time transaction costs in connection with the separation of the two companies of $57.1 million and $13.0 million during 2014 and 2013, respectively. These costs included consulting and professional fees associated with preparing for and executing the Spinoff, as well as lease cancellation fees.






30


BUSINESS SEGMENTS

The primary measurement used by management to measure the financial performance of each segment is EBIT. Refer to Note 16 - Segment Information in the Notes to the Consolidated Financial Statements for the reconciliation of EBIT by segment to consolidated income before income taxes.
 
The presentation of segment results below includes a reconciliation of the changes in net sales for each segment reported in accordance with U.S. GAAP to net sales adjusted to remove the effects of acquisitions made in 2014 and 2013 and changes in foreign currency exchange rate changes. The effects of acquisitions and foreign currency exchange rate changes on net sales are removed to allow investors and the Company to meaningfully evaluate the percentage change in net sales on a comparable basis from period to period.

The following items highlight the Company's acquisitions and divestitures completed in 2014 and 2013:
During the fourth quarter of 2014, the Company acquired substantially all of the assets of Revolvo. Results for Revolvo are reported in the Process Industries segment.
During the second quarter of 2014, the Company acquired substantially all of the assets of Schulz. Results for Schulz are reported in the Process Industries segment.
During the second quarter of 2013, the Company completed the acquisition of Hamilton Gear Ltd., d/b/a Standard Machine (Standard Machine), as well as substantially all of the assets of Smith Services, Inc. (Smith Services). Results for Standard Machine and Smith Services are reported in the Process Industries segment.
During the first quarter of 2013, the Company completed the acquisition of Interlube Systems Ltd. (Interlube). Results for Interlube are reported in the Mobile Industries segment.


Mobile Industries Segment:
 
2014
2013
$ Change
% Change
Net sales
$
1,685.4

$
1,775.8

$
(90.4
)
(5.1
%)
EBIT
$
65.6

$
193.7

$
(128.1
)
(66.1
%)
EBIT margin
3.9
%
10.9
%

(700) bps

  
2014
2013
$ Change
% Change
Net sales
$
1,685.4

$
1,775.8

$
(90.4
)
(5.1
%)
Less: Acquisitions
3.6


3.6

NM

         Currency
(17.1
)

(17.1
)
NM

Net sales, excluding the impact of acquisitions and currency
$
1,698.9

$
1,775.8

$
(76.9
)
(4.3
%)
The Mobile Industries segment's net sales, excluding the effects of acquisitions and foreign currency exchange rate changes, decreased in 2014 compared with 2013, primarily due to lower volume of $80 million. The lower volume was primarily driven by a reduction in sales to the light vehicle sector due to planned program exits that concluded in 2013 of approximately $110 million and lower heavy truck and aerospace demand, partially offset by organic growth in the rail end market sector. EBIT decreased in 2014 compared with 2013, primarily due to the impact of the aerospace business impairment and restructuring charges of $125 million and the impact of lower sales volume and price/mix, including planned program exits of $37 million. These factors were partially offset by the sale of real estate in Sao Paulo of $23 million.

31


Process Industries Segment:
 
2014
2013
$ Change
Change
Net sales
$
1,390.8

$
1,259.6

$
131.2

10.4 %

EBIT
$
267.1

$
189.3

$
77.8

41.1 %

EBIT margin
19.2
%
15.0
%

420
 bps
 
 
 
 
 
  
2014
2013
$ Change
% Change
Net sales
$
1,390.8

$
1,259.6

$
131.2

10.4 %

Less: Acquisitions
16.0


16.0

NM

         Currency
(13.3
)

(13.3
)
NM

Net sales, excluding the impact of acquisitions and currency
$
1,388.1

$
1,259.6

$
128.5

10.2 %

The Process Industries segment’s net sales, excluding the effects of acquisitions and foreign currency exchange rate changes, increased for 2014 compared with 2013, primarily due to an increase in volume of $121 million and favorable pricing of $5 million. The higher volume was primarily due to higher demand in the wind energy and industrial distribution end market sectors. EBIT in 2014 increased compared with 2013 primarily due to the impact of higher volume of $59 million and lower material and manufacturing costs of $39 million, partially offset by unfavorable price/mix of $10 million and higher selling, general and administrative expenses of $8 million.


Unallocated Corporate:
 
2014
2013
$ Change
Change
Corporate expenses
$
71.4

$
70.4

$
1.0

1.4%

Corporate expenses % to net sales
2.3
%
2.3
%


Corporate expenses increased in 2014 compared with 2013 primarily due to higher expense related to incentive compensation plans and foreign currency exchange rate changes, which were partially offset by cost-reduction initiatives.


32


THE BALANCE SHEETS

The following discussion is a comparison of the Consolidated Balance Sheets at December 31, 2015 and 2014.

On February 3, 2016, the Company furnished a Current Report on Form 8-K to the Securities and Exchange Commission that included an earnings release issued that same day reporting results for the fourth quarter and full year of 2015, which was furnished as Exhibit 99.1 thereto (the Earning Release). The Earnings Release reported: (a) accounts receivable of $447.0 million; (b) other assets of $128.9 million; (c) accrued expenses of $247.8 million; and (d) total shareholders' equity of $1,337.2 million as of December 31, 2015. The consolidated balance sheet in this Annual Report on Form 10-K reports (a) accounts receivable of $454.6 million; (b) other assets of $116.2 million; (c) accrued expenses of $255.4 million; and (d) total shareholders' equity of $1,324.5 million as of December 31, 2015. The changes reflect adjustments to (1) present offsetting items separately in the accounts receivable and accrued expenses accounts and (2) correct an entry between deferred tax assets and other comprehensive income, a component of shareholders' equity.

Current Assets:
  
December 31,
  
  
  
2015
2014
$ Change
% Change
Cash and cash equivalents
$
129.6

$
278.8

$
(149.2
)
(53.5
%)
Restricted cash
0.2

15.3

(15.1
)
(98.7
%)
Accounts receivable, net
454.6

475.7

(21.1
)
(4.4
%)
Inventories, net
543.2

585.5

(42.3
)
(7.2
%)
Deferred income taxes

49.9

(49.9
)
(100.0
%)
Deferred charges and prepaid expenses
22.7

25.2

(2.5
)
(9.9
%)
Other current assets
56.1

51.5

4.6

8.9
%
Total current assets
$
1,206.4

$
1,481.9

$
(275.5
)
(18.6
%)

The reduction in cash and cash equivalents was primarily due to share repurchases and the acquisition of the Belts business. Refer to the Consolidated Statements of Cash Flows for further discussion of the change in cash and cash equivalents. Restricted cash decreased due to the closure of a pledged account for workers compensation. Accounts receivable, net, decreased as a result of foreign currency exchange rate changes and lower sales in December 2015 compared with December 2014, partially offset by the impact of current year acquisitions. Inventories, net, decreased as a result of foreign currency exchange rate changes and lower production volume, partially offset by the impact of current-year acquisitions. The change in deferred income taxes was the result of the reclassification to non-current deferred tax assets as a result of the adoption of Accounting Standards Update 2015-17, Balance Sheet Classification of Deferred Taxes (ASU 2015-17), as of the year ended December 31, 2015.


Property, Plant and Equipment, Net:
  
December 31,
  
  
  
2015
2014
$ Change
% Change
Property, plant and equipment
$
2,171.7

$
2,164.1

$
7.6

0.4
%
Less: allowances for depreciation
(1,393.9
)
(1,383.6
)
(10.3
)
(0.7
%)
Property, plant and equipment, net
$
777.8

$
780.5

$
(2.7
)
(0.3
%)
The change in property, plant and equipment, net, in 2015 was primarily due to current-year acquisitions, partially offset by the impact of foreign currency exchange rate changes.

Property, plant and equipment, net included a write-off of $9.7 million in 2015 due to the correction of an error.  Refer to Note 8 - Property, Plant and Equipment for additional information.



33


Other Assets:
  
December 31,
  
  
  
2015
2014
$ Change
% Change
Goodwill
$
327.3

$
259.5

$
67.8

26.1
%
Non-current pension assets
86.3

176.2

(89.9
)
(51.0
%)
Other intangible assets
271.3

239.8

31.5

13.1
%
Deferred income taxes
65.9

11.2

54.7

NM

Other non-current assets
50.3

52.3

(2.0
)
(3.8
%)
Total other assets
$
801.1

$
739.0

$
62.1

8.4
%
The increase in goodwill was primarily due to the acquisition of the Belts business in the third quarter of 2015. The decrease in non-current pension assets was primarily due to the remeasurement of the Company's U.S. defined benefit pension plans as a result of the purchase of two group annuity contracts from Prudential, including the related premium, that requires Prudential to pay and administer future pension benefits for approximately 8,400 U.S. Timken retirees in the aggregate, partially offset by an increase in the discount rate to measure the underlying pension obligation. The increase in other intangible assets was primarily due to the acquisition of the Belts business in the third quarter of 2015, partially offset by current-year amortization expense. The increase in deferred income taxes was primarily due to the adoption of ASU 2015-17, as well as the impact of current year book-tax temporary differences including pension expense, partially offset by bonus depreciation and other items.


Current Liabilities:
  
December 31,
  
  
  
2015
2014
$ Change
% Change
Short-term debt
$
62.0

$
7.4

$
54.6

NM

Current portion of long-term debt
15.1

0.6

14.5

NM

Accounts payable
159.7

143.9

15.8

11.0
 %
Salaries, wages and benefits
102.3

146.7

(44.4
)
(30.3
%)
Income taxes payable
13.1

80.2

(67.1
)
(83.7
%)
Other current liabilities
153.1

155.0

(1.9
)
(1.2
%)
Total current liabilities
$
505.3

$
533.8

$
(28.5
)
(5.3
%)
The increase in short-term debt was primarily due to net borrowings of $49 million under the Accounts Receivable Facility and additional borrowings under foreign lines of credit of $6 million. The increase in current portion of long-term debt was primarily due to the reclassification of $15 million of the fixed rate medium-term notes maturing in the third quarter of 2016. The increase in accounts payable was due primarily to higher days outstanding driven by the Company's initiative to extend payment terms with its suppliers. The decrease in accrued salaries, wages and benefits was the result of the impact of fewer associates on the payroll at the end of 2015 as a result of cost reduction initiatives, partially offset by lower accruals for 2015 performance-based compensation compared with 2014. The decrease in income taxes payable was primarily due to the reclassification of uncertain tax positions to a non-current income taxes payable and income tax payments, partially offset by the current tax provision for 2015.


34


Non-Current Liabilities:
  
December 31,
  
  
  
2015
2014
$ Change
% Change
Long-term debt
$
580.6

$
522.1

$
58.5

11.2
%
Accrued pension cost
146.9

165.9

(19.0
)
(11.5
%)
Accrued postretirement benefits cost
136.1

141.8

(5.7
)
(4.0
%)
Deferred income taxes
3.6

4.1

(0.5
)
(12.2
%)
Other non-current liabilities
68.2

44.6

23.6

52.9
%
Total non-current liabilities
$
935.4

$
878.5

$
56.9

6.5
%
The increase in long-term debt was due to borrowings of $265.7 million under the Senior Credit Facility, partially offset by payments of $190.6 million and the effect of the reclassification of $15 million of the fixed rate medium-term notes maturing in the third quarter of 2016 to current liabilities. The decrease in accrued pension cost during 2015 was primarily due to pension contributions of $10.6 million and a decrease of $8.0 million as a result of an increase in the discount rate used to measure the pension obligation. The increase in other non-current liabilities during 2015 was primarily due to a reclassification of $31.0 million from current income taxes payable to non-current income taxes payable, partially offset by a $5.3 million decrease in long-term incentive compensation accruals.
  

Shareholders’ Equity:
  
December 31,
  
  
  
2015
2014
$ Change
% Change
Common stock
$
958.2

$
952.5

$
5.7

0.6
%
Earnings invested in the business
1,457.6

1,615.4

(157.8
)
(9.8
%)
Accumulated other comprehensive loss
(287.0
)
(482.5
)
195.5

(40.5
%)
Treasury shares
(804.3
)
(509.2
)
(295.1
)
(58.0
%)
Noncontrolling interest
20.1

12.9

7.2

55.8
%
Total equity
$
1,344.6

$
1,589.1

$
(244.5
)
(15.4
%)
Earnings invested in the business in 2015 decreased by the net loss attributable to the Company of $70.8 million and dividends declared of $87.0 million. The decrease in accumulated other comprehensive loss was primarily due to a pension and post-retirement liability adjustment of $265.9 million after tax, partially offset by a $71.5 million decrease in foreign currency translation. The pension and post-retirement liability adjustment was primarily due to pension settlement charges (including the premiums paid), net of the increase in the discount rate to measure the underlying pension obligation. The foreign currency translation adjustments were due to the strengthening of the U.S. dollar relative to most foreign currencies, including Brazilian Real, Canadian Dollar, Chinese Renminbi, Romanian Leu and British Pound. See "Other Matters - Foreign Currency" for further discussion regarding the impact of foreign currency translation. The increase in treasury shares was primarily due to the Company's purchase of 8.6 million of its common shares for $309.7 million in 2015, partially offset by net shares issued for stock compensation plans during 2015.



35


CASH FLOWS
 
2015
2014
$ Change
Net cash provided by operating activities - continuing operations
$
374.8

$
281.5

$
93.3

Net cash provided by operating activities - discontinued operations

25.5

(25.5
)
     Net cash provided by operating activities
374.8

307.0

67.8

Net cash used by investing activities - continuing operations
(265.2
)
(117.7
)
(147.5
)
Net cash used by investing activities - discontinued operations

(77.0
)
77.0

     Net cash used by investing activities
(265.2
)
(194.7
)
(70.5
)
Net cash used by financing activities - continuing operations
(241.6
)
(302.2
)
60.6

Net cash provided by financing activities - discontinued operations

100.0

(100.0
)
     Net cash used by financing activities
(241.6
)
(202.2
)
(39.4
)
Effect of exchange rate changes on cash
(17.2
)
(15.9
)
(1.3
)
Decrease in cash and cash equivalents
$
(149.2
)
$
(105.8
)
$
(43.4
)
Operating activities from continuing operations provided net cash of $374.8 million in 2015, after providing net cash of $281.5 million in 2014. The increase was primarily due to the net favorable change in working capital items of $89.7 million from 2014 to 2015.

The following chart displays the impact of working capital items on cash during 2015 and 2014, respectively:
 
2015
2014
$ Change
Cash provided (used):
 
 
 
Accounts receivable
$
11.9

$
(48.3
)
$
60.2

Inventories
52.8

(26.8
)
79.6

Trade accounts payable
11.6

8.0

3.6

Other accrued expenses
(51.5
)
2.2

(53.7
)
   Increase (decrease) in cash provided (used) for working capital items
$
24.8

$
(64.9
)
$
89.7

Net cash from continuing operations used by investing activities of $265.2 million in 2015 increased from the same period in 2014 primarily due to a $191.6 million increase in cash used for acquisitions, partially offset by a $38.8 million increase in cash provided from divestitures.
 
Net cash from continuing operations used by financing activities was $241.6 million in 2015, compared with $302.2 million in 2014. The decrease in cash used by financing activities was primarily due to an increase in net borrowings, a decrease in restricted cash, partially offset by higher total cost of purchases of the Company's common shares during 2015 compared with 2014 and lower net proceeds from the exercise of options. In addition, there was a transfer of cash to TimkenSteel as part of the Spinoff in 2014.

The following chart displays the factors impacting cash from financing activities during 2015 and 2014, respectively:
 
2015
2014
$ Change
Net borrowings
$
130.1

$
85.7

$
44.4

Cash transferred to TimkenSteel Corporation

(46.5
)
46.5

Purchase of treasury shares
(309.7
)
(270.9
)
(38.8
)
Proceeds from exercise of stock options
4.1

16.8

(12.7
)
Decrease in restricted cash
14.8


14.8

Cash dividends paid to shareholders
(87.0
)
(90.3
)
3.3

Other
6.1

3.0

3.1

   Decrease in cash used for financing activities
$
(241.6
)
$
(302.2
)
$
60.6

 


36


LIQUIDITY AND CAPITAL RESOURCES

Total debt was $657.7 million and $530.1 million at December 31, 2015 and 2014, respectively. Debt exceeded cash and cash equivalents by $527.9 million and $236.0 million at December 31, 2015 and 2014, respectively. The ratio of net debt to capital was 28.2% and 12.9% at December 31, 2015 and 2014, respectively.

Reconciliation of total debt to net debt and the ratio of net debt to capital:

Net Debt:
  
December 31,
  
2015
2014
Short-term debt
$
62.0

$
7.4

Current portion of long-term debt
15.1

0.6

Long-term debt
580.6

522.1

Total debt
$
657.7

$
530.1

Less: Cash and cash equivalents
129.6

278.8

 Restricted cash
0.2

15.3

Net debt
$
527.9

$
236.0



Ratio of Net Debt to Capital:
  
December 31,
  
2015
2014
Net debt
$
527.9

$
236.0

Total equity
1,344.6

1,589.1

Capital (net debt + total equity)
$
1,872.5

$
1,825.1

Ratio of net debt to capital
28.2
%
12.9
%
The Company presents net debt because it believes net debt is more representative of the Company's financial position than total debt due to the amount of cash and cash equivalents held by the Company.

At December 31, 2015, approximately $123 million, or over 90%, of the Company's cash and cash equivalents resided in jurisdictions outside the United States. It is the Company's practice to use available cash in the United States to pay down short term debt drawn on its Senior Credit Facility or Accounts Receivable Facility, in order to minimize total interest expense. As a result, the majority of the Company's cash on hand was outside the United States. Repatriation of these funds to the United States could be subject to domestic and foreign taxes and some portion may be subject to governmental restrictions. Part of the Company's strategy is to grow in attractive market sectors, many of which are outside the United States. This strategy may include making investments in facilities and equipment and potential new acquisitions. The Company plans to fund these investments, as well as meet working capital requirements, with cash and cash equivalents and unused lines of credit within the geographic location of these investments when possible.

The Company has a $100 million Accounts Receivable Facility that matures on November 30, 2018. The Accounts Receivable Facility is subject to certain borrowing base limitations and is secured by certain domestic accounts receivable of the Company. As of December 31, 2015, the Company had $49.0 million in outstanding borrowings, at an interest rate of 1.05%. There was $5.6 million of additional borrowing capacity available under the Accounts Receivable Facility at December 31, 2015.



37


The Company has a $500.0 million Senior Credit Facility that matures on June 19, 2020. At December 31, 2015, the Company had $75.2 million of outstanding borrowings under the Senior Credit Facility and had zero letters of credit outstanding, which reduced the availability under the Senior Credit Facility to $424.8 million. Under the Senior Credit Facility, the Company has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. At December 31, 2015, the Company was in full compliance with the covenants under the Senior Credit Facility. The maximum consolidated leverage ratio permitted under the Senior Credit Facility is 3.5 to 1.0 (3.75 to 1.0 for a limited period up to four quarters following an acquisition with a purchase price of $200 million or greater). As of December 31, 2015, the Company’s consolidated leverage ratio was 1.44 to 1.0. The minimum consolidated interest coverage ratio permitted under the Senior Credit Facility is 3.5 to 1.0. As of December 31, 2015, the Company’s consolidated interest coverage ratio was 14.86 to 1.0.

The interest rate under the Senior Credit Facility is based on the Company’s debt rating. In addition, the Company pays a facility fee based on the consolidated leverage ratio multiplied by the aggregate commitments of all of the lenders under the Senior Credit Facility. The Senior Credit Facility has an interest rate of 1.45% as of December 31, 2015.

Other sources of liquidity include short-term and long-term lines of credit for certain of the Company’s foreign subsidiaries, which provide for borrowings up to $217.9 million in the aggregate. The majority of these lines are uncommitted. At December 31, 2015, the Company had borrowings outstanding of $13.0 million and guarantees of $4.4 million, which reduced the availability under these facilities to $200.5 million.

The Company expects that any cash requirements in excess of cash on hand will be met by the committed funds available under its Accounts Receivable Facility and the Senior Credit Facility. Management believes it has sufficient liquidity to meet its obligations through at least the term of the Senior Credit Facility.

The Company expects to remain in compliance with its debt covenants. However, the Company may need to limit its borrowings under the Senior Credit Facility or other facilities in order to remain in compliance. As of December 31, 2015, the Company could have borrowed the full amounts available under the Senior Credit Facility and Accounts Receivable Facility, and would have still been in compliance with its debt covenants.

In August 2014, the Company issued $350 million of fixed-rate unsecured notes that mature in September 2024 (the 2024 Notes). The Company used a portion of the net proceeds from this issuance to repay the $250 million of fixed-rated unsecured notes that matured on September 15, 2014.

The Company expects to generate cash from continuing operations of approximately $300 million in 2016, a decrease of approximately $75 million, or 20%, compared with 2015, as the Company anticipates lower income, excluding non-cash impairment and pension settlement charges. Pension contributions are expected to be approximately $15.0 million in 2016, compared with $10.8 million in 2015. The Company expects capital expenditures of approximately 4.5% of sales in 2016, compared with 3.7% of sales in 2015.



38


CONTRACTUAL OBLIGATIONS

The Company’s contractual debt obligations and contractual commitments outstanding as of December 31, 2015 were as follows:

Payments due by period:
Contractual Obligations
Total
Less than
1 Year
1-3 Years
3-5 Years
More than
5 Years
Interest payments
$
248.0

$
26.4

$
49.0

$
48.3

$
124.3

Long-term debt, including current portion
595.7

15.1

80.2


500.4

Short-term debt
62.0

62.0




Operating leases
142.2

35.1

53.9

39.2

14.0

Purchase commitments
19.2

12.8

6.4



Retirement benefits
297.3

29.2

47.9

77.6

142.6

Total
$
1,364.4

$
180.6

$
237.4

$
165.1

$
781.3

The interest payments beyond five years primarily relate to medium-term notes. Refer to Note 10 - Financing Arrangements for additional information.
Purchase commitments are defined as an agreement to purchase goods or services that are enforceable and legally binding on the Company. Included in purchase commitments above are certain obligations related to take or pay contracts, capital commitments, service agreements and utilities. Many of these commitments relate to take or pay contracts, in which the Company guarantees payment to ensure availability of products or services. These purchase commitments do not represent the entire anticipated purchases in the future, but represent only those items that the Company is contractually obligated to purchase. The majority of the products and services purchased by the Company are purchased as needed, with no commitment.

In order to maintain minimum funding requirements, the Company is required to make contributions to the trusts established for its defined benefit pension plans and other postretirement benefit plans. The table above shows the expected future minimum cash contributions to the trusts for the funded plans as well as estimated future benefit payments to participants for the unfunded plans.  Those minimum funding requirements and estimated benefit payments can vary significantly. The amounts in the table above are based on actuarial estimates using current assumptions for, among other things, discount rates, expected return on assets and health care cost trend rates. See Note 14 - Retirement Benefit Plans and Note 15 - Postretirement Benefit Plans to our consolidated financial statements for additional information on retirement benefit plans and other postretirement benefit plans.
During 2015, the Company made cash contributions of approximately $10.8 million to its global defined benefit pension plans. The Company currently expects to make contributions to its global defined benefit pension plans totaling approximately $15 million in 2016. Returns for the Company’s global defined benefit pension plan assets in 2015 were 0.61%, below the expected rate of return of 6.0% predominantly due to decreases in the long duration fixed-income markets. The lower returns negatively impacted the funded status of the plans at the end of 2015. However, due to the Company's pension de-risking activities, as well as a 49 basis points increase in discount rates used to measure the Company's defined benefit pension obligations, the lower returns were largely offset and the Company expects lower pension expense, excluding pension settlement charges in future years. Refer to Note 14 - Retirement Benefit Plans and Note 15 - Postretirement Benefit Plans in the Notes to the Consolidated Financial Statements for additional information.

As disclosed in Note 11 – Contingencies and Note 17 – Income Taxes in the Notes to the Consolidated Financial Statements, the Company has exposure for certain legal and tax matters.

As of December 31, 2015, the Company had approximately $51.3 million of total gross unrecognized tax benefits. The Company anticipates a decrease in its unrecognized tax positions of $35 million to $40 million during the next 12 months. The anticipated decrease is primarily due to settlements with tax authorities. Future tax positions are not known at this time and therefore not included in the above summary of the Company’s fixed contractual obligations. Refer to Note 17 – Income Taxes in the Notes to the Consolidated Financial Statements for additional information.
 
The Company does not have any off-balance sheet arrangements with unconsolidated entities or other persons.

39


RECENTLY ADOPTED ACCOUNTING PRONOUNCMENTS

Information required for this Item is incorporated by reference to Note 1 - Significant Accounting Policies in the Notes to the Consolidated Financial Statements.


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 generally recognizes revenue when title passes to the customer. This occurs at the shipping point except for goods sold by certain foreign entities and certain exported goods, where title passes when the goods reach their destination. Selling prices are fixed based on purchase orders or contractual arrangements. Shipping and handling costs billed to customers are included in net sales and the related costs are included in cost of products sold in the Consolidated Statements of Income.

The Company recognizes a portion of its revenues on the percentage of completion method measured on the cost-to-cost basis. In 2015, 2014 and 2013, the Company recognized approximately $66 million, $50 million and $55 million, respectively, in net sales under the percentage-of-completion method.

Inventory:
Inventories are valued at the lower of cost or market, with approximately 53% valued by the first-in, first-out (FIFO) method and the remaining 47% valued by the last-in, first-out (LIFO) method. The majority of the Company’s domestic inventories are valued by the LIFO method, and all of the Company’s international inventories are valued by the FIFO method. An actual valuation of the inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs. Because these are subject to many factors beyond management’s control, annual results may differ from interim results as they are subject to the final year-end LIFO inventory valuation. The Company recognized a decrease in its LIFO reserve of $11.6 million during 2015 compared with an increase in its LIFO reserve of $0.4 million during 2014.

Goodwill:
The Company tests goodwill and indefinite-lived intangible assets for impairment at least annually. The Company performs its annual impairment test as of October first, after the annual forecasting process is completed. Furthermore, goodwill is reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Each interim period, management of the Company assesses whether or not an indicator of impairment is present that would necessitate that a goodwill impairment analysis be performed in an interim period other than during the fourth quarter.

The goodwill impairment analysis is a two-step process. Step one compares the carrying amount of the reporting unit to its estimated fair value. To the extent that the carrying value of the reporting unit exceeds its estimated fair value, step two is performed, where the reporting unit’s carrying value of goodwill is compared with the implied fair value of goodwill. To the extent that the carrying value of goodwill exceeds the implied fair value of goodwill, impairment exists and must be recognized.

The Company reviews goodwill for impairment at the reporting unit level. The Mobile Industries segment has three reporting units and the Process Industries segment has two reporting units. The reporting units within the Mobile Industries segment are Mobile Industries, Aerospace Transmissions and Aerospace Aftermarket. The reporting units within the Process Industries segment are Process Industries and Industrial Services.





40


The Company prepares its goodwill impairment analysis by comparing the estimated fair value of each reporting unit, using an income approach (a discounted cash flow model), as well as a market approach, with its carrying value. The income approach and market approach are weighted in arriving at fair value based on the relative merits of the methods used and the quantity and quality of collected data to arrive at the indicated fair value.

The income approach requires several assumptions including future sales growth, EBIT (earnings before interest and taxes) margins and capital expenditures. The Company’s reporting units each provide their forecast of results for the next three years. These forecasts are the basis for the information used in the discounted cash flow model. The discounted cash flow model also requires the use of a discount rate and a terminal revenue growth rate (the revenue growth rate for the period beyond the three years forecasted by the reporting units), as well as projections of future operating margins (for the period beyond the forecasted three years). During the fourth quarter of 2015, the Company used a discount rate for its reporting units of 9.0% to 12.5% and a terminal revenue growth rate of 1% to 3%.

The market approach requires several assumptions including sales and EBITDA (earnings before interest, taxes, depreciation and amortization) multiples for comparable companies that operate in the same markets as the Company’s reporting units. During the fourth quarter of 2015, the Company used sales multiples of 0.60 to 2.55 for its reporting units. During the fourth quarter of 2015, the Company used EBITDA multiples of 6.0 to 9.5 for its reporting units.

As of December 31, 2015, the Company had $327.3 million of goodwill on its Consolidated Balance Sheet, of which $97.0 million was attributable to the Mobile Industries segment and $230.3 million was attributable to the Process Industries segment. See Note 9 - Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements for the carrying amount of goodwill by segment.

The fair value of the Aerospace Transmission reporting unit was $96.0 million, compared with their carrying value of $88.3 million. The fair value of the other reporting units exceeded its carrying value by a significant amount. As a result, the Company did not recognize any goodwill impairment charges during the fourth quarter of 2015.

A 30 basis point increase in the discount rate would have resulted in the Aerospace Transmission reporting unit failing step one of the goodwill impairment analysis, which would have required the completion of step two of the goodwill impairment analysis to arrive at a potential goodwill impairment loss. A 3.9% decline in projected cash flows would have caused the Aerospace Transmission reporting unit to fail and the fair value would have still exceeded its carrying value.

Restructuring costs:
The Company’s policy is to recognize restructuring costs in accordance with Accounting Standards Codification (ASC) Topic 420, “Exit or Disposal Cost Obligations,” and ASC Topic 712, “Compensation and Non-retirement Post-Employment Benefits.” Detailed contemporaneous documentation is maintained and updated to ensure that accruals are properly supported. If management determines that there is a change in estimate, the accruals are adjusted to reflect this change.

Income taxes:
The Company, which is subject to income taxes in the United States and numerous non-U.S. jurisdictions, accounts for income taxes in accordance with ASC Topic 740, “Income Taxes.”  Deferred tax assets and liabilities are recorded for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as net operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The Company records valuation allowances against deferred tax assets by tax jurisdiction when it is more likely than not that such assets will not be realized. In determining the need for a valuation allowance, the historical and projected financial performance of the entity recording the net deferred tax asset is considered along with any other pertinent information. Deferred tax assets relate primarily to pension and post-retirement benefit obligations in the United States, which the Company believes are more likely than not to result in future tax benefits. In 2015, the company recorded $34.7M of tax benefit related to the reversal of valuation allowances. See Note 17 - Income Taxes in the Notes to Consolidated Financial Statements for further discussion on the valuation allowance reversals.





41


In the ordinary course of the Company’s business, there are many transactions and calculations where the ultimate income tax determination is uncertain. The Company is regularly under audit by tax authorities. Accruals for uncertain tax positions are provided for in accordance with the requirements of ASC Topic 740. The Company records interest and penalties related to uncertain tax positions as a component of income tax expense. In 2015, the company recorded $5.9M of net tax benefits related to uncertain tax positions. The company recorded tax benefits of $18.6M related to settlements with tax authorities and reduction in prior year reserves and $12.7M of tax expense related to current and prior year tax positions and interest expense. See Note 17 - Income Taxes in the Notes to Consolidated Financial Statements for further discussion on the uncertain tax positions reserve reversals.

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities, valuation allowances against deferred tax assets, and accruals for uncertain tax positions.


Benefit Plans:
The Company sponsors a number of defined benefit pension plans that cover eligible associates. The Company also sponsors several funded and unfunded post-retirement plans that provide health care and life insurance benefits for eligible retirees and their dependents. These plans are accounted for in accordance with ASC Topic 715-30, "Defined Benefit Plans – Pension," and ASC Topic 715-60, "Defined Benefit Plans – Other Postretirement."
  
The measurement of liabilities related to these plans is based on management's assumptions related to future events, including discount rates, rates of return on pension plan assets, rates of compensation increases and health care cost trend rates. Management regularly evaluates these assumptions and adjusts them as required and appropriate. Other plan assumptions are also reviewed on a regular basis to reflect recent experience and the Company's future expectations. Actual experience that differs from these assumptions may affect future liquidity, expense and the overall financial position of the Company. While the Company believes that current assumptions are appropriate, significant differences in actual experience or significant changes in these assumptions may materially affect the Company's pension and other post-retirement employee benefit obligations and its future expense and cash flow.

The discount rate is used to calculate the present value of expected future pension and post-retirement cash flows as of the measurement date. The Company establishes the discount rate by constructing a notional portfolio of high-quality corporate bonds and matching the coupon payments and bond maturities to projected benefit payments under the Company's pension and post-retirement welfare plans. The bonds included in the portfolio are generally non-callable. A lower discount rate will result in a higher benefit obligation; conversely, a higher discount rate will result in a lower benefit obligation. The discount rate is also used to calculate the annual interest cost, which is a component of net periodic benefit cost.

The expected rate of return on plan assets is determined by analyzing the historical long-term performance of the Company's pension plan assets, as well as the mix of plan assets between equities, fixed income securities and other investments, the expected long-term rate of return expected for those asset classes and long-term inflation rates. Short-term asset performance can differ significantly from the expected rate of return, especially in volatile markets. A lower-than-expected rate of return on pension plan assets will increase pension expense and future contributions.


42


Defined Benefit Pension Plans:
The Company recognized net periodic benefit cost of $497.8 million in 2015 for defined benefit pension plans compared with $54.6 million in 2014. The increase in net periodic cost was primarily due to higher pension settlement charges and lower expected return on plan assets, partially offset by lower interest costs and lower amortization of net actuarial losses. The increase in pension settlement charges was primarily due to the Company entering into two agreements pursuant to which two of the Company's U.S. defined benefit pension plans purchased group annuity contracts from Prudential. The two group annuity contracts requi