10-K 1 d269602d10k.htm FORM 10-K FORM 10-K
Table of Contents

 

 

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, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             

Commission file number: 1-1169

 

 

THE TIMKEN COMPANY

(Exact name of registrant as specified in its charter)

 

Ohio   34-0577130
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
1835 Dueber Avenue, S.W., Canton, Ohio   44706
(Address of principal executive offices)   (Zip Code)

(330) 438-3000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

 

Name of each exchange on which registered

Common Stock, without par value   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

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  ¨    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  ¨

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 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  ¨

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 definition of “larger accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨      Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of June 30, 2011, the aggregate market value of the registrant’s common shares held by non-affiliates of the registrant was $4,481,899,833 based on the closing sale price as reported on the New York Stock Exchange.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at January 31, 2012

Common Shares, without par value   97,739,712 shares

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Document

 

Parts Into Which Incorporated

Proxy Statement for the Annual Meeting of Shareholders to be held May 8, 2012 (Proxy Statement)   Part III

 

 

 


Table of Contents

THE TIMKEN COMPANY

INDEX TO FORM 10-K REPORT

 

               PAGE  

I.

   PART I.      
   Item 1.    Business      1   
   Item 1A.    Risk Factors      6   
   Item 1B.    Unresolved Staff Comments      10   
   Item 2.    Properties      11   
   Item 3.    Legal Proceedings      11   
   Item 4.    Mine Safety Disclosures      11   
   Item 4A.    Executive Officers of the Registrant      12   

II.

   PART II.      
   Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      13   
   Item 6.    Selected Financial Data      16   
   Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      17   
   Item 7A.    Quantitative and Qualitative Disclosures about Market Risk      43   
   Item 8.    Financial Statements and Supplementary Data      44   
   Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      87   
   Item 9A.    Controls and Procedures      87   
   Item 9B.    Other Information      89   

III.

   Part III.      
   Item 10.    Directors, Executive Officers and Corporate Governance      89   
   Item 11.    Executive Compensation      89   
   Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      89   
   Item 13.    Certain Relationships and Related Transactions, and Director Independence      89   
   Item 14.    Principal Accountant Fees and Services      89   

IV.

   Part IV.      
   Item 15.    Exhibits and Financial Statement Schedules      90   

Exhibit 10.1

        

Exhibit 10.2

        

Exhibit 10.3

        

Exhibit 10.4

        

Exhibit 10.5

        

Exhibit 10.6

        

Exhibit 10.7

        

Exhibit 10.8

        

Exhibit 10.9

        

Exhibit 10.10

        

Exhibit 10.11

        

Exhibit 10.12

        

Exhibit 10.13

        

Exhibit 12

        

Exhibit 21

        

Exhibit 23

        

Exhibit 24

        

Exhibit 31.1

        

Exhibit 31.2

        

Exhibit 32

        

Exhibit 101

        


Table of Contents

PART I.

Item 1. Business

General

As used herein, the term “Timken” or the “Company” refers to The Timken Company and its subsidiaries unless the context otherwise requires. The Timken Company develops, manufactures, markets and sells products for friction management and mechanical power transmission, alloy steels and steel components.

The Company was founded in 1899 by Henry Timken, who received two patents on the design of a tapered roller bearing. Timken grew to become the world’s largest manufacturer of tapered roller bearings. Over the years, the Company has expanded its breadth of bearing products beyond tapered roller bearings to include cylindrical, spherical, needle and precision ball bearings. In addition to bearings, Timken further broadened its portfolio to include a wide array of friction management products and maintenance services to improve the operation of customers’ machinery and equipment, such as lubricants, seals, bearing maintenance tools and condition-monitoring equipment. The Company also manufactures mechanical power transmission components and assemblies, as well as systems such as helicopter transmissions, high-quality alloy steel, bars and tubing to custom specifications to meet demanding performance requirements and finished and semi-finished steel components.

Timken’s global footprint consists of 58 manufacturing facilities, 10 technology and engineering centers, 14 distribution centers and warehouses and nearly 21,000 employees. Timken operates in 30 countries and territories.

Industry Segments and Geographical Financial Information

Information required by this item is incorporated by reference to Note 14  –  Segment Information in the Notes to the Consolidated Financial Statements.

Major Customers

The Company develops, manufactures, markets and sells products for friction management and power transmission, alloy steels and steel components to many industries and customers. The Company does not have any sales to a single customer that are 10% or more of total sales or segment sales.

Products

The Timken Company manufactures and manages global supply chains for two core product lines: anti-friction bearings and adjacent mechanical power transmission components, as well as specialty steel and related precision steel components. Differentiation in these two product lines is achieved by either: (1) product type or (2) the targeted applications utilizing the product.

Bearings and Power Transmission. Selection and development of bearings for customers’ applications and demand for high reliability require engineering and sophisticated analytical techniques. Timken’s know-how, combined with high precision tolerance, proprietary internal geometry and premium quality material, 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, they also are used in a wide variety of industrial applications, ranging from paper and steel mills, mining, oil and gas extraction and production, gear drives, health and positioning control, wind mills and food processing. Timken manufactures or in some cases purchases the required components and then sells them assembled or as individual components in a wide variety of configurations and sizes. In addition to bearings, Timken provides mechanical power transmission products, including chains, augers, gear boxes, seals, lubricants, and related products and services.

Tapered Roller Bearings. The tapered roller bearing is Timken’s original entrant to the anti-friction bearing segment. The tapered rollers permit ready absorption of both radial and axial load combinations. For this reason, tapered roller bearings are particularly well-adapted to reducing friction where shafts, gears or wheels are used. Bearings generally consist of four components: (1) the cone or inner race; (2) the cup or outer race; (3) the rollers, which roll between the cup and cone; and (4) the cage, which serves as a retainer and maintains proper spacing between the rollers.

 

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Precision Cylindrical and Ball Bearings. Timken’s aerospace facilities produce high-performance ball and cylindrical bearings for ultra high-speed and/or high-accuracy applications in the aerospace, medical and dental, computer and other industries. These bearings utilize ball and straight rolling elements and are in the super precision end of the general ball and straight roller bearing product range in the bearing industry. A majority of these bearings products are custom-designed bearings and spindle assemblies. They often involve specialized materials and coatings for use in applications that subject the bearings to extreme operating conditions of speed and temperature.

Spherical and Cylindrical Roller Bearings. Timken produces spherical and cylindrical roller bearings for large gear drives, rolling mills and other industrial and infrastructure development applications. These products are sold worldwide to original equipment manufacturers and industrial distributors serving major end-markets, including construction and mining, natural resources, defense, pulp and paper production, rolling mills and general industrial goods. The same rigorous analysis and development apply to these products as well.

Chains and Augers. Through the acquisition of Drives LLC (Drives) in 2011, Timken now manufactures American National Standards Institute (ANSI) precision roller chain, pintle chain, agricultural conveyor chain, engineering class chain, oil field roller chain and auger products. These highly engineered products are vital to a wide range of mobile and industrial machinery applications, including agriculture, oil and gas, aggregate and mining, primary metals, forest products and other heavy industries, including food and beverage and packaged goods sectors, which often require high-end, specialty products such as stainless-steel and corrosion-resistant roller chains.

Gear-Drive Systems. Through the acquisition of Philadelphia Gear Corp. (Philadelphia Gear) in 2011, Timken now provides aftermarket gear box repair services and gear-drive systems for the industrial, energy and military marine sectors, including refining and pipeline systems, mining, cement, pulp and paper making and water management systems.

Services. Timken also provides bearing reconditioning and repair; condition monitoring and reliability services to maximize performance, durability and maintenance intervals for industrial and railroad customers, both domestically and internationally. Other services include maintenance and rework services for large industrial equipment used in metal mills and energy sectors. The total services accounted for less than 5% of the Company’s net sales for the year ended December 31, 2011.

Aerospace Products and Services. Timken’s portfolio of parts, systems and services for the aerospace market has grown to include products used in helicopters and fixed-wing aircraft for the military and commercial aviation industries. Timken provides design, manufacturing and testing for a wide variety of power transmission and drive train components including bearings, transmissions, turbine engine components, gears and rotor-head assemblies and housings. Other parts include airfoils (such as blades, vanes, rotors and diffusers), nozzles and other precision flight-critical components.

In addition to original equipment, Timken provides a wide range of aftermarket products and services for global customers, including complete engine overhaul, bearing repair, component reconditioning and replacement parts for gas turbine engines, transmissions and fuel controls, gearboxes and accessory systems in helicopters and fixed-wing aircraft. Our precision bearings also have applications in spacecraft and robotic vehicles, like Curiosity, the newest Mars Rover. Customers for these precision bearings also include manufacturers of medical and health equipment, machine tools, industrial motion control systems and precision robotics.

Steel. Timken produces more than 450 grades of carbon, micro-alloy and alloy steel, which are sold as ingots, bars and tubes in a variety of chemistries, lengths and finishes. Our metallurgical expertise and operational capabilities enable us to provide customized solutions for the automotive, industrial and energy sectors. Timken® specialty steels are used in a wide variety of end products including oil country drill pipe, bits and collars, gears, hubs, axles, crankshafts and connecting rods, bearing races and rolling elements, bushings, fuel injectors, wind energy shafts and other demanding applications, where mechanical power transmission is critical to the end customer.

Precision Steel Components. Timken also produces custom-made steel products, including steel components for automotive and industrial customers. Steel components have provided the Company with the opportunity to further expand its market for tubing and capture higher value-added steel sales by streamlining customer supply chains. It also enables Timken’s traditional tubing customers in the automotive and bearing industries to take advantage of ready-to-finish components that cost less than other alternatives. Customization of products is an important component of the Company’s steel business where mechanical power transmission is critical to the end customer.

 

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Sales and Distribution

Timken’s products in the Mobile Industries, Process Industries and Aerospace and Defense segments are sold principally by its own internal sales organizations. A portion of the Process Industries segment’s sales are made through authorized distributors.

Traditionally, a main focus of the Company’s sales strategy has consisted of collaborative projects with customers. For this reason, the Company’s sales forces are primarily located in close proximity to its customers rather than at production sites. In some instances, the sales forces are located inside customer facilities. The Company’s sales force is highly-trained and knowledgeable regarding all friction management products, and employees assist customers during the development and implementation phases and provide ongoing support.

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

Timken’s steel products are sold principally by its own sales organization. Most orders are customized to satisfy customer-specific applications and are shipped directly to customers from Timken’s steel manufacturing plants. Less than 10% of Timken’s Steel Group net sales are intersegment sales. In addition, sales are made to other anti-friction bearing companies and to the automotive and truck, forging, construction, industrial equipment, oil and gas drilling and aircraft industries and to steel service centers.

Timken has entered into individually negotiated contracts with some of its customers in its Mobile Industries, Process Industries, Aerospace and Defense and Steel segments. 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 in which Timken sells products. Timken competes primarily based on price, quality, timeliness of delivery, product design and the ability to provide engineering support and service on a global basis. The Company competes with domestic manufacturers and many foreign manufacturers of anti-friction bearings, including SKF Group, Schaeffler Group, NTN Corporation, JTEKT Corporation (JTEKT) and NSK Ltd.

Competition within the steel industry, both domestically and globally, is intense and is expected to remain so. Principal bar competitors include foreign-owned domestic producers Gerdau Special Steel North America (a unit of Brazilian steelmaker Gerdau, S.A) and Republic Steel (a unit of Mexican steel producer ICH), along with domestic steel producers Steel Dynamics, Inc. and Nucor Corporation. Seamless tubing competitors include foreign-owned domestic producers ArcelorMittal Tubular Products (a unit of Luxembourg-based ArcelorMittal, S.A.), V&M Star Tubes (a unit of Vallourec, S.A.), and Tenaris, S.A. Additionally, Timken competes with a wide variety of offshore producers of both bars and tubes, including Sanyo Special Steel and Ovako. Timken also provides value-added steel products to its customers in the energy, industrial and automotive sectors. Competitors within the value-added market segment include Linamar, Jernberg and Curtis Screw Company.

Maintaining high standards of product quality and reliability, while keeping production costs competitive, is essential to Timken’s ability to compete with domestic and foreign manufacturers in both the anti-friction bearing and steel businesses.

 

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Joint Ventures

Investments in affiliated companies accounted for under the equity method were approximately $2.0 million and $9.4 million, respectively, at December 31, 2011 and 2010. The amount at December 31, 2011 was reported in other non-current assets on the Consolidated Balance Sheets. The significant decrease between the amount at December 31, 2011 and the amount at December 31, 2010 was due to the impairment and subsequent sale of International Component Supply, Ltda. (ICS). The Company also consolidated one of its investments in affiliated companies, Advanced Green Components (AGC), as a result of it qualifying as a variable interest entity. The net assets of AGC at December 31, 2011 were $0.6 million.

Backlog

The following table provides the backlog of orders of Timken’s domestic and overseas operations at December 31, 2011 and 2010:

 

000000000000 000000000000
      December 31,  
      2011      2010  
 (Dollars in millions)              

 Segment:

     

 Mobile Industries

   $ 654.4       $ 629.3   

 Process Industries

     421.8         330.7   

 Aerospace & Defense

     443.2         376.4   

 Steel

     530.7         872.0   

 Total Company

   $ 2,050.1       $ 2,208.4   

Approximately 91% of the Company’s backlog at December 31, 2011 is scheduled for delivery in the succeeding twelve months. Actual shipments are dependent upon ever-changing production schedules of customers. Accordingly, Timken does not believe that its backlog data and comparisons thereof, as of different dates, are reliable indicators of future sales or shipments.

Raw Materials

The principal raw materials used by Timken in steel manufacturing are scrap metal, nickel, molybdenum and other alloys. The availability and costs of raw materials and energy resources are subject to curtailment or change due to, among other things, new laws or regulations, changes in global demand levels, suppliers’ allocations to other purchasers, interruptions in production by suppliers, changes in exchange rates and prevailing price levels. For example, the weighted average consumption cost of scrap metal decreased 49.0% from 2008 to 2009, increased 59.0% from 2009 to 2010 and increased 22.9% from 2010 to 2011.

The Company continues to expect that it will be able to pass a significant portion of cost increases through to customers in the form of price increases or surcharges.

Disruptions in the supply of raw materials or energy resources could temporarily impair the Company’s ability to manufacture its products for its customers or require the Company to pay higher prices in order to obtain these raw materials or energy resources from other sources, which could affect the Company’s revenues and profitability. Any increase in the costs for such raw materials or energy resources could materially affect the Company’s earnings. Timken believes that the availability of raw materials and alloys is adequate for its needs, and, in general, it is not dependent on any single source of supply.

Research

Timken operates a network of technology and engineering centers to support its global customers with sites in North America, Europe and Asia. This network develops and delivers innovative friction management and mechanical power transmission solutions and technical services. The largest technical center is located in North Canton, Ohio, near Timken’s world headquarters. Other sites in the United States include Mesa, Arizona; Manchester, Connecticut; Keene and Lebanon, New Hampshire; and King of Prussia, Pennsylvania. Within Europe, the Company has technology facilities in Ploiesti, Romania; and Colmar, France, and in Asia, it operates technology and engineering facilities in Bangalore, India and Shanghai, China.

Expenditures for research, development and application amounted to approximately $49.6 million, $49.9 million and $50.0 million in 2011, 2010 and 2009, respectively. Of these amounts, approximately $0.3 million, $1.6 million and $1.7 million, respectively, were funded by others in 2011, 2010 and 2009.

 

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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 2011, 21 of the Company’s plants had obtained ISO 14001 certification.

The Company believes it has established adequate reserves to cover its environmental expenses and has a well-established environmental compliance audit program, which includes a proactive approach to bringing its domestic and international units to higher standards of environmental performance. This program measures performance against applicable laws, as well as standards that have been established for all units worldwide. It is difficult to assess the possible effect of compliance with future requirements that differ from existing ones. As previously reported, the Company is unsure of the future financial impact to the Company that could result from the United States Environmental Protection Agency’s (EPA’s) final rules to tighten the National Ambient Air Quality Standards for fine particulate and ozone. In addition, the Company is unsure of the future financial impact to the Company that could result from U.S. EPA instituting hourly ambient air quality standards for sulfur dioxide and nitrogen oxide. The Company is also unsure of potential future financial impacts to the Company that could result from possible future legislation regulating emissions of greenhouse gases.

The Company and of its certain of its U.S. subsidiaries have been designated as potentially responsible parties by the EPA for site 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 remediation have been asserted against numerous other entities, which are believed to be financially solvent and are expected to substantially fulfill their proportionate share of the obligation.

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

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

Patents, Trademarks and Licenses

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

Employment

At December 31, 2011, Timken had 20,954 employees. Approximately 10% of Timken’s U.S. employees are covered under collective bargaining agreements.

Available Information

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

 

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Item 1A: Risk Factors

The following are certain risk factors that could affect our business, financial condition and results of operations. The risks that are highlighted below are not the only ones that we face. These risk factors should be considered in connection with evaluating forward-looking statements contained in this Annual Report on Form 10-K because these factors could cause our actual results and financial condition to differ materially from those projected in forward-looking statements. If any of the following risks actually occur, our business, financial condition or results of operations could be negatively affected.

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

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

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

Competition within the steel industry, both domestically and worldwide, is intense and is expected to remain so. Global production overcapacity has occurred in the past and may recur in the future, which would exert downward pressure on domestic steel prices and result in, at times, a dramatic narrowing, or with many companies the elimination, of gross margins. High levels of steel imports into the United States could exacerbate this pressure on domestic steel prices. In addition, many of our competitors are continuously exploring and implementing strategies, including acquisitions and the addition or repositioning of capacity, which focus on manufacturing higher margin products that compete more directly with our steel products. These factors could lead to significant downward pressure on prices for our steel products, which could have a material adverse effect on our revenues and profitability.

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

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

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

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

Our results of operations may be materially affected by the conditions in the global financial markets. 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.

 

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If a customer becomes insolvent or files for bankruptcy, our ability to recover accounts receivable from that customer would be adversely affected and any payment we received during the preference period prior to a bankruptcy filing may be potentially recoverable by the bankruptcy estate. Furthermore, if certain of our customers liquidate in bankruptcy, we may incur impairment charges relating to obsolete inventory and machinery and equipment. In addition, financial instability of certain companies in the supply chain could disrupt production in any particular industry. A disruption of production in any of the industries where we participate could have a material adverse effect on our financial condition and earnings.

Any change in the operation of our raw material surcharge mechanisms, a raw material market index or the availability or cost of raw materials and energy resources could materially affect our revenues and earnings.

We require substantial amounts of raw materials, including scrap metal and alloys and natural gas to operate our business. Many of our customer contracts contain surcharge pricing provisions. The surcharges are generally tied to a widely-available market index for that specific raw material. Recently many of the widely-available raw material market indices have experienced wide fluctuations. Any change in a raw material market index could materially affect our revenues. Any change in the relationship between the market indices and our underlying costs could materially affect our earnings. Any change in our projected year-end input costs could materially affect our last-in, first-out (LIFO) inventory valuation method and earnings.

Moreover, future disruptions in the supply of our raw materials or energy resources could impair our ability to manufacture our products for our customers or require us to pay higher prices in order to obtain these raw materials or energy resources from other sources, and could thereby affect our sales and profitability. Any increase in the prices for such raw materials or energy resources could materially affect our costs and therefore our earnings.

Warranty, recall or product liability claims could materially adversely affect our earnings.

In our business, we are exposed to warranty and product liability claims. In addition, we may be required to participate in the recall of a product. A successful warranty or product liability claim against us, or a requirement that we participate in a product recall, could have a material adverse effect on our earnings.

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

We have taken approximately $262 million in impairment and restructuring charges during the last five years. Changes in business or economic conditions, or our business strategy, may result in additional restructuring programs and may require us to take additional charges in the future, which could have a material adverse effect on our earnings.

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

We are subject to the risk of substantial environmental liability and limitations on our operations due to environmental laws and regulations. We are subject to extensive federal, state, local and foreign environmental, health and safety laws and regulations concerning matters such as air emissions, wastewater discharges, solid and hazardous waste handling and disposal and the investigation and remediation of contamination. The risks of substantial costs and liabilities related to compliance with these laws and regulations are an inherent part of our business, and future conditions may develop, arise or be discovered that create substantial environmental compliance or remediation liabilities and costs.

Compliance with environmental, health and safety legislation and regulatory requirements may prove to be more limiting and costly than we anticipate. To date, we have committed significant expenditures in our efforts to achieve and maintain compliance with these requirements at our facilities, and we expect that we will continue to make significant expenditures related to such compliance in the future. New laws and regulations, including those which may relate to emissions of greenhouse gases, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean-up requirements could require us to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our business, financial condition or results of operations. From time to time, we may be subject to legal proceedings brought by private parties or governmental authorities with respect to environmental matters, including matters involving alleged property damage or personal injury.

 

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Unexpected equipment failures or other disruptions of our operations may increase our costs and reduce our sales and earnings due to production curtailments or shutdowns.

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

The global nature of our business exposes us to foreign currency fluctuations that may affect our asset values, results of operations and competitiveness.

We are exposed to the risks of currency exchange rate fluctuations because a significant portion of our net sales, costs, assets and liabilities, are denominated in currencies other than the U.S. dollar. These risks include a reduction in our asset values, net sales, operating income and competitiveness.

For those countries outside the United States where we have significant sales, devaluation in the local currency would reduce the value of our local inventory as presented in our Consolidated Financial Statements. In addition, a stronger U.S. dollar would result in reduced revenue, operating profit and shareholders’ equity due to the impact of foreign exchange translation on our Consolidated Financial Statements. Fluctuations in foreign currency exchange rates may make our products more expensive for others to purchase or increase our operating costs, affecting our competitiveness and our profitability.

Changes in exchange rates between the U.S. dollar and other currencies and volatile economic, political and market conditions in emerging market countries have in the past adversely affected our financial performance and may in the future adversely affect the value of our assets located outside the United States, our gross profit and our results of operations.

Global political instability and other risks of international operations may adversely affect our operating costs, revenues and the price of our products.

Our international operations expose us to risks not present in a purely domestic business, including primarily:

 

   

changes in tariff regulations, which may make our products more costly to export or import;

 

   

difficulties establishing and maintaining relationships with local OEMs, distributors and dealers;

 

   

import and export licensing requirements;

 

   

compliance with a variety of foreign laws and regulations, including unexpected changes in taxation and environmental or other regulatory requirements, which could increase our operating and other expenses and limit our operations;

 

   

disadvantages of competing against companies from countries that are not subject to U.S. laws and regulations, including the Foreign Corrupt Practices Act;

 

   

difficulty in staffing and managing geographically diverse operations; and

 

   

tax exposures related to cross-border intercompany transfer pricing and other tax risks unique to international operations.

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

 

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Underfunding of our defined benefit and other postretirement plans has caused and may in the future cause a significant reduction in our shareholders’ equity.

We recorded a decrease in shareholders’ equity related to pension and postretirement benefit liabilities in 2011 primarily due to a decrease in discount rates and lower than expected returns on pension and postretirement assets. In the future, we may be required to record additional charges related to pension and other postretirement liabilities as a result of asset returns, discount rate changes or other actuarial adjustments. These charges may be significant and would cause a significant reduction in our shareholders’ equity.

The underfunded status of our pension plans may require large contributions which may divert funds from other uses.

The underfunded status of our pension plans may require us to make large contributions to such plans. We made cash contributions of approximately $291 million, $230 million and $63 million in 2011, 2010 and 2009, respectively, to our defined benefit pension plans and currently expect to make cash contributions of approximately $165 million in 2012 to such plans. However, we cannot predict whether changing economic conditions, the future performance of assets in the plans or other factors will lead us or require us to make contributions in excess of our current expectations, diverting funds we would otherwise apply to other uses.

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

Our defined benefit pension plans had assets with an estimated value of approximately $2.6 billion and liabilities with an estimated value of approximately $3.1 billion, both as of December 31, 2011. Our future expense and funding obligations for the defined benefit pension plans depend upon a number of factors, including the level of benefits provided for by the plans, the future performance of assets set aside in trusts for these plans, the level of interest rates used to determine the discount rate to calculate the amount of liabilities, actuarial data and experience and any changes in government laws and regulations. In addition, if the various investments held by our pension trusts do not perform as expected or the liabilities increase as a result of discount rates and other actuarial changes, our pension expense and required contributions would increase and, as a result, could materially adversely affect our business. Due to the value of our defined benefit plan assets and liabilities, even a minor decrease in interest rates, to the extent not offset by contributions or asset returns, could increase our obligations under such plans. We may be legally required to make contributions to the pension plans in the future in excess of our current expectations, and those contributions could be material.

Work stoppages or similar difficulties could significantly disrupt our operations, reduce our revenues and materially affect our earnings.

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

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

We are subject to a wide variety of domestic and foreign laws and regulations, and legal compliance risks, including securities laws, tax laws, employment and pension-related laws, competition laws, U.S. and foreign export and trading laws, and laws governing improper business practices. We are affected by new laws and regulations, and changes to existing laws and regulations, including interpretations by courts and regulators.

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

 

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

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

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

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

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

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

Item 1B. Unresolved Staff Comments

None.

 

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Item 2. Properties

Timken has manufacturing facilities at multiple locations in the United States and in a number of countries outside the United States. The aggregate floor area of these facilities worldwide is approximately 13,946,000 square feet, all of which, except for approximately 1,471,000 square feet, is owned in fee. The facilities not owned in fee are leased. The buildings occupied by Timken are principally made of brick, steel, reinforced concrete and concrete block construction. All buildings are in satisfactory operating condition in which to conduct business.

Timken’s Mobile Industries and Process Industries segments’ manufacturing facilities in the United States are located in Bucyrus, Canton and Niles, Ohio; Hueytown, Alabama; Sante Fe Springs, California; New Castle, Delaware; Ball Ground, Georgia; Carlyle, Fulton and Mokena, Illinois; South Bend, Indiana; Lenexa, Kansas; Randleman and Iron Station, North Carolina; Gaffney, Union and Honea Path, South Carolina; Pulaski and Knoxville, Tennessee; Ogden, Utah; Altavista, Virginia; and Ferndale, Washington. These facilities, including warehouses at plant locations and a technology center in Canton, Ohio that primarily serves the Mobile Industries and Process Industries business segments, have an aggregate floor area of approximately 5,295,000 square feet.

Timken’s Mobile Industries and Process Industries segments’ manufacturing plants outside the United States are located in Benoni, South Africa; Villa Carcina, Italy; Colmar, France; Northampton, England; Ploiesti, Romania; Sao Paulo and Belo Horizonte, Brazil; Jamshedpur and Chennai, India; Sosnowiec, Poland; Delta, Prince George and St. Thomas, Canada; and Wuxi, Xiangtan and Yantai, China. These facilities, including warehouses at plant locations, have an aggregate floor area of approximately 3,885,000 square feet.

Timken’s Aerospace and Defense segment’s manufacturing facilities in the United States are located in Mesa, Arizona; Los Alamitos, California; Manchester, Connecticut; Keene and Lebanon, New Hampshire; New Philadelphia, Ohio; and Rutherfordton, North Carolina. These facilities, including warehouses at plant locations, have an aggregate floor area of approximately 1,017,000 square feet.

Timken’s Aerospace and Defense segment’s manufacturing facilities outside the United States are located in Wolverhampton, England; and Chengdu, China. These facilities, including warehouses at plant locations, have an aggregate floor area of approximately 290,000 square feet.

Timken’s Steel segment’s manufacturing facilities in the United States are located in Canton and Eaton, Ohio; Columbus, North Carolina; and Houston, Texas. These facilities have an aggregate floor area of approximately 3,459,000 square feet. The Steel Group also has a ferrous scrap and recycling operation in Akron, Ohio.

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

The plant utilization for the Mobile Industries segment was between approximately 70% and 80% in 2011. The plant utilization for the Process Industries segment was between approximately 70% and 80% in 2011. The plant utilization for the Aerospace and Defense segment was between approximately 50% and 60% in 2011. Finally, the Steel segment plant utilization was between approximately 80% and 90% in 2011. Plant utilization for all of the segments, except Aerospace and Defense, was higher in 2011 than in 2010.

Item 3. Legal Proceedings

The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

Item 4. Mine Safety Disclosures

Not applicable.

 

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Item 4A. Executive Officers of the Registrant

The executive officers are elected by the Board of Directors normally for a term of one year and until the election of their successors. All executive officers have been employed by Timken or by a subsidiary of the Company during the past five-year period. The executive officers of the Company as of February 17, 2012 are as follows:

 

Name

       Age          

Current Position and Previous Positions

During Last Five Years

Ward J. Timken

   44   2005 Chairman of the Board

James W. Griffith

   58   2002 President and Chief Executive Officer; Director

William R. Burkhart

   46   2000 Senior Vice President and General Counsel

Christopher A. Coughlin

   51   2007 Senior Vice President—Supply Chain Management
     2009 President—Process Industries
     2010 President—Process Industries & Supply Chain
     2011 President—Process Industries

Glenn A. Eisenberg

   50   2002 Executive Vice President—Finance and Administration

Richard G. Kyle

   46   2007 Vice President—Manufacturing—Mobile Industries
     2009 President—Mobile Industries
     2011 President—Mobile Industries & Aerospace

J. Ted Mihaila

   57   2006 Senior Vice President and Controller

Salvatore J. Miraglia, Jr.

   61   2005 President—Steel Group

 

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PART II

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

The Company’s common stock is traded on the New York Stock Exchange under the symbol “TKR.” The estimated number of record holders of the Company’s common stock at December 31, 2011 was 5,240. The estimated number of beneficial shareholders at December 31, 2011 was 44,238.

The following table provides information about the high and low sales prices for the Company’s common stock and dividends paid for each quarter for the last two fiscal years.

 

000000000 000000000 000000000 000000000 000000000 000000000
     2011      2010  
     Stock prices      Dividends      Stock prices      Dividends  
     High      Low      per share      High      Low      per share  

First quarter

     $ 52.69       $ 44.32       $ 0.18         $ 30.69       $ 22.03       $ 0.09   

Second quarter

     $ 57.83       $ 45.77       $ 0.20         $ 35.90       $ 25.88       $ 0.13   

Third quarter

     $ 52.86       $ 31.16       $ 0.20         $ 39.59       $ 24.84       $ 0.13   

Fourth quarter

     $ 45.45       $ 30.17       $ 0.20         $ 49.35       $ 37.38       $ 0.18   

 

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

 

Issuer Purchases of Common Stock:

The following table provides information about purchases of its common stock by the Company during the quarter ended December 31, 2011.

 

                      Total number      Maximum  
                   of shares      number of  
                   purchased as      shares that  
                   part of publicly      may yet  
     Total number      Average      announced      be purchased  
     of shares      price paid      plans or      under the plans  
 Period    purchased  (1)      per share  (2)      programs      or programs  (3)  

 10/1/11 - 10/31/11

     2,758         $33.07         -         2,000,000   

 11/1/11 - 11/30/11

     2,969         38.99         -         2,000,000   

 12/1/11 - 12/31/11

     2,228         38.55         -         2,000,000   

 Total

     7,955         $36.82         -         2,000,000   

 

(1) 

Represents shares of the Company’s common stock that are 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 stock as quoted on the New York Stock Exchange at the time of vesting. For shares tendered in connection with the exercises of stock options, the price paid is the real time trading stock price at the time the options are exercised.

(3) 

Pursuant to the Company’s 2006 common stock purchase plan, the Company may purchase up to four million shares of common stock at an amount not to exceed $180 million in the aggregate. The Company may purchase shares under its 2006 common stock purchase plan until December 31, 2012. 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. On February 10, 2012, the Board of Directors of the Company approved a new stock purchase plan pursuant to which the Company may purchase up to ten million shares of its common stock. This new stock purchase plan replaces the Company’s 2006 common stock purchase plan.

 

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

 

 

 

LOGO

Assumes $100 invested on January 1, 2007, in Timken Common Stock, the S&P 500 Index,

the S&P 400 Industrials and the Bearing/Steel Peer Group Indices.

 

000000000 000000000 000000000 000000000 000000000
      2007      2008      2009      2010      2011  

 Timken

   $ 114.97       $ 70.80       $ 87.88       $ 179.70       $ 148.32   

 S&P 500

     105.49         66.46         84.05         96.71         98.76   

 S&P 400 Industrials

     119.62         75.91         99.92         130.90         129.38   

 80% Bearing/20% Steel

     99.24         47.09         76.55         92.86         70.80   

 

** Effective with fiscal year 2011, the custom bearing/steel peer group index has been replaced with the S&P 400 Industrials index because the Company believes it more accurately reflects a peer benchmark for the Company's portfolio of businesses given Timken's strategic initiatives to diversify beyond its heritage bearing and steel product offerings. For comparability, both peer indices have been shown.

The line graph compares the cumulative total shareholder returns over five years for The Timken Company, the S&P 500 Stock Index, the S&P 400 Industrials Index and a custom peer group index that proportionally reflects Timken's bearing and steel businesses. The S&P Steel Index comprises the steel portion of the peer group index. This index is comprised of AK Steel, Allegheny Technologies, Cliffs Natural Resources, Nucor and US Steel. The remaining portion of the peer group index is a self constructed bearing index that consists of five companies. These five companies are Kaydon, JTEKT, NSK, NTN and SKF Group. The last four are non-US bearing companies that are based in Japan (JTEKT, NSK, NTN), and Sweden (SKF Group).

 

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Item 6. Selected Financial Data

Summary of Operations and Other Comparative Data

 

00000000 00000000 00000000 00000000 00000000
      2011     2010     2009     2008     2007  
 (Dollars in millions, except per share data)                               

 Statements of Income

          

 Net sales

   $         5,170.2      $         4,055.5      $         3,141.6      $         5,040.8      $         4,532.1   

 Gross profit

     1,369.7        1,021.7        582.7        1,151.9        955.0   

 Selling, administrative and general expenses

     626.2        563.8        472.7        657.1        631.2   

 Impairment and restructuring charges

     14.4        21.7        164.1        32.8        28.4   

 Operating income (loss)

     729.1        436.2        (54.1     462.0        294.9   

 Other income (expense), net

     (1.1     3.8        (0.1     16.2        5.1   

 Interest expense, net

     31.2        34.5        40.0        38.6        42.3   

 Income (loss) from continuing operations

     456.6        269.5        (66.0     282.6        210.7   

 Income (loss) from discontinued operations, net of income taxes

     -        7.4        (72.6     (11.3     12.9   

 Net income (loss) attributable to The Timken Company

   $ 454.3      $ 274.8      $ (134.0   $ 267.7      $ 220.1   

 Balance Sheets

          

 Inventories, net

   $ 964.4      $ 828.5      $ 671.2      $ 1,000.5      $ 936.0   

 Property, plant and equipment—net

     1,308.9        1,267.7        1,335.2        1,517.0        1,452.8   

 Total assets

     4,352.1        4,180.4        4,006.9        4,536.0        4,379.2   

 Total debt:

          

Short-term debt

     22.0        22.4        26.3        91.5        108.4   

Current portion of long-term debt

     14.3        9.6        17.1        17.1        33.9   

Long-term debt

     478.8        481.7        469.3        515.3        580.6   

 Total debt

     515.1        513.7        512.7        623.9        722.9   

 Net debt

          

Total debt

     515.1        513.7        512.7        623.9        722.9   

Less: cash and cash equivalents and restricted cash

     (468.4     (877.1     (755.5     (133.4     (42.9

 Net debt: (1)

     46.7        (363.4     (242.8     490.5        680.0   

 Total liabilities

     2,309.6        2,238.6        2,411.3        2,873.0        2,399.2   

 Shareholders’ equity

   $ 2,042.5      $ 1,941.8      $ 1,595.6      $ 1,663.0      $ 1,980.0   

 Capital:

          

Net debt

     46.7        (363.4     (242.8     490.5        680.0   

Shareholders’ equity

     2,042.5        1,941.8        1,595.6        1,663.0        1,980.0   

 Net debt + shareholders’ equity (capital)

     2,089.2        1,578.4        1,352.8        2,153.5        2,660.0   

 Other Comparative Data

          

 Income (loss) from continuing operations / Net sales

     8.8%        6.6%        (2.1)%        5.6%        4.6%   

 Net income (loss) attributable to The Timken Company / Net sales

     8.8%        6.8%        (4.3)%        5.3%        4.9%   

 Return on equity (2)

     22.4%        13.9%        (4.1)%        17.0%        10.6%   

 Net sales per employee (3)

   $ 253.5      $ 222.2      $ 168.8      $ 244.3      $ 216.0   

 Capital expenditures

   $ 205.3      $ 115.8      $ 114.1      $ 258.1      $ 289.8   

 Depreciation and amortization

   $ 192.5      $ 189.7      $ 201.5      $ 200.8      $ 187.9   

 Capital expenditures / Net sales

     4.0%        2.9%        3.6%        5.1%        6.4%   

 Dividends per share

   $ 0.78      $ 0.53      $ 0.45      $ 0.70      $ 0.66   

 Basic earnings (loss) per share - continuing operations (4)

   $ 4.65      $ 2.76      $ (0.64   $ 2.90      $ 2.17   

 Diluted earnings (loss) per share - continuing operations (4)

   $ 4.59      $ 2.73      $ (0.64   $ 2.89      $ 2.16   

 Basic earnings (loss) per share (5)

   $ 4.65      $ 2.83      $ (1.39   $ 2.78      $ 2.31   

 Diluted earnings (loss) per share (5)

   $ 4.59      $ 2.81      $ (1.39   $ 2.77      $ 2.29   

 Net debt to capital (1)

     2.2%        (23.0)%        (17.9)%        22.8%        25.6%   

 Number of employees at year-end (6)

     20,954        19,839        16,667        20,550        20,720   

 Number of shareholders (7)

     44,238        39,118        27,127        47,742        49,012   

 

(1) 

The Company presents net debt because it believes net debt is more representative of the Company’s financial position than total debt due to the amount of cash and cash equivalents.

(2)

Return on equity is defined as income from continuing operations divided by ending shareholders’ equity.

(3) 

Based on average number of employees employed during the year.

(4) 

Based on average number of shares outstanding during the year.

(5) 

Based on average number of shares outstanding during the year and includes discontinued operations for all periods presented.

(6) 

Adjusted to exclude NRB operations and Latrobe Steel for all periods.

(7) 

Includes an estimated count of shareholders having common stock held for their accounts by banks, brokers and trustees for benefit plans.

 

 

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Dollars in millions, except per share data)

OVERVIEW

The Timken Company (Timken or the Company) designs, manufactures, sells and services highly-engineered anti-friction bearings and assemblies, high-quality alloy steels and mechanical power transmission systems, as well as provides a broad spectrum of related products and services. The Company has four operating segments: (1) Mobile Industries; (2) Process Industries; (3) Aerospace and Defense; and (4) Steel. The following is a description of the Company’s operating segments:

 

   

Mobile Industries provides bearings, mechanical power transmission components, drive- and roller-chains, augers and related products and services to original equipment manufacturers and suppliers of agricultural, construction and mining equipment, passenger cars, light trucks, medium and heavy-duty trucks, rail cars and locomotives, as well as to automotive and heavy truck aftermarket distributors.

 

   

Process Industries provides bearings, mechanical power transmission components, industrial chains, and related products and services to original equipment manufacturers and suppliers of power transmission, energy and heavy industries machinery and equipment. This includes rolling mills, cement and aggregate processing equipment, paper mills, sawmills, printing presses, cranes, hoists, drawbridges, wind energy turbines, gear drives, drilling equipment, coal conveyors, coal crushers, marine and food processing equipment. This segment also serves the aftermarket through its global network of authorized industrial distributors.

 

   

Aerospace and Defense provides bearings, helicopter transmission systems, rotor head assemblies, turbine engine components, gears and other precision flight-critical components for commercial and military aviation applications and provides aftermarket services, including repair and overhaul of engines, transmissions and fuel controls, as well as aerospace bearing repair and component reconditioning. Additionally, this segment manufactures precision bearings, higher-level assemblies and sensors for manufacturers of health and positioning control equipment.

 

   

Steel produces more than 450 grades of carbon and alloy steel, which are sold as ingots, bars and tubes in a variety of chemistries, lengths and finishes. This segment’s metallurgical expertise and operational capabilities result in customized solutions for the automotive, industrial and energy sectors. Timken® specialty steels feature prominently in a wide variety of end products including oil country drill pipe, bits and collars, gears, hubs, axles, crankshafts and connecting rods, bearing races and rolling elements, and bushings, fuel injectors and wind energy shafts.

The Company’s strategy balances corporate aspirations for sustained growth with a determination to optimize the Company’s existing business portfolio, thereby generating strong profits and cash flows. Timken pursues its growth strategy through differentiation and expansion.

 

   

For differentiation, the Company leverages its technological capabilities to enhance existing products and services and to create new products that capture value for its customers. The Company recently broadened its product offering by expanding a line of spherical, cylindrical and housed bearings, developing new products and services – including the new Ecoturn® seal for the railroad industry – and introducing numerous new custom-developed grades of specialty alloy steel.

 

   

Regarding expansion, the Company’s strategy is to grow in attractive market sectors, with particular emphasis on those industrial markets that value the reliability offered by the Company’s products and create significant aftermarket demand, thereby providing a lifetime of opportunity in both product sales and services. The Company’s strategy also encompasses expanding its portfolio in new geographic spaces with an emphasis in Asia. The Company’s acquisition strategy is directed at complementing its existing portfolio and expanding the Company’s market position globally.

Simultaneously, the Company works to optimize its existing business with specific initiatives aimed at transformation and execution. This includes diversifying the overall portfolio of businesses and products to create further value and profitability, which can include addressing or repositioning underperforming product lines and segments, revising market sector or geographic strategies and divesting non-strategic assets. The Company drives execution by embracing a continuous improvement culture that is charged with lowering costs, eliminating waste, increasing efficiency, encouraging organizational agility and building greater brand equity.

 

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The following items highlight certain of the Company’s more significant strategic accomplishments in 2011:

 

   

In October 2011, the Company completed the acquisition of Drives LLC (Drives) for $92 million. Drives is a leading manufacturer of highly engineered drive-chains, roller-chains and conveyor augers for the agricultural and industrial applications. Based in Fulton, Illinois, Drives employs 430 associates and had trailing 12-month sales through September 2011 of approximately $100 million. Sales and EBIT for the Timken Drives business is reported in the Company’s Mobile Industries and Process Industries segments based on customer application.

 

   

In August 2011, the Company and The University of Akron announced an open-innovation agreement to accelerate technology. The two organizations plan to combine their expertise in materials and surface engineering technologies at newly established laboratories in The University of Akron’s College of Engineering.

 

   

In July 2011, the Company and Stark State College broke ground on a jointly developed 18,000 square foot Wind Energy Research and Development Center in Canton, Ohio, on the Stark State College campus. This new center will be focused on advanced development of bearing systems for wind turbines and other ultra-large applications.

 

   

In July 2011, the Company acquired the assets of Philadelphia Gear Corp. (Philadelphia Gear), a leading provider of high-performance gear drives and components with a strong focus on value-added aftermarket capabilities in the industrial and military marine sectors, for $200 million. Based in King of Prussia, Pennsylvania, with approximately 220 associates, Philadelphia Gear had trailing 12-month sales through June 2011 of approximately $100 million. The Timken Gears and Services business is included in the Process Industries segment.

 

   

In 2011, the Company launched initiatives to enhance productivity and increase output at two of its Canton, Ohio steel facilities. These changes will effectively create new capacity at both of these steel facilities to support growing demand for finished bar products and billets for tubing product which serve customers in the global industrial, oil and gas, and mobile markets. These initiatives include an investment of approximately $35 million for an in-line forge press at the Company’s Faircrest Steel Plant.

 

   

In August 2011, the Company announced that it is evaluating an investment of approximately $225 million at its Faircrest Steel Plant. The potential investment would be expected to increase capacity, expand product range and strengthen the competitiveness of Timken’s specialty alloy steel bars business. A ladle refiner and a new large-bloom continuous caster would be key components of this investment and would likely target production in 2014. The Company entered into preliminary discussions with suppliers and government agencies, and opened early negotiations with United Steelworkers of America Local 1123 (union), which represents operative associates in Canton, Ohio, under a collective bargaining agreement scheduled to expire in 2013. The Company and representatives of the Union have tentatively agreed on a five-year contract to replace the existing labor agreement. A ratification vote has been scheduled for February 21, 2012.

 

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RESULTS OF OPERATIONS

2011 compared to 2010

Overview:

 

      2011      2010      $ Change     % Change  

 Net sales

   $ 5,170.2       $ 4,055.5       $     1,114.7        27.5

 Income from continuing operations

     456.6         269.5         187.1        69.4

 Income from discontinued operations

     -         7.4         (7.4     (100.0 )% 

 Income attributable to noncontrolling interest

     2.3         2.1         0.2        9.5

 Net income attributable to The Timken Company

   $ 454.3       $ 274.8       $ 179.5        65.3

 Diluted earnings per share:

          

Continuing operations

   $ 4.59       $ 2.73       $ 1.86        68.1

Discontinued operations

     -         0.08         (0.08     (100.0 )% 

 Diluted earnings per share

   $ 4.59       $ 2.81       $ 1.78        63.3

 Average number of shares—diluted

     98,655,513         97,516,202         -        1.2

The Company reported net sales for 2011 of $5.2 billion, compared to $4.1 billion in 2010, a 27.5% increase. The increase in sales was primarily due to higher volume across all business segments except for the Aerospace and Defense segment, higher surcharges, pricing, the impact of acquisitions and the effect of currency rate changes. In 2011, net income per diluted share was $4.59, compared to net income per diluted share of $2.81 in 2010. The Company’s net income for 2011 reflects continued improvement in the end market sectors served by the Mobile Industries, Process Industries and Steel segments. In addition, net income for 2011 reflects higher surcharges and pricing and the impact of acquisitions, partially offset by higher raw material and logistics costs and selling, general and administrative expenses.

The income from discontinued operations recognized in 2010 was the result of favorable working capital adjustments from the sale of the Company’s Needle Roller Bearings (NRB) operations, completed in December 2009.

Outlook

The Company expects higher sales in the range of approximately 5% to 8% in 2012 compared to 2011, primarily driven by higher volumes across the Process Industries, Aerospace and Defense and Steel business segments, as well as favorable pricing and the full-year impact of acquisitions completed in 2011, partially offset by the effect of currency-rate changes. The Company expects to leverage sales growth from these segments to drive improved operating performance. However, the strengthening margins will be partially offset by lower utilization of manufacturing capacity, higher raw material costs and slightly higher selling, general and administrative expenses to support the higher sales.

From a liquidity standpoint, the Company expects to generate cash from operations of approximately $515 million, which is a 143% increase over 2011, primarily driven by lower working capital increases and lower pension and postretirement contributions. Pension and postretirement contributions are expected to be approximately $265 million in 2012 compared to $416 million in 2011. The Company expects to increase capital expenditures to approximately $345 million in 2012 compared to $205 million in 2011.

 

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The Statements of Income

 Sales by Segment:

      2011    2010    $ Change   % Change    

 (Excludes intersegment sales)

                  

 Mobile Industries

     $ 1,768.9        $ 1,560.3        $ 208.6         13.4 %

 Process Industries

       1,240.5          900.0          340.5         37.8 %

 Aerospace and Defense

       324.1          338.3          (14.2 )       (4.2 )%

 Steel

       1,836.7          1,256.9          579.8         46.1 %

 Total Company

     $ 5,170.2        $ 4,055.5        $ 1,114.7         27.5 %

Net sales for 2011 increased $1.1 billion, or 27.5%, compared to 2010, primarily due to higher volume of approximately $530 million principally driven by the Mobile Industries’ off-highway and rail market sectors, increases in Process Industries’ distribution channel’s demand and the Steel segment’s industrial and oil and gas market sectors. In addition, the increase in sales reflects higher surcharges of approximately $225 million, higher pricing and favorable sales mix of approximately $185 million, the impact of acquisitions of approximately $120 million and the effect of currency rate changes of approximately $55 million. The favorable impact from acquisitions for 2011 was primarily due to the acquisitions of Philadelphia Gear in July 2011 and Drives in October 2011, as well as the acquisition of QM Bearings and Power Transmission, Inc. (QM Bearings), completed in September 2010.

 Gross Profit:

000000000 000000000 000000000 000000000
      2011      2010      $ Change      Change  

 Gross profit

   $ 1,369.7       $ 1,021.7       $ 348.0         34.1%   

 Gross profit % to net sales

     26.5%         25.2%         -         130  bps 

 Rationalization expenses included in cost of products sold

   $ 6.7       $ 5.5       $ 1.2         21.8%   

Gross profit increased in 2011 compared to 2010, primarily due to the impact of higher sales volume of approximately $230 million, higher surcharges of approximately $225 million and the impact of pricing and sales mix of approximately $180 million, partially offset by higher raw material and logistics costs of approximately $335 million. Gross profit in 2011 also benefited from the impact of acquisitions.

 Selling, General and Administrative Expenses:

00000 00000 00000 00000
      2011      2010      $ Change      Change  

 Selling, general and administrative expenses

   $         626.2       $         563.8       $         62.4         11.1%   

 Selling, general and administrative expenses % to net sales

     12.1%         13.9%         -         (180 ) bps 

The increase in selling, general and administrative expenses of $62.4 million in 2011 compared to 2010 was primarily due to higher salaries and related costs to support higher sales volume, as well as higher expense related to incentive compensation plans of approximately $15 million. Selling, general and administrative expenses for 2010 benefited from a favorable adjustment to the allowance for doubtful accounts of approximately $10 million. In addition, the acquisitions of Philadelphia Gear and Drives added approximately $15 million of selling, general and administrative expenses for 2011. Selling, general and administrative expenses, as a percentage of sales, decreased in 2011 compared to 2010 as a result of the Company’s ability to effectively leverage these costs against higher sales.

 

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 Impairment and Restructuring Charges:

000000000 000000000 000000000
      2011      2010      $ Change  

 Impairment charges

   $ 0.5       $ 4.7       $ (4.2

 Severance and related benefit costs

     0.1         6.4         (6.3

 Exit costs

     13.8         10.6         3.2   

 Total

   $ 14.4       $ 21.7       $ (7.3

Impairment and restructuring charges decreased $7.3 million in 2011 compared to 2010. In 2011, the Company recognized $13.8 million of exit costs, which primarily related to its former manufacturing facility in Sao Paulo, Brazil relating to environmental remediation costs and workers compensation claims made by former associates. In 2010, the impairment charges of $4.7 million primarily related to fixed asset impairment charges at the Company’s facility in Mesa, Arizona and its former manufacturing facility in Sao Paulo, Brazil. The severance and related benefit costs of $6.4 million recognized in 2010 primarily related to manufacturing workforce reductions that began in 2009 to realign the Company’s organization, improve efficiency and reduce costs. The exit costs of $10.6 million recognized in 2010 primarily related to environmental remediation costs at the Company’s former manufacturing facility in Sao Paulo, Brazil and a former manufacturing plant in Columbus, Ohio. Refer to Note 10 – Impairment and Restructuring in the Notes to the Consolidated Financial Statements for additional discussion.

 Interest Expense and Income:

0000000 0000000 0000000 0000000
      2011     2010     $ Change     % Change  

 Interest expense

   $ 36.8      $ 38.2      $ (1.4     (3.7)%   

 Interest income

   $ (5.6   $ (3.7   $ (1.9     (51.4)%   

Interest expense for 2011 decreased compared to 2010 primarily due to lower financing costs as a result of the refinancing of the Company’s $500 million Amended and Restated Credit Agreement (Senior Credit Facility), which occurred in May 2011. The Company expects to recognize approximately $1.3 million of deferred financing costs on an annual basis, compared to $3.0 million under the previous credit facility. Interest income increased for 2011 compared to 2010 primarily due to higher interest rates on invested cash balances.

 Income Tax Expense:

      2011      2010      $ Change      Change  

 Income tax expense

   $       240.2       $       136.0       $ 104.2         76.6%   

 Effective tax rate

       34.5%           33.5%         -         100  bps 

The effective tax rate on the pretax income for 2011 was favorable relative to the U.S. federal statutory rate primarily due to earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, the U.S. manufacturing deduction, the U.S. research tax credit and the net effect of other U.S. tax items, partially offset by losses at certain foreign subsidiaries where no tax benefit could be recorded, U.S. state and local taxes and the net effect of other discrete items.

The effective tax rate for 2010 was favorable relative to the U.S. federal statutory rate primarily due to earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, the U.S. manufacturing deduction, the U.S. research tax credit and the net effect of other U.S. tax items, partially offset by losses at certain foreign subsidiaries where no tax benefit could be recorded, and U.S. state and local taxes. The effective tax rate for 2010 also includes the net impact of a $21.6 million charge in the first quarter to record the deferred tax impact of the Patient Protection and Affordable Care Act of 2010 (as amended) (PPACA), partially offset by a $19.8 million tax benefit in the fourth quarter to record the benefit of contributions made to a newly established Voluntary Employee Benefit Association (VEBA) trust to fund certain retiree healthcare costs.

The change in the effective tax rate in 2011 compared to 2010 was primarily due to certain discrete tax expense items recorded in 2011 and higher U.S. state and local taxes, partially offset by earnings in certain foreign jurisdictions where the effective tax rate is less than 35%.

 

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Table of Contents

Business Segments:

Effective January 1, 2011, the primary measurement used by management to measure the financial performance of each segment is EBIT (earnings before interest and taxes). Prior to January 1, 2011, the primary measurement used by management to measure the financial performance of each segment was adjusted EBIT (earnings before interest and taxes, excluding the effect of impairment and restructuring, manufacturing rationalization and integration charges, one-time gains or losses on the disposal of non-strategic assets, allocated receipts received or payments made under the U.S. Continued Dumping and Subsidy Offset Act (CDSOA) and gains and losses on the dissolution of subsidiaries). The change in 2011 was primarily due to the completion of most of the Company’s previously-announced restructuring initiatives. Segment results for 2010 and 2009 have been reclassified to conform to the 2011 presentation of segments. Refer to Note 14 – Segment Information in the Notes to the Consolidated Financial Statements for the reconciliation of EBIT by segment to consolidated income before income taxes.

The presentation below reconciles the changes in net sales for each segment reported in accordance with U.S. GAAP to net sales adjusted to remove the effects of acquisitions made in 2011 and 2010 and currency exchange rates. The effects of acquisitions and currency exchange rates are removed to allow investors and the Company to meaningfully evaluate the percentage change in net sales on a comparable basis from period to period. During the third quarter of 2011, the Company completed the acquisition of substantially all of the assets of Philadelphia Gear, which is part of the Process Industries segment. During the fourth quarter of 2011, the Company completed the acquisition of Drives, the results of which are reported in the Mobile Industries and Process Industries segments based on customer application. During the fourth quarter of 2010, the Company completed the acquisition of substantially all of the assets of City Scrap and Salvage Co. (City Scrap), which is part of the Steel segment. During the third quarter of 2010, the Company completed the acquisition of QM Bearings, which is part of the Process Industries segment. The year 2010 represents the base year for which the effects of currency are measured; as such, currency is assumed to be zero for 2010.

 Mobile Industries Segment:

0000000 0000000 0000000 0000000
      2011      2010      $ Change      Change  

 Net sales, including intersegment sales

   $     1,769.4       $     1,560.6       $     208.8         13.4%   

 EBIT

   $ 243.2       $ 207.6       $ 35.6         17.1%   

 EBIT margin

     13.7%         13.3%         -         40 bps   
           
      2011      2010      $ Change      % Change  

 Net sales, including intersegment sales

   $ 1,769.4       $ 1,560.6       $ 208.8         13.4%   

 Acquisitions

     11.1         -         11.1         NM   

 Currency

     30.4         -         30.4         NM   

 Net sales, excluding the impact of acquisitions and currency

   $ 1,727.9       $ 1,560.6       $ 167.3         10.7%   

The Mobile Industries segment’s net sales, excluding the effects of acquisitions and currency-rate changes, increased 10.7% in 2011 compared to 2010, primarily due to higher volume of approximately $140 million and pricing and surcharges of approximately $30 million. The higher volume was seen across most market sectors, led by an approximately 30% increase in off-highway, an approximately 30% increase in rail and an approximately 15% increase in heavy truck, partially offset by an approximately 10% decrease in light-vehicle. EBIT was higher in 2011 compared to 2010, primarily due to the impact of higher volume of approximately $60 million and the impact of pricing and surcharges of approximately $30 million, partially offset by higher raw material and logistics costs of approximately $45 million and higher selling, general and administrative costs of approximately $10 million.

Sales for the Mobile Industries segment are expected to be relatively flat in 2012 compared to 2011, as the full-year impact of 2011 acquisitions, as well as higher pricing, offset lower volume. The expected decrease in volume is primarily due to an approximately 25% decrease in light-vehicle and a 15% decrease in heavy truck, partially offset by a 15% increase in rail. Sales for the Mobile Industries segment, excluding the effect of acquisitions and currency-rate changes, are expected to decrease approximately 5% in 2012, compared to 2011. EBIT for the Mobile Industries segment is expected to decline in 2012 compared to 2011 as a result of lower volumes and higher raw material costs.

 

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Table of Contents

 Process Industries Segment:

00000000 00000000 00000000 00000000
      2011      2010      $ Change      Change  

 Net sales, including intersegment sales

   $ 1,244.6       $ 903.4       $ 341.2         37.8%   

 EBIT

   $ 281.6       $ 133.6       $ 148.0         110.8%   

 EBIT margin

     22.6%         14.8%         -         780 bps   
           
      2011      2010      $ Change      % Change  

 Net sales, including intersegment sales

   $ 1,244.6       $ 903.4       $ 341.2         37.8%   

 Acquisitions

     103.8         -         103.8         NM   

 Currency

     22.2         -         22.2         NM   

 Net sales, excluding the impact of acquisitions and currency

   $ 1,118.6       $ 903.4       $ 215.2         23.8%   

The Process Industries segment’s net sales, excluding the effect of acquisitions and currency-rate changes, increased 23.8% for 2011 compared to 2010, primarily due to higher volume of approximately $190 million and pricing and sales mix of approximately $25 million. The higher sales primarily resulted from a 25% increase to industrial distributors. In addition, the higher sales resulted from a 15% increase to original equipment manufacturers, primarily driven by an approximately 30% increase in gear drives and an approximately 25% increase in global energy. EBIT was higher in 2011 compared to 2010 due to the impact of increased volume of approximately $100 million and higher pricing and favorable sales mix of $40 million, partially offset by higher raw material costs of $15 million. EBIT for the Process Industries segments also benefited from acquisitions in 2011.

Sales for the Process Industries segment are expected to increase by 8% to 13% in 2012 compared to 2011. The increase in sales reflects continued strengthening in global industrial distribution, growth in Asia and sales from new product lines, as well as the full-year impact of 2011 acquisitions and pricing. Sales for the Process Industries segment, excluding the effect of acquisitions and currency-rate changes, are expected to increase by approximately 5% to 10% in 2012 compared to 2011. EBIT for the Process Industries segment is expected to be flat in 2012 compared to 2011 as a result of pricing and higher volumes, partially offset by higher raw material costs.

 Aerospace and Defense Segment:

00000000 00000000 00000000 00000000
      2011      2010      $ Change     Change  

 Net sales, including intersegment sales

   $ 324.1       $ 338.3       $ (14.2     (4.2 )% 

 EBIT

   $ 7.6       $ 16.7       $ (9.1     (54.5 )% 

 EBIT margin

     2.3%         4.9%         -        (260 ) bps 
          
      2011      2010      $ Change     % Change  

 Net sales, including intersegment sales

   $ 324.1       $ 338.3       $ (14.2     (4.2 )% 

 Currency

     2.2         -         2.2        N

 Net sales, excluding the impact of currency

   $ 321.9       $ 338.3       $ (16.4     (4.8 )% 

The Aerospace and Defense segment’s net sales, excluding the effect of currency-rate changes, decreased 4.8% for 2011 compared to 2010. The decline was due to a decrease in volume of approximately $20 million, partially offset by favorable pricing. The decrease in volume was driven by reduced volume of defense-related products, partially offset by increased volume from commercial aerospace customers. EBIT decreased 54.5% in 2011 compared to 2010, primarily due to the impact of lower volume of approximately $8 million, a product warranty charge of approximately $5 million and an inventory write-down of approximately $3 million, partially offset by favorable pricing and reduced selling, general and administrative costs totaling approximately $7 million.

Sales for the Aerospace and Defense segment are expected to increase by approximately 10% to 15% in 2012 compared to 2011, as a result of anticipated strengthening in the defense and commercial aerospace sectors. EBIT for the Aerospace and Defense segment is expected to be up significantly in 2012 compared to 2011 as a result of higher volumes and better manufacturing efficiency.

 

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Table of Contents

 Steel Segment:

00000000 00000000 00000000 00000000
      2011      2010      $ Change      Change  

 Net sales, including intersegment sales

   $ 1,956.5       $ 1,359.5       $ 597.0         43.9%   

 EBIT

   $ 270.7       $ 146.2       $ 124.5         85.2%   

 EBIT margin

     13.8%         10.8%         -         300  bps 
           
      2011      2010      $ Change      % Change  

 Net sales, including intersegment sales

   $ 1,956.5       $ 1,359.5       $ 597.0         43.9%   

 Acquisitions

     7.6         -         7.6         NM   

 Currency

     0.7         -         0.7         NM   

 Net sales, excluding the impact of acquisitions and currency

   $ 1,948.2       $ 1,359.5       $ 588.7         43.3%   

The Steel segment’s net sales for 2011, excluding the effects of acquisitions and currency-rate changes, increased 43.3% compared to 2010, due to higher volume of approximately $240 million, higher surcharges of approximately $210 million, higher pricing of approximately $80 million and favorable sales mix of approximately $60 million. The higher volume was experienced across all market sectors, primarily driven by an 80% increase in oil and gas and a 26% increase in industrial. Surcharges increased to $572.8 million in 2011, from $362.7 million in 2010. Approximately 40% of the increase in surcharges was a result of higher volumes. Surcharges are a pricing mechanism that the Company uses to recover scrap steel, energy and certain alloy costs, which are derived from published monthly indices. The average scrap index for 2011 was $482 per ton, compared to $426 per ton for 2010. Steel shipments for 2011 were 1,286,000 tons, compared to 1,026,000 tons for 2010, an increase of 25%. The Steel segment’s average selling price, including surcharges, was $1,522 per ton for 2011, compared to an average selling price of $1,325 per ton for 2010. The increase in the average selling prices was primarily the result of higher surcharges and base prices. The higher surcharges were the result of higher prices for certain input raw materials, especially scrap steel and nickel.

The Steel segment’s EBIT increased $124.5 million in 2011 compared to 2010, primarily due to higher surcharges of approximately $210 million, pricing and sales mix of approximately $130 million and the impact of higher sales volume of approximately $85 million, partially offset by higher raw material costs of $250 million, higher logistics costs of approximately $25 million and higher LIFO expense. In 2011, the Steel segment recognized LIFO expense of $15.2 million, compared to LIFO expense of $2.8 million in 2010. Raw material costs consumed in the manufacturing process, including scrap steel, alloys and energy, increased 22% in 2011 compared to the prior year, to an average cost of $555 per ton.

Sales for the Steel segment are expected to increase 5% to 10% for 2012 compared to 2011, primarily due to higher average selling prices and slightly higher volume. The Company expects stronger demand, driven by a 13% increase in oil and gas market sectors and a 5% increase in mobile market sectors. EBIT for the Steel segment is expected to increase in 2012 compared to 2011 as higher pricing more than offsets higher raw material costs. Scrap, alloy and energy costs are expected to increase in the near term from current levels as global industrial production improves and then levels off.

 Corporate:

      2011      2010      $ Change      Change  

 Corporate expenses

   $     75.4       $     67.4       $ 8.0         11.9%   

 Corporate expenses % to net sales

     1.5%         1.7%         -         (20 ) bps 

Corporate expenses increased in 2011 compared to 2010, primarily due to higher performance-based compensation of approximately $8 million.

 

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Table of Contents

RESULTS OF OPERATIONS:

2010 compared to 2009

 Overview:

      2010      2009     $ Change      % Change  

 Net sales

   $ 4,055.5       $ 3,141.6      $       913.9         29.1%   

 Income (loss) from continuing operations

     269.5         (66.0     335.5         NM   

 Income (loss) from discontinued operations

     7.4         (72.6     80.0         110.2%   

 Income (loss) attributable to noncontrolling interest

     2.1         (4.6     6.7         145.7%   

 Net income (loss) attributable to The Timken Company

   $ 274.8       $ (134.0   $ 408.8         305.1%   

 Diluted earnings (loss) per share:

          

 Continuing operations

   $ 2.73       $ (0.64   $ 3.37         NM   

Discontinued operations

     0.08         (0.75     0.83         110.7%   

Diluted earnings (loss) per share

   $ 2.81       $ (1.39   $ 4.20         302.2%   

 Average number of shares - diluted

     97,516,202         96,135,783        -         1.4%   

The Company reported net sales for 2010 of $4.1 billion, compared to $3.1 billion in 2009, a 29.1% increase. Sales in 2010 were higher across all business segments except for the Aerospace and Defense segment. The increase in sales was primarily driven by strong demand from the Mobile Industries and Steel segments and the industrial distribution channel within the Process Industries segment, as well as higher surcharges, partially offset by lower sales in the Aerospace and Defense segment. For 2010, diluted earnings per share were $2.81, compared to a net loss per share of $1.39 for 2009. Income from continuing operations per diluted share was $2.73 for 2010, compared to a net loss from continuing operations of $0.64 for 2009.

The Company’s results for 2010 reflect the improvement of the end-market sectors served principally by the Mobile Industries and Steel segments, higher surcharges, improved manufacturing performance, lower restructuring costs and the favorable impact of prior-year restructuring initiatives, partially offset by lower demand from aerospace and defense customers, higher raw material costs and related LIFO expense and higher expense related to incentive compensation plans.

The income from discontinued operations recognized in 2010 is the result of favorable working capital adjustments from the sale of the Company’s NRB operations, completed in December 2009, while the loss from discontinued operations was due to the negative impact of the deteriorating global economy on NRB’s business operations.

The Statements of Income

 Sales by Segment:

      2010    2009    $ Change   % Change

 (Excludes intersegment sales)

                  

 Mobile Industries

     $     1,560.3        $     1,245.0        $     315.3         25.3%   

 Process Industries

       900.0          806.0          94.0         11.7%   

 Aerospace and Defense

       338.3          417.7          (79.4 )       (19.0)%   

 Steel

       1,256.9          672.9          584.0         86.8%   

 Total Company

     $ 4,055.5        $ 3,141.6        $ 913.9         29.1%   

Net sales for 2010 increased $913.9 million, or 29.1%, compared to 2009, primarily due to higher volume of approximately $655 million primarily across the Mobile Industries’ light-vehicle, off-highway and heavy truck market sectors, the Process Industries’ industrial distribution channel and the Steel segment. Net sales for 2010 also increased due to higher surcharges of approximately $250 million.

 

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Table of Contents

 Gross Profit:

      2010      2009      $ Change     Change  

 Gross profit

   $       1,021.7       $       582.7       $       439.0        75.3%   

 Gross profit % to net sales

     25.2%         18.5%         -        670  bps 

 Rationalization expenses included in cost of products sold

   $ 5.5       $ 8.2       $ (2.7     (32.9)%   

Gross profit margins increased in 2010 compared to 2009, due to the impact of higher sales volume of approximately $280 million, higher steel surcharges of approximately $250 million, improved manufacturing utilization of approximately $150 million and improved pricing of approximately $100 million. These increases were partially offset by higher raw material costs of approximately $275 million and related LIFO expense of approximately $90 million.

In 2010, rationalization expenses of $5.5 million included in cost of products sold primarily related to the closure of the manufacturing facility in Sao Paulo, Brazil and the continued rationalization of Process Industries’ Canton, Ohio bearing facilities. In 2009, rationalization expenses of $8.2 million included in cost of products sold primarily related to certain Mobile Industries’ and Aerospace and Defense manufacturing facilities and the continued rationalization of Process Industries’ Canton, Ohio bearing facilities. Rationalization expenses in 2010 primarily consisted of relocation and closure costs. Rationalization expenses in 2009 primarily included the write-down of inventory, accelerated depreciation on assets and the relocation of equipment.

 Selling, General and Administrative Expenses:

      2010      2009      $ Change      Change  

 Selling, general and administrative expenses

   $       563.8       $       72.7       $ 91.1         19.3%   

 Selling, general and administrative expenses % to net sales

     13.9%         15.0%         -         (110 ) bps 

The increase in selling, general and administrative expenses of $91.1 million in 2010 compared to 2009 was primarily due to higher expense related to incentive compensation plans of approximately $65 million, with the remainder of the increase relating to higher employee and professional costs.

 Impairment and Restructuring Charges:

      2010      2009      $ Change  

 Impairment charges

   $         4.7       $       107.6       $    (102.9) 

 Severance and related benefit costs

     6.4         52.8         (46.4

 Exit costs

     10.6         3.7         6.9   

 Total

   $ 21.7       $ 164.1       $ (142.4

The following discussion explains the major impairment and restructuring charges recorded for the periods presented; however, it is not intended to reflect a comprehensive discussion of all amounts in the tables above. Refer to Note 10 – Impairment and Restructuring in the Notes to the Consolidated Financial Statements for further details by segment.

Workforce Reductions

In 2009, the Company began the realignment of its organization to improve efficiency and reduce costs as a result of the economic downturn that began during the latter part of 2008. The initiative was completed in 2010 and included both selling and administrative cost reductions, as well as manufacturing workforce reductions. During 2010, the Company recorded $5.6 million of severance and related benefit costs to eliminate approximately 200 associates. Of the $5.6 million charge for 2010, $2.0 million related to the Aerospace and Defense segment, $1.6 million related to the Process Industries segment, $1.4 million related to the Mobile Industries segment and $0.6 million related to Corporate positions. During 2009, the Company recorded $42.9 million of severance and related benefit costs, to eliminate approximately 3,280 manufacturing associates. Of the $42.9 million charge, $26.0 million related to the Mobile Industries segment, $8.5 million related to the Process Industries segment, $3.3 million related to the Steel segment, $3.1 million related to the Aerospace and Defense segment and $2.0 million related to Corporate positions.

Torrington Campus

On July 20, 2009, the Company sold the remaining portion of its Torrington, Connecticut office complex. In anticipation of the loss that the Company expected to record upon completion of the sale of this property, the Company recorded an impairment charge of $6.4 million during the second quarter of 2009.

 

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Mobile Industries

In March 2007, the Company announced the closure of its manufacturing facility in Sao Paulo, Brazil. The Company completed the closure of this manufacturing facility on March 31, 2010. During 2010, the Company recorded $4.4 million of exit costs, $1.3 million of severance and related benefit costs and $1.1 million of impairment charges associated with the closure of this facility. The exit costs were primarily due to site remediation costs. During 2009, the Company recorded $5.2 million of severance and related benefit costs and $1.7 million of exit costs associated with the closure of this facility.

In 2009, the Company recorded impairment charges of $71.7 million for certain fixed assets in the United States, Canada, France and China related to several automotive product lines. The Company reviewed these assets for impairment during the fourth quarter due to declining sales and as part of the Company’s initiative to exit programs where adequate returns could not be obtained through pricing initiatives. Incorporating this information into its annual long-term forecasting process, the Company determined the undiscounted projected future cash flows for these product lines could not support the carrying value of these asset groups. The Company then arrived at fair value by either valuing the assets in use where the assets were still producing product or in exchange where the assets had been idled.

In addition to the above charges, the Company recorded $3.1 million of environmental exit costs in 2010 at the site of its former plant in Columbus, Ohio.

Process Industries

In 2009, the Company recorded impairment charges of $27.7 million, exit costs of $1.6 million and severance and related benefits of $0.6 million related to the rationalization of its three bearing plants in Canton, Ohio. In 2009, the Company closed two of the three bearing plants. The significant impairment charge was recorded during the second quarter of 2009 as a result of the rapid deterioration of the market sectors served by one of the rationalized plants resulting in the carrying value of the fixed assets for this plant exceeding their projected future cash flows. The Company then arrived at fair value by either valuing the assets in use, where the assets were still producing product, or in exchange, where the assets had been idled. The fair value was determined based on market comparisons of similar assets. In 2010, the Company recorded $1.0 million of exit costs as a result of Process Industries’ rationalization plans primarily due to demolition costs.

In October 2009, the Company announced the consolidation of its distribution centers in Bucyrus, Ohio and Spartanburg, South Carolina into a leased facility near the existing Spartanburg location. The closure of the Bucyrus Distribution Center was completed in June 2011. This initiative is expected to deliver annual pretax savings of approximately $4 million to $8 million. During 2009, the Company recorded $4.5 million of severance and related benefit costs related to this closure.

Aerospace and Defense

In 2010, the Company recorded fixed asset impairment charges of $2.0 million at its location in Mesa, Arizona. The impairment charges were recorded as a result of the carrying value of certain machinery and equipment exceeding their expected future cash flows.

 Interest Expense and Income:

      2010      2009      $ Change      % Change  

 Interest expense

   $       38.2       $       41.9       $   (3.7)         (8.8)%   

 Interest income

   $ (3.7)       $ (1.9)       $ (1.8)         (94.7)%   

Interest expense for 2010 decreased compared to 2009 primarily due to lower average debt levels, partially offset by the amortization of deferred financing costs associated with the refinancing of the Company’s former $500 million Amended and Restated Credit Agreement (Former Senior Credit Facility) and the issuance of $250 million aggregate principal amount of fixed-rate 6% unsecured senior notes (Senior Notes), both of which occurred in the third quarter of 2009. Interest income increased for 2010 compared to 2009 due to significantly higher average invested cash balances in 2010.

 

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 Other Income and Expense:

0000000 0000000 0000000 0000000
      2010      2009     $ Change     % Change  

 CDSOA receipts, net of expenses

   $ 2.0       $ 3.6      $ (1.6     (44.4)%   

 Equity investment impairment loss

     -         (6.1     6.1        100.0%    

 Other

     1.8         2.4        (0.6     (25.0)%   

 Other income (expense), net

   $ 3.8       $ (0.1   $ 3.9        NM   

The equity investment impairment loss for 2009 reflects an impairment loss on two of the Company’s joint ventures, ICS for $4.7 million and Endorsia International AB (Endorsia) for $1.4 million. The Company recorded the impairment loss as a result of the carrying value of these investments exceeding the expected future cash flows of these joint ventures.

 Income Tax Expense:

      2010      2009     $ Change      Change  

 Income tax expense (benefit)

   $       136.0       $       (28.2   $ 164.2         NM   

 Effective tax rate

       33.5%           29.9%        -         360  bps 

The effective tax rate on the pretax income for 2010 was favorable relative to the U.S. federal statutory rate primarily due to earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, the U.S. manufacturing deduction, the U.S. research tax credit and the net effect of other U.S. tax items, partially offset by losses at certain foreign subsidiaries where no tax benefit could be recorded, and U.S. state and local taxes. The effective tax rate for 2010 also includes the net impact of a $21.6 million charge in the first quarter to record the deferred tax impact of the PPACA, partially offset by a $19.8 million tax benefit in the fourth quarter to record the benefit of contributions made to a newly established VEBA trust to fund certain retiree healthcare costs.

The effective tax rate on the pretax loss for 2009 was unfavorable relative to the U.S. federal statutory tax rate primarily due to losses at certain foreign subsidiaries where no tax benefit could be recorded. This item was partially offset by the U.S. research tax credit and the net effect of other items.

 Discontinued Operations:

      2010      2009     $ Change      % Change  

 Operating results, net of tax

   $ -       $     (60.0   $ 60.0         100.0%   

 Gain (loss) on disposal, net of tax

     7.4         (12.6     20.0         158.7%   

 Income (loss) from discontinued operations, net of income taxes

   $       7.4       $   (72.6   $ 80.0         110.2%   

In December 2009, the Company completed the divestiture of its NRB operations to JTEKT Corporation (JTEKT). Discontinued operations represent operating results of the NRB operations for 2009 and the gain (loss) on disposal of these operations for 2010 and 2009. For 2009, the operating results, net of tax, of the NRB operations were a loss of $60.0 million, primarily due to the deterioration of the markets served by the NRB operations and higher restructuring charges in 2009. The restructuring charges include a pretax impairment loss of $33.7 million and pension curtailment of $2.2 million, as well as other pretax charges related to severance and related benefits of $16.0 million. The impairment loss was the result of the projected proceeds from the sale of NRB operations being lower than the net book value of the net assets expected to be transferred as a result of the sale of the NRB operations to JTEKT. In 2009, the Company recorded a loss on disposal of $12.6 million, net of tax.

In 2010, the Company recognized a gain on disposal of $7.4 million, net of income taxes, as a result of a favorable working capital adjustment. The working capital adjustment was partially offset by a correction of an error of $1.3 million, net of income taxes, related to a foreign currency translation adjustment for the Company’s Canadian operations that were sold as part of the NRB divestiture. The Company realized during the third quarter of 2010 that this adjustment should have been written-off in the fourth quarter of 2009 and recognized as part of the loss on the sale of the NRB operations. Management of the Company concluded the effect of this adjustment was immaterial to the Company’s 2009 and 2010 financial statements. Refer to Note 2 – Acquisitions and Divestitures in the Notes to the Consolidated Financial Statements for additional discussion.

 

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 Net Income (Loss) Attributable to Noncontrolling Interest:

00000000 00000000 00000000 00000000
      2010      2009     $ Change      % Change  

 Net income (loss) attributable to noncontrolling interest

   $ 2.1       $ (4.6   $ 6.7         145.7%   

For 2010, the net income attributable to noncontrolling interest was $2.1 million, compared to a net loss attributable to noncontrolling interest of $4.6 million in 2009. The increase in net income attributable to noncontrolling interests in 2010 was primarily due to improved market conditions served by subsidiaries in which the Company holds less than 100% ownership.

In 2009, the loss attributable to noncontrolling interest increased by $6.1 million due to a correction of an error related to the $18.4 million goodwill impairment loss the Company recorded in the fourth quarter of 2008 for the Mobile Industries segment. In recording the goodwill impairment loss in the fourth quarter of 2008, the Company did not recognize that a portion of the goodwill impairment loss related to two separate subsidiaries in India and South Africa in which the Company holds less than 100% ownership. As a result, the Company’s 2008 financial statements were understated by $6.1 million and the Company’s first quarter 2009 financial statements were overstated by $6.1 million. Management concluded the effect of this adjustment was not material to the Company’s 2009 or 2008 financial statements.

Business Segments:

The presentation below reconciles the changes in net sales for each segment reported in accordance with U.S. GAAP to net sales adjusted to remove the effects of acquisitions made in 2010 and currency exchange rates. The effects of acquisitions and currency exchange rates are removed to allow investors and the Company to meaningfully evaluate the percentage change in net sales on a comparable basis from period to period. During the third quarter of 2010, the Company completed the acquisition of QM Bearings. QM Bearings is part of the Process Industries segment. The acquisition of City Scrap, completed on December 31, 2010, had no impact on the 2010 operating results. The year 2009 represents the base year for which the effects of currency are measured; as a result, currency is assumed to be zero for 2009.

 Mobile Industries Segment:

0000000 0000000 0000000 0000000
      2010      2009     $ Change      Change  

 Net sales, including intersegment sales

   $       1,560.6       $       1,245.0      $       315.6         25.3%   

 EBIT

   $ 207.6       $ (85.5   $ 293.1         342.8%   

 EBIT margin

     13.3%         (6.9)%        -         2,020  bps 
          
      2010      2009     $ Change      % Change  

 Net sales, including intersegment sales

   $ 1,560.6       $ 1,245.0      $ 315.6         25.3%   

 Currency

     3.5         -        3.5         NM   

 Net sales, excluding the impact of currency

   $ 1,557.1       $ 1,245.0      $ 312.1         25.1%   

The Mobile Industries segment’s net sales, excluding the effects of currency-rate changes, increased 25.1% in 2010 compared to 2009, primarily due to higher volume of approximately $220 million and higher pricing of approximately $90 million. The higher sales were seen across all market sectors, led by a 40% increase in heavy truck, a 33% increase in off-highway and a 28% increase in light vehicles. EBIT was higher in 2010 compared to 2009 primarily due to the impact of higher volume and pricing of approximately $180 million, lower impairment and restructuring charges of approximately $95 million, favorable sales mix of approximately $40 million and improved manufacturing utilization of approximately $25 million. These increases were partially offset by higher selling, general and administrative expenses of approximately $30 million and LIFO expense of approximately $25 million.

 

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 Process Industries Segment:

      2010      2009      $ Change      Change  

 Net sales, including intersegment sales

   $       903.4       $       808.7       $ 94.7         11.7%   

 EBIT

   $ 133.6       $ 72.6       $ 61.0         84.0%   

 EBIT margin

     14.8%         9.0%         -         580  bps 
           
      2010      2009      $ Change      % Change  

 Net sales, including intersegment sales

   $ 903.4       $ 808.7       $ 94.7         11.7%   

 Acquisitions

     4.9         -         4.9         NM   

 Currency

     1.7         -         1.7         NM   

 Net sales, excluding the impact of acquisitions and currency

   $ 896.8       $ 808.7       $ 88.1         10.9%   

The Process Industries segment’s net sales, excluding the effect of acquisitions and currency-rate changes, increased 10.9% for 2010 compared to 2009, primarily due to higher volume of approximately $80 million. The increased sales resulted from a 20% increase in the industrial distribution channel, a 116% increase in global wind energy and a 10% increase in gear drives. These increases were partially offset by a 26% decline in the metals sector. EBIT was higher in 2010 compared to 2009 due to the impact of increased volume of approximately $45 million, lower impairment and restructuring charges of approximately $40 million and better manufacturing utilization of approximately $35 million. These increases were partially offset by higher selling, general and administrative expenses of approximately $30 million and higher raw material costs and related LIFO expense of $25.0 million.

 Aerospace and Defense Segment:

      2010     2009      $ Change     Change  

 Net sales, including intersegment sales

   $       338.3      $       417.7       $ (79.4     (19.0)%   

 EBIT

   $ 16.7      $ 65.4       $ (48.7     (74.5)%   

 EBIT margin

     4.9%        15.7%         -        (1,080 ) bps 
         
      2010     2009      $ Change     % Change  

 Net sales, including intersegment sales

   $ 338.3      $ 417.7       $ (79.4     (19.0)%   

 Currency

     (1.4     -         (1.4     NM   

 Net sales, excluding the impact of currency

   $ 339.7      $ 417.7       $ (78.0     (18.7)%   

The Aerospace and Defense segment’s net sales, excluding the effect currency-rate changes, decreased 18.7% for 2010 compared to 2009. The decline was due to a decrease in volume of approximately $90 million, partially offset by favorable pricing. Volume was down across most market sectors within the Aerospace and Defense segment, especially the defense and civil aviation market sectors. EBIT decreased 74.5% in 2010 compared to 2009, primarily due to lower volume of approximately $35 million, higher manufacturing costs of approximately $20 million and higher LIFO expense of approximately $10 million, partially offset by cost reductions, pricing and sales mix.

 

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 Steel Segment:

      2010      2009     $ Change      Change  

 Net sales, including intersegment sales

   $       1,359.5       $       714.9      $       644.6         90.2%   

 EBIT

   $ 146.2       $ (63.4   $ 209.6         330.6%   

 EBIT margin

     10.8%         (8.9 )%      -         1,970  bps 
          
      2010      2009     $ Change      % Change  

 Net sales, including intersegment sales

   $ 1,359.5       $ 714.9      $ 644.6         90.2%   

 Currency

     0.7         -        0.7         NM   

 Net sales, excluding the impact of currency

   $ 1,358.8       $ 714.9      $ 643.9         90.1%   

The Steel segment’s net sales for 2010, excluding the effects of currency-rate changes, increased 90.1% compared to 2009, primarily due to higher volume of approximately $445 million, across all market sectors, and higher surcharges of approximately $250 million, partially offset by an unfavorable sales mix of approximately $50 million. Surcharges increased to $350.4 million in 2010 from $100.1 million in 2009. The average scrap index for 2010 was $426 per ton, compared to $258 per ton for 2009. Steel shipments for 2010 were 1,026,000 tons, compared to 595,000 tons for 2009, an increase of 72%. The Steel segment’s average selling price, including surcharges, was $1,323 per ton for 2010, compared to an average selling price of $1,202 per ton for 2009. The increase in the average selling prices was primarily the result of higher surcharges, partially offset by unfavorable sales mix. The higher surcharges were the result of higher prices for certain input raw materials, especially scrap steel, molybdenum and nickel.

The Steel segment’s EBIT increased $209.6 million in 2010 compared to 2009, primarily due to higher surcharges, the impact of higher sales volume of approximately $175 million and lower manufacturing costs of approximately $110 million, partially offset by the impact of higher raw material costs of approximately $255 million and higher LIFO expense of approximately $40 million. In 2010, the Steel segment recognized LIFO expense of $2.8 million, compared to LIFO income of $37.1 million in 2009. Raw material costs consumed in the manufacturing process, including scrap steel, alloys and energy, increased 38% in 2010 compared to the prior year, to an average cost of $455 per ton.

 Corporate:

      2010      2009      $ Change      Change  

 Corporate expenses

   $       67.4       $       51.4       $       16.0         31.1%   

 Corporate expenses % to net sales

     1.7%         1.6%         -         10  bps 

Corporate expenses increased in 2010 compared to 2009, as a result of higher performance-based compensation of approximately $18 million.

 

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THE BALANCE SHEETS

The following discussion is a comparison of the Consolidated Balance Sheets at December 31, 2011 and December 31, 2010.

 Current Assets:

      December 31,                 
      2011      2010      $ Change     % Change  

 Cash and cash equivalents

   $       464.8       $       877.1       $    (412.3)      (47.0)%   

 Restricted cash

     3.6         -         3.6        NM   

 Accounts receivable, net

     645.5         516.6         128.9        25.0%    

 Inventories, net

     964.4         828.5         135.9        16.4%    

 Deferred income taxes

     113.7         100.4         13.3        13.2%    

 Deferred charges and prepaid expenses

     12.8         11.3         1.5        13.3%    

 Other current assets

     87.5         65.3         22.2        34.0%    

Total current assets

   $ 2,292.3       $ 2,399.2       $ (106.9)        (4.5)%   

Refer to the Consolidated Statements of Cash Flows for a discussion of the decrease in cash and cash equivalents. Accounts receivable, net increased as a result of the higher sales in the fourth quarter of 2011 as compared to the same period in 2010, as well as the acquisitions of Philadelphia Gear and Drives. Inventories increased primarily to support higher sales volume and expected future demand. Inventories also increased as a result of acquisitions. The increase in deferred income taxes was primarily due to an increase in book-tax differences related to accrued liabilities, primarily related to incentive-based compensation, and other employee benefit accruals. The increase in other current assets was primarily due to an increase in short-term marketable securities of approximately $30 million, partially offset by the sale of the Company’s equity investment in ICS, which had been classified as assets held for sale.

 Property, Plant and Equipment-Net:

      December 31,                
      2011     2010     $ Change     % Change  

 Property, plant and equipment

   $     3,589.4      $     3,454.0      $ 135.4        3.9

 Less: allowances for depreciation

     (2,280.5     (2,186.3     (94.2     (4.3 )% 

Property, plant and equipment - net

   $ 1,308.9      $ 1,267.7      $ 41.2        3.2

The increase in property, plant and equipment – net in 2011 was primarily due to the impact of acquisitions in 2011, as well as capital expenditures in 2011 exceeding depreciation expense.

In November 2010, the Company entered into an agreement to sell the real estate of its former manufacturing facility in Sao Paulo, Brazil. The transfer of this land is expected to be completed in 2012 after the Company has completed the soil remediation of the site and the groundwater remediation plan has been approved. Based on the terms of the agreement, once the title transfers, the Company expects to receive approximately $33.7 million, including interest, over an 18-month period, subject to fluctuations in foreign currency exchange rates.

 

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Other Assets:

      December 31,                  
      2011      2010      $ Change      % Change  

Goodwill

   $     307.2       $     224.4       $ 82.8         36.9

Other intangible assets

     261.6         129.2         132.4         102.5

Deferred income taxes

     141.9         121.5         20.4         16.8

Other non-current assets

     40.2         38.4         1.8         4.7

Total other assets

   $ 750.9       $ 513.5       $ 237.4         46.2

The increase in goodwill was primarily due to the acquisitions of Philadelphia Gear and Drives. The increase in other intangible assets was primarily due to current-year acquisitions, partially offset by amortization expense recognized during 2011. The increase in deferred income taxes was primarily due to increases in the Company’s accrued pension liabilities during 2011, partially offset by contributions to a VEBA trust for retiree healthcare costs.

Current Liabilities:

      December 31,                 
      2011      2010      $ Change     % Change  

Short-term debt

   $       22.0       $       22.4       $ (0.4     (1.8 )% 

Accounts payable

     287.3         263.5         23.8        9.0

Salaries, wages and benefits

     259.3         228.8         30.5        13.3

Income taxes payable

     70.2         14.0         56.2        401.4

Deferred income taxes

     3.1         0.7         2.4        342.9

Other current liabilities

     188.4         172.0         16.4        9.5

Current portion of long-term debt

     14.3         9.6         4.7        49.0

Total current liabilities

   $ 844.6       $ 711.0       $ 133.6        18.8

The increase in accounts payable was primarily due to higher sales volume. The increase in accrued salaries, wages and benefits was the result of accruals for current-year incentive plans. The increase in income taxes payable was primarily due to the provision for income taxes in 2011 as a result of an increase in income before income taxes and the reclassification of approximately $40 million from other non-current liabilities as a result of an expected closure of a U.S. federal tax audit within the next 12 months. These increases were partially offset by income tax payments during 2011.

Non-Current Liabilities:

      December 31,                 
      2011      2010      $ Change     % Change  

Long-term debt

   $ 478.8       $ 481.7       $ (2.9     (0.6 )% 

Accrued pension cost

     491.0         394.5         96.5        24.5

Accrued postretirement benefits cost

     395.9         531.2         (135.3     (25.5 )% 

Deferred income taxes

     7.5         6.0         1.5        25.0

Other non-current liabilities

     91.8         114.2         (22.4     (19.6 )% 

Total non-current liabilities

   $     1,465.0       $     1,527.6       $ (62.6     (4.1 )% 

The increase in accrued pension cost was primarily due to a decrease in the discount rates used to calculate the projected benefit obligation, as well as returns on pension assets below the expected rate of return of 8.5%, partially offset by contributions of approximately $291 million to the Company’s defined benefit pension plans during 2011. The decrease in accrued postretirement benefits cost was primarily due to a contribution of $125 million to a VEBA trust to fund healthcare benefits. The decrease of other non-current liabilities was primarily due to the reclassification of approximately $40 million to income taxes payable for an expected closure of a U.S. federal tax audit within the next 12 months.

 

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Shareholders’ Equity:

      December 31,                
      2011     2010     $ Change     % Change  

Common stock

   $ 942.3      $ 934.8      $ 7.5        0.8

Earnings invested in the business

     2,004.7        1,626.4        378.3        23.3

Accumulated other comprehensive loss

     (889.5     (624.7     (264.8     (42.4 )% 

Treasury shares

     (29.2     (11.5     (17.7     (153.9 )% 

Noncontrolling interest

     14.2        16.8        (2.6     (15.5 )% 

Total equity

   $     2,042.5      $     1,941.8      $ 100.7        5.2

Earnings invested in the business increased in 2011 by net income of $454.3 million, partially offset by dividends declared of $76.0 million. The increase in the accumulated other comprehensive loss was primarily due to a $218.2 million net after-tax pension and postretirement liability adjustment and a $48.5 million decrease in foreign currency translation. The pension and postretirement liability adjustment was primarily due the realization of an actuarial loss in 2011 due to a decrease in the discount rates for defined benefit pension and postretirement plans, as well as lower than expected returns on plan assets, partially offset by the amortization of prior-year service costs and actuarial losses for these plans. The decrease in the foreign currency translation adjustment was due to the U.S, dollar strengthening relative to other currencies, such as the Indian rupee, the South African rand, the Polish zloty, the Brazilian real, Canadian dollar and the Euro. Treasury shares increased during 2011 as a result of the Company repurchasing stock under its 2006 common stock purchase plan.

CASH FLOWS:

      2011     2010     $ Change  

Net cash provided by operating activities

   $ 211.7      $ 312.7      $ (101.0

Net cash used by investing activities

     (508.0     (152.9     (355.1

Net cash used by financing activities

     (106.6     (32.9     (73.7

Effect of exchange rate changes on cash

     (9.4     (5.3     (4.1

(Decrease) Increase in cash and cash equivalents

   $     (412.3   $     121.6      $ (533.9

Operating activities provided net cash of $211.7 million in 2011 compared to $312.7 million in 2010. This change was primarily due to higher pension and other postretirement benefit contributions and payments as well as higher cash used by working capital items, partially offset by higher net income. Pension and other postretirement benefit contributions and payments were $456.0 million in 2011, compared to $337.0 million in 2010. Net income attributable to The Timken Company increased $179.5 million in 2011 compared to 2010.

The following chart displays the impact of working capital items on cash during 2011 and 2010:

 

      2011     2010  

Cash Provided (Used):

    

Accounts receivable

   $     (111.6   $     (104.8

Inventories

     (125.6     (150.0

Trade accounts payable

     14.9        105.4   

Other accrued expenses

     29.1        68.3   

Investing activities used cash of $508.0 million in 2011 after using cash of $152.9 million in 2010 as a result of an increase in acquisitions of $269.5 million and an increase in capital expenditures of $89.5 million. The increase in acquisitions related to the purchase of Philadelphia Gear, which was completed in July 2011, and the purchase of Drives, which was completed in October 2011.

The net cash used by financing activities was $106.6 million in 2011 after using cash of $32.9 million in 2010. The increase in cash used for financing activities was primarily due to a $26.6 million reduction in proceeds from stock option exercises, a $24.7 million increase in cash dividends paid to shareholders and a $14.6 million increase in the Company’s repurchases of its common stock in 2011 compared to 2010. The Company purchased one million shares of its common stock for an aggregate of $43.8 million in 2011 after purchasing one million shares of its common stock for an aggregate of $29.2 million in 2010.

 

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LIQUIDITY AND CAPITAL RESOURCES

Total debt was $515.1 million and $513.7 million at December 31, 2011 and December 31, 2010, respectively. Debt exceeded cash and cash equivalents by $46.7 million at December 31, 2011. Cash and cash equivalents exceeded total debt by $363.4 million at December 31, 2010. Debt in excess of cash as a percentage of total capital was 2.2% at December 31, 2011, compared to cash in excess of debt as a percentage of total capital of 23.0% at December 31, 2010.

Reconciliation of total debt to net (cash) debt and the ratio of net debt to capital:

Net Debt:

 

      December 31,  
      2011     2010  

Short-term debt

   $ 22.0      $ 22.4   

Current portion of long-term debt

     14.3        9.6   

Long-term debt

     478.8        481.7   

Total debt

     515.1        513.7   

Less: Cash and cash equivalents

         (464.8         (877.1

Restricted cash

     (3.6     -   

Net debt (cash)

   $ 46.7      $ (363.4

Ratio of Net Debt to Capital:

 

      December 31,  
      2011     2010  

Net debt (cash)

   $ 46.7      $ (363.4

Total equity

     2,042.5        1,941.8   

Net debt (cash) + total equity (capital)

   $     2,089.2      $     1,578.4   

Ratio of net debt (cash) to capital

     2.2     (23.0 )% 

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.

At December 31, 2011, the Company had no outstanding borrowings under its two-year Asset Receivable Securitization Financing Agreement (Asset Securitization Agreement), which provides for borrowings up to $150 million, subject to certain borrowing base limitations, and is secured by certain domestic trade receivables of the Company. The Company had full availability under the Asset Securitization Agreement at December 31, 2011.

On May 11, 2011, the Company amended and restated its Senior Credit Facility, replacing the Former Senior Credit Facility, which was due to expire on July 10, 2012. The Senior Credit Facility now matures on May 11, 2016. At December 31, 2011, the Company had no outstanding borrowings under the Senior Credit Facility but had letters of credit outstanding totaling $17.2 million, which reduced the availability under the Senior Credit Facility to $482.8 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, 2011, the Company was in full compliance with the covenants under the Senior Credit Facility and its other debt agreements. The maximum consolidated leverage ratio permitted under the Senior Credit Facility is 3.25 to 1.0. As of December 31, 2011, the Company’s consolidated leverage ratio was 0.54 to 1.0. The minimum consolidated interest coverage ratio permitted under the Senior Credit Facility is 4.0 to 1.0. As of December 31, 2011, the Company’s consolidated interest coverage ratio was 29.12 to 1.0.

The interest rate under the Senior Credit Facility is based on the Company’s consolidated leverage ratio. In addition, the Company pays a facility fee based on the consolidated leverage ratio multiplied by the aggregate commitments of all of the lenders under the Senior Credit Facility.

Other sources of liquidity include lines of credit for certain of the Company’s foreign subsidiaries, which provide for borrowings up to $266.2 million. The majority of these lines are uncommitted. At December 31, 2011, the Company had borrowings outstanding of $54.1 million against these lines, which reduced the availability under these facilities to $212.1 million.

 

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

At December 31, 2011, approximately $247 million, or 53.1%, of the Company’s cash and cash equivalents resided in jurisdictions outside the United States. Repatriation of these funds to the United States could be subject to government restrictions and domestic and foreign taxes. Part of the Company’s strategy is to expand its portfolio in new geographic spaces. This may include making investments in facilities and equipment and potential new acquisitions. The Company plans to fund these investments, as well as meet working capital requirements, with cash and cash equivalents and unused lines of credit within the geographic location of these investments when possible.

The Company expects to remain in compliance with its debt covenants. However, the Company may need to limit its borrowings under the Senior Credit Facility or other facilities in order to remain in compliance. As of December 31, 2011, the Company could have borrowed the full amounts available under the Senior Credit Facility and Asset Securitization Agreement and would have still been in compliance with its debt covenants.

The Company expects cash from operations in 2012 to improve 143% over 2011 as the Company anticipates higher net income, as well as lower working capital increases and a decrease in pension and postretirement contributions. The Company expects to make approximately $265 million in pension and postretirement contributions in 2012, compared to $416 million in 2011. The Company also expects to increase capital expenditures to $345 million in 2012 compared to $205 million in 2011, which includes the Company’s potential investment at its Faircrest steel plant in Canton, Ohio. This investment is dependent on the Company and the United Steelworkers entering into a new collective bargaining agreement.

CONTRACTUAL OBLIGATIONS

The Company’s contractual debt obligations and contractual commitments outstanding as of December 31, 2011 were as follows:

Payments due by Period:

 

              Less than                      More than  

Contractual Obligations

   Total      1 Year      1-3 Years      3-5 Years      5 Years  

Interest payments

   $ 224.6       $ 29.4       $ 49.5       $ 24.1       $ 121.6   

Long-term debt, including current portion

     493.1         14.3         273.6         15.0         190.2   

Short-term debt

     22.0         22.0         -         -         -   

Operating leases

     147.7         37.8         57.2         35.0         17.7   

Purchase commitments

     23.9         14.0         9.9         -         -   

Retirement benefits

     2,802.8         303.7         568.7         560.0         1,370.4   

Total

   $     3,714.1       $       421.2       $       958.9       $       634.1       $     1,699.9   

The interest payments beyond five years primarily relate to medium-term notes that mature over the next 17 years.

As of December 31, 2011, the Company had approximately $87.2 million of total gross unrecognized tax benefits. The Company anticipates a decrease in its unrecognized tax positions of approximately $42 million to $43 million during the next 12 months. The anticipated decrease is primarily due to settlements with tax authorities. Future tax positions are not known at this time and therefore not included in the above summary of the Company’s fixed contractual obligations. Refer to Note 15 – Income Taxes in the Notes to the Consolidated Financial Statements for additional discussion.

During 2011, the Company made cash contributions of approximately $291 million to its global defined benefit pension plans, of which $276.4 million was discretionary. The Company also contributed $125 million to a VEBA trust to fund retiree healthcare costs. The Company currently expects to make contributions to its global defined benefit pension plans totaling approximately $165 million in 2012, of which $145 million is discretionary. The Company also currently expects to make contributions to a VEBA trust to fund retiree healthcare costs totaling $100 million in 2012. The Company may consider making additional discretionary contributions to either its global defined benefit pension plans or its postretirement benefit plans during 2012. Returns for the Company’s global defined benefit pension plan assets in 2011 were below the expected rate of return assumption of 8.5% due to broad decreases in global equity markets. The lower returns negatively impacted the funded status of the plans at the end of 2011 and are expected to result in higher pension expense in future years. The impact of these unfavorable returns, as well as the impact of the lower discount rate for expense in 2012 compared to 2011 will increase pension expense by approximately $19 million in 2012. Returns for the Company’s U.S. defined benefit plan pension assets for 2011 were approximately 4.8%.

 

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During 2011, the Company purchased one million shares of its common stock for approximately $43.8 million in the aggregate under its 2006 common stock purchase plan. This plan authorizes the Company to buy, in the open market or in privately negotiated transactions, up to four million shares of common stock, which are to be held as treasury shares and used for specified purposes, up to an aggregate of $180 million. The authorization expires on December 31, 2012. As of December 31, 2011, the Company had purchased two million shares of its common stock for an aggregate amount of approximately $73.1 million under this plan. On February 10, 2012, the Board of Directors of the Company approved a new common stock purchase plan pursuant to which the Company may purchase up to ten million shares of the Company’s common stock. This plan replaces the 2006 common stock purchase plan. The new plan expires on December 31, 2015.

As disclosed in Note 9 – Contingencies and Note 15 – Income Taxes in the Notes to the Consolidated Financial Statements, the Company has exposure for certain legal and tax matters.

The Company does not have any off-balance sheet arrangements with unconsolidated entities or other persons.

RECENTLY ADOPTED ACCOUNTING PRONOUNCMENTS

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The following paragraphs include a discussion of some critical areas that require a higher degree of judgment, estimates and complexity.

Revenue recognition:

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

In July 2011, the Company acquired the assets of Philadelphia Gear Corp. Philadelphia Gear recognizes a portion of their revenues on percentage of completion method. In 2011, the Company recognized approximately $40 million in net sales under the percentage of completion method.

Inventory:

Inventories are valued at the lower of cost or market, with approximately 55% valued by the last-in, first-out (LIFO) method and the remaining 45% valued by the first-in, first-out (FIFO) method. The majority of the Company’s domestic inventories are valued by the LIFO method and all of the Company’s international (outside the United States) inventories are valued by the FIFO method. An actual valuation of the inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs. Because these are subject to many factors beyond management’s control, annual results may differ from interim results as they are subject to the final year-end LIFO inventory valuation. The Company recognized an increase in its LIFO reserve of $23.1 million for 2011, compared to an increase in its LIFO reserve of $26.9 million for 2010.

Goodwill:

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

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

 

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The Company reviews goodwill for impairment at the reporting unit level. The Company’s reporting units are the same as its reportable segments: Mobile Industries, Process Industries, Aerospace and Defense and Steel. The Company prepares its goodwill impairment analysis by comparing the estimated fair value of each reporting unit, using an income approach as well as a market approach, with its carrying value.

During 2011, the Company adopted the provisions of Accounting Standards Update (ASU) No. 2011-8, “Intangibles–Goodwill and Other (Topic 350): Testing Goodwill for Impairment,” which allows companies to assess qualitative factors to determine if goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test. Based on a review of various qualitative factors, management concluded that the goodwill for Process Industries and Steel segments was not impaired and that two-step approach was not required to be performed for these reporting units. Based on a review of various qualitative factors, management concluded that the goodwill for the Aerospace and Defense segment would be tested under the two-step approach. The Mobile Industries segment does not have goodwill.

The income approach requires several assumptions including future sales growth, EBIT (earnings before interest and taxes) margins and capital expenditures. The Company’s four 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 2011, the Company used a discount rate for the Aerospace and Defense reporting unit of 12% and a terminal revenue growth rate of 3%.

The market approach requires several assumptions including sales multiples 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 2011, the Company used sales multiples for the Aerospace and Defense reporting unit of 1.3 and EBITDA multiples of 10.5.

As a result of the goodwill impairment analysis performed during the fourth quarter of 2011, the Company recognized no goodwill impairment charges for the year ended December 31, 2011. As of December 31, 2011, the Company had $307.2 million of goodwill on its Consolidated Balance Sheet, of which $162.1 million was attributable to the Aerospace and Defense segment. See Note 7 – Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements for the carrying amount of goodwill by segment. The fair value of this reporting unit was $506.8 million compared to a carrying value of $456.8 million. A 120 basis point increase in the discount rate would have resulted in the Aerospace and Defense segment 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 1,300 basis point decrease in the projected cash flows would have resulted in the Aerospace and Defense segment 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.

In 2011, the income approach for the Aerospace and Defense segment was weighted by 70% and the market approach was weighted by 30% in arriving at fair value. This is a change from 2010 when the income approach and the market approach were weighted equally in arriving at fair value. The 70/30 weighting was selected to give consideration for the fact that the metrics for the last twelve months for Aerospace and Defense segment were not reflective of expected performance and the discounted-cash flow model provided a more normalized view of future operating conditions for the Aerospace and Defense segment. Had the Company used a 50/50 weighting, the Company would still have passed step one of the goodwill impairment test for the Aerospace and Defense segment for the year ended December 31, 2011.

Restructuring costs:

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

 

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Benefit plans:

The Company sponsors a number of defined benefit pension plans that cover eligible associates. The Company also sponsors several funded and unfunded postretirement plans that provide health care and life insurance benefits for eligible retirees and their dependents. These plans are accounted for in accordance with accounting rules for defined benefit pension plans and postemployment plans.

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 postretirement employee benefit obligations and its future expense and cash flow.

A discount rate is used to calculate the present value of expected future pension and postretirement cash flows as of the measurement date. The Company establishes the discount rate by constructing a portfolio of high-quality corporate bonds and matching the coupon payments and bond maturities to projected benefit payments under the Company’s pension and postretirement welfare plans. The bonds included in the portfolio 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.

For expense purposes in 2011, the Company applied a discount rate of 5.75% for the defined benefit pension plans and 5.50% for the postretirement welfare plans. For expense purposes for 2012, the Company will apply a discount rate of 5.00% for the defined benefit pension plans and 4.85% for the postretirement welfare plans. A .25 percentage point reduction in the discount rate would increase net periodic pension benefit cost by approximately $5.0 million for the defined benefit pension plans and $0.5 million for the postretirement welfare plans for 2012.

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. For expense purposes in 2011, the Company applied an expected rate of return of 8.50% for the Company’s pension plan assets. For expense purposes for 2012, the Company will apply an expected rate of return on plan assets of 8.25%. A .25 percentage point reduction in the expected rate of return would increase net periodic pension benefit cost by approximately $6.0 million for 2012. At the end of 2010, the Company established a VEBA trust for certain bargained associates’ retiree medical benefits. For expense purposes in 2011, the Company applied an expected rate of return of 5.0% to the VEBA trust assets. For expense purposes for 2012, the Company will continue to apply an expected rate of return of 5.0% to the VEBA trust assets. A .25 percentage point reduction in the expected rate of return would increase net periodic postretirement benefit cost by approximately $0.5 million for 2012.

For measurement purposes for postretirement benefits, the Company assumed a weighted-average annual rate of increase in per capita cost (health care cost trend rate) for medical benefits of 7.9% for 2012, declining steadily for the next 66 years to 5.0%; and 9.0% for prescription drug benefits for 2012, declining steadily for the next 66 years to 5.0%. The assumed health care cost trend rate may have a significant effect on the amounts reported. A one percentage point increase in the assumed health care cost trend rate would have increased the 2011 total service and interest cost components by $0.8 million and would have increased the postretirement obligation by $15.3 million. A one percentage point decrease would provide corresponding reductions of $0.8 million and $14.2 million, respectively.

The U.S. Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Medicare Act) provides for prescription drug benefits under Medicare Part D (Medicare Subsidy) and contains a tax-free subsidy to plan sponsors who provide “actuarially equivalent” prescription plans. The Company’s actuary determined that the prescription drug benefit provided by the Company’s postretirement plan is considered to be actuarially equivalent to the benefit provided under the Medicare Act. The effects of the Medicare Act include reductions to the accumulated postretirement benefit obligation and net periodic postretirement benefit cost of $63.4 million and $5.6 million, respectively. The 2011 expected Medicare Subsidy was $3.2 million, of which $0.9 million was received prior to December 31, 2011.

 

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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 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 loss 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. Net deferred tax assets relate primarily to pension and postretirement benefit obligations in the United States, which the Company believes are more likely than not to result in future tax benefits.

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 740-10. The Company records interest and penalties related to uncertain tax positions as a component of income tax expense.

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.

Other loss reserves:

The Company has a number of loss exposures that are incurred in the ordinary course of business such as environmental claims, product liability, product warranty, litigation and accounts receivable reserves. Establishing loss reserves for these matters requires management’s estimate and judgment with regards to risk exposure and ultimate liability or realization. These loss reserves are reviewed periodically and adjustments are made to reflect the most recent facts and circumstances.

OTHER DISCLOSURES

Foreign Currency

Assets and liabilities of subsidiaries are translated at the rate of exchange in effect on the balance sheet date; income and expenses are translated at the average rates of exchange prevailing during the reporting period. Related translation adjustments are reflected as a separate component of accumulated other comprehensive loss. Foreign currency gains and losses resulting from transactions are included in the Consolidated Statements of Income.

The Company recognized a foreign currency exchange loss of $1.4 million for the year ended December 31, 2011 after recognizing foreign currency exchange gains of $4.3 million and $8.2 million during the years ended December 31, 2010 and 2009, respectively. For the year ended December 31, 2011, the Company recorded a negative non-cash foreign currency translation adjustment of $48.5 million that decreased shareholders’ equity, compared to a negative non-cash foreign currency translation adjustment of $5.2 million that decreased shareholders’ equity for the year ended December 31, 2010. The foreign currency translation adjustments for the year ended December 31, 2011 were negatively impacted by the strengthening of the U.S. dollar relative to other currencies such as the Indian rupee, the South African rand, the Polish zloty, the Brazilian real, the Canadian dollar and the Euro.

Trade Law Enforcement

The U.S. government has an antidumping duty order in effect covering tapered roller bearings from China. The Company is a producer of these bearings in the United States. The U.S. government is currently conducting a review of whether or not this order should continue in place for an additional five years. The U.S. government also had antidumping duty orders in effect on ball bearings from France, Germany, Italy, Japan, and the United Kingdom. The Company produces ball bearings in the U.S. The ball bearing orders on France, Germany, and Italy were sunset effective September, 2011 and are hence revoked. The ball bearing orders on Japan and the U.K. were sunset by a court order in July, 2011. That court decision, however, is now under appeal by the U.S. International Trade Commission, and the Company.

 

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Continued Dumping and Subsidy Offset Act

The CDSOA provides for distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic producers where the domestic producers have continued to invest in their technology, equipment and people. The Company received CDSOA receipts of $3.5 million, $5.2 million and $6.2 million in 2011, 2010 and 2009, respectively. In 2011, the Company reported expenses in excess of CDSOA receipts of $1.1 million. The Company reported CDSOA receipts, net of expenses, of $2.0 million and $3.6 million in 2010 and 2009, respectively.

In September 2002, the World Trade Organization (WTO) ruled that CDSOA payments are not consistent with international trade rules. In February 2006, U.S. legislation was enacted that would end CDSOA distributions for dumped imports covered by antidumping duty orders entering the United States after September 30, 2007. Instead, any such antidumping duties collected would remain with the U.S. Treasury. This legislation would be expected to eventually reduce any distributions in years beyond 2007, with distributions eventually ceasing. Several countries have objected that this U.S. legislation is not consistent with WTO rulings, and have been granted retaliation rights by the WTO, typically in the form of increased tariffs on some imported goods from the United States. The European Union and Japan have been retaliating in this fashion against the operation of U.S. law.

In 2006, the U.S. Court of International Trade (CIT) ruled, in two separate decisions, that the procedure for determining recipients eligible to receive CDSOA distributions is unconstitutional. In February 2009, the U.S. Court of Appeals for the Federal Circuit reversed both decisions of the CIT. In December 2009, a plaintiff petitioned the U.S. Supreme Court to hear a further appeal, but the Supreme Court declined the petition, allowing the appellate court reversals to stand. There are, however, several remaining constitutional challenges to the CDSOA law that are now before the CIT. The Company is unable to determine, at this time, what the ultimate outcome of litigation regarding CDSOA will be.

There are a number of factors that can affect whether the Company receives any CDSOA distributions and the amount of such distributions in any given year. These factors include, among other things, potential additional changes in the law, ongoing and potential additional legal challenges to the law and the administrative operation of the law. Accordingly, the Company cannot reasonably estimate the amount of CDSOA distributions it will receive in future years, if any. It is possible that court rulings might prevent the Company from receiving any CDSOA distributions in 2012 and beyond. Any reduction of CDSOA distributions would reduce the Company’s earnings and cash flow.

Quarterly Dividend

On February 10, 2012, the Company’s Board of Directors declared a quarterly cash dividend of $0.23 per share. The dividend will be paid on March 2, 2012 to shareholders of record as of February 21, 2012. This will be the 359th consecutive dividend paid on the common stock of the Company.

 

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Forward-Looking Statements

Certain statements set forth in this Annual Report on Form 10-K and in the Company’s 2011 Annual Report to Shareholders (including the Company’s forecasts, beliefs and expectations) that are not historical in nature are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, Management’s Discussion and Analysis on pages 17 through 41 contains numerous forward-looking statements. Forward-looking statements generally will be accompanied by words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “guidance,” “intend,” “may,” “possible,” “potential,” “predict,” “project” or other similar words, phrases or expressions. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. The Company cautions readers that actual results may differ materially from those expressed or implied in forward-looking statements made by or on behalf of the Company due to a variety of factors, such as:

 

  a) deterioration in world economic conditions, including additional adverse effects from the global economic slowdown, terrorism or hostilities. This includes: political risks associated with the potential instability of governments and legal systems in countries in which the Company or its customers conduct business, and changes in currency valuations;

 

  b) the effects of fluctuations in customer demand on sales, product mix and prices in the industries in which the Company operates. This includes: the ability of the Company to respond to rapid changes in customer demand, the effects of customer bankruptcies or liquidations, the impact of changes in industrial business cycles, and whether conditions of fair trade continue in the U.S. markets;

 

  c) competitive factors, including changes in market penetration, increasing price competition by existing or new foreign and domestic competitors, the introduction of new products by existing and new competitors, and new technology that may impact the way the Company’s products are sold or distributed;

 

  d) changes in operating costs. This includes: the effect of changes in the Company’s manufacturing processes; changes in costs associated with varying levels of operations and manufacturing capacity; availability of raw materials and energy; the Company’s ability to mitigate the impact of fluctuations in raw materials and energy costs and the operation of the Company’s surcharge mechanism; changes in the expected costs associated with product warranty claims; changes resulting from inventory management and cost reduction initiatives and different levels of customer demands; the effects of unplanned work stoppages; and changes in the cost of labor and benefits;

 

  e) the success of the Company’s operating plans; the ability to integrate acquired companies; the ability of acquired companies to achieve satisfactory operating results, including results being accretive to earnings; and the Company’s ability to maintain appropriate relations with unions that represent Company associates in certain locations in order to avoid disruptions of business;

 

  f) unanticipated litigation, claims or assessments. This includes: claims or problems related to intellectual property, product liability or warranty, environmental issues, and taxes;

 

  g) changes in worldwide financial markets, including availability of financing and interest rates, which affect: the Company’s cost of funds and/or ability to raise capital; the Company’s pension obligations and investment performance; and/or customer demand and the ability of customers to obtain financing to purchase the Company’s products or equipment that contain the Company’s products; and

 

  h) those items identified under Item 1A. Risk Factors on pages 6 through 10.

Additional risks relating to the Company’s business, the industries in which the Company operates or the Company’s common stock may be described from time to time in the Company’s filings with the Securities and Exchange Commission. All of these risk factors are difficult to predict, are subject to material uncertainties that may affect actual results and may be beyond the Company’s control.

Readers are cautioned that it is not possible to predict or identify all of the risks, uncertainties and other factors that may affect future results and that the above list should not be considered to be a complete list. Except as required by the federal securities laws, the Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

Changes in short-term interest rates related to several separate funding sources impact the Company’s earnings. These sources are borrowings under an Asset Securitization Agreement, borrowings under the Senior Credit Facility, floating rate tax-exempt U.S. municipal bonds with a weekly reset mode and short-term bank borrowings at international subsidiaries. If the market rates for short-term borrowings increased by one-percentage-point around the globe, the impact would be an increase in interest expense of $0.9 million with a corresponding decrease in income from continuing operations before income taxes of the same amount. This amount was determined by considering the impact of hypothetical interest rates on the Company’s borrowing cost, year-end debt balances by category and an estimated impact on the tax-exempt municipal bonds’ interest rates.

Foreign Currency Exchange Rate Risk

Fluctuations in the value of the U.S. dollar compared to foreign currencies, including the Euro, also impact the Company’s earnings. The greatest risk relates to products shipped between the Company’s European operations and the United States. Foreign currency forward contracts are used to hedge these intercompany transactions. Additionally, hedges are used to cover third-party purchases of product and equipment. As of December 31, 2011, there were $145.2 million of hedges in place. A uniform 10% weakening of the U.S. dollar against all currencies would have resulted in a charge of $4.4 million related to these hedges, which would have partially offset the otherwise favorable impact of the underlying currency fluctuation. In addition to the direct impact of the hedged amounts, changes in exchange rates also affect the volume of sales or foreign currency sales price as competitors’ products become more or less attractive.

Commodity Price Risk

In the ordinary course of business, the Company is exposed to market risk with respect to commodity price fluctuations, primarily related to our purchases of raw materials and energy, principally scrap steel, other ferrous and non-ferrous metals, alloys and natural gas. Whenever possible, the Company manages its exposure to commodity risks primarily through the use of supplier pricing agreements that enable the Company to establish the purchase prices for certain inputs that are used in our manufacturing and distribution business. Timken utilizes a raw material surcharge as a component of pricing steel to pass through the cost increases of scrap steel and other raw materials, as well as natural gas. From time to time, the Company also uses derivative financial instruments to hedge a portion of its exposure to price risk related to natural gas purchases.

 

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Item 8. Financial Statements and Supplementary Data

Consolidated Statements of Income

 

     Year Ended December 31,  
      2011     2010     2009  

(Dollars in millions, except per share data)

                  

Net sales

   $     5,170.2      $     4,055.5      $     3,141.6   

Cost of products sold

     3,800.5        3,033.8        2,558.9   

Gross Profit

     1,369.7        1,021.7        582.7   

Selling, administrative and general expenses

     626.2        563.8        472.7   

Impairment and restructuring charges

     14.4        21.7        164.1   

Operating Income (Loss)

     729.1        436.2        (54.1

Interest expense

     (36.8     (38.2     (41.9

Interest income

     5.6        3.7        1.9   

Other (expense) income, net

     (1.1     3.8        (0.1

Income (Loss) From Continuing Operations Before Income Taxes

     696.8        405.5        (94.2

Provision for (benefit from) income taxes

     240.2        136.0        (28.2

Income (Loss) From Continuing Operations

     456.6        269.5        (66.0

Income (loss) from discontinued operations, net of income taxes

     -        7.4        (72.6

Net Income (Loss)

     456.6        276.9        (138.6

Less: Net income (loss) attributable to noncontrolling interest

     2.3        2.1        (4.6

Net Income (Loss) Attributable to The Timken Company

   $ 454.3      $ 274.8      $ (134.0

Amounts Attributable to The Timken Company's Common Shareholders:

      

Income (loss) from continuing operations, net of income taxes

   $ 454.3      $ 267.4      $ (61.4

Income (loss) from discontinued operations, net of income taxes

     -        7.4        (72.6

Net Income (Loss) Attributable to The Timken Company

   $ 454.3      $ 274.8      $ (134.0

  Net Income (Loss) per Common Share Attributable to The Timken Company Common Shareholders

      

Earnings (loss) per share - Continuing Operations

   $ 4.65      $ 2.76      $ (0.64

Earnings (loss) per share - Discontinued Operations

     -        0.07        (0.75

Basic earnings (loss) per share

   $ 4.65      $ 2.83      $ (1.39

Diluted earnings (loss) per share - Continuing
Operations

   $ 4.59      $ 2.73      $ (0.64

Diluted earnings (loss) per share - Discontinued
Operations

     -        0.08        (0.75

Diluted earnings (loss) per share

   $ 4.59      $ 2.81      $ (1.39

Dividends per share

   $ 0.78      $ 0.53      $ 0.45   

See accompanying Notes to the Consolidated Financial Statements.

 

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Table of Contents

Consolidated Balance Sheets

 

     December 31,  
      2011     2010  

(Dollars in millions)

            

ASSETS

    

Current Assets

    

Cash and cash equivalents

   $ 464.8      $ 877.1   

Restricted cash

     3.6        -   

Accounts receivable, less allowances: 2011 - $19.0 million; 2010 - $27.6 million

     645.5        516.6   

Inventories, net

     964.4        828.5   

Deferred income taxes

     113.7        100.4   

Deferred charges and prepaid expenses

     12.8        11.3   

Other current assets

     87.5        65.3   

Total Current Assets

     2,292.3        2,399.2   

Property, Plant and Equipment - Net

     1,308.9        1,267.7   

Other Assets

    

Goodwill

     307.2        224.4   

Other intangible assets

     261.6        129.2   

Deferred income taxes

     141.9        121.5   

Other non - current assets

     40.2        38.4   

Total Other Assets

     750.9        513.5   

Total Assets

   $     4,352.1      $     4,180.4   

LIABILITIES AND EQUITY

    

Current Liabilities

    

Short - term debt

   $ 22.0      $ 22.4   

Accounts payable, trade

     287.3        263.5   

Salaries, wages and benefits

     259.3        228.8   

Income taxes payable

     70.2        14.0   

Deferred income taxes

     3.1        0.7   

Other current liabilities

     188.4        172.0   

Current portion of long - term debt

     14.3        9.6   

Total Current Liabilities

     844.6        711.0   

Non—Current Liabilities

    

Long - term debt

     478.8        481.7   

Accrued pension cost

     491.0        394.5   

Accrued postretirement benefits cost

     395.9        531.2   

Deferred income taxes

     7.5        6.0   

Other non - current liabilities

     91.8        114.2   

Total Non - Current Liabilities

     1,465.0        1,527.6   

Shareholders’ Equity

    

Class I and II Serial Preferred Stock without par value:

    

Authorized - 10,000,000 shares each class, none issued

     -        -   

Common stock without par value:

    

Authorized - 200,000,000 shares

    

Issued (including shares in treasury) (2011 - 98,375,135 shares; 2010 - 98,153,317 shares)

    

Stated capital

     53.1        53.1   

Other paid - in capital

     889.2        881.7   

Earnings invested in the business

     2,004.7        1,626.4   

Accumulated other comprehensive loss

     (889.5     (624.7

Treasury shares at cost (2011 - 708,327 shares; 2010 - 350,201 shares)

     (29.2     (11.5

Total Shareholders’ Equity

     2,028.3        1,925.0   

Noncontrolling interest

     14.2        16.8   

Total Equity

     2,042.5        1,941.8   

Total Liabilities and Equity

   $ 4,352.1      $ 4,180.4   

See accompanying Notes to the Consolidated Financial Statements.

 

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Table of Contents

Consolidated Statements of Cash Flows

 

     Year Ended December 31,  
      2011     2010     2009  

(Dollars in millions)

                  

CASH PROVIDED (USED)

      

Operating Activities

      

Net income (loss) attributable to The Timken Company

   $ 454.3      $ 274.8      $ (134.0

Net (income) loss from discontinued operations

     -        (7.4     72.6   

Net income (loss) attributable to noncontrolling interest

     2.3        2.1        (4.6

Adjustments to reconcile income from continuing operations to net cash provided by operating activities:

      

Depreciation and amortization

     192.5        189.7        201.5   

Impairment charges

     3.3        4.7        113.7   

Loss on sale of assets

     0.6        6.5        6.8   

Deferred income tax provision

     99.8        58.8        22.8   

Stock-based compensation expense

     16.9        16.9        14.9   

Pension and other postretirement expense

     74.9        93.1        96.7   

Pension and other postretirement benefit contributions and payments

     (456.0     (337.0     (113.5

Changes in operating assets and liabilities:

      

Accounts receivable

     (111.6     (104.8     174.5   

Inventories

     (125.6     (150.0     356.1   

Accounts payable, trade

     14.9        105.4        (84.4

Other accrued expenses

     29.1        68.3        (71.7

Income taxes

     33.9        97.2        (48.6

Other - net

     (17.6     (13.0     (2.7

Net Cash Provided by Operating Activities - Continuing Operations

     211.7        305.3        600.1   

Net Cash Provided (Used) by Operating Activities - Discontinued Operations

     -        7.4        (12.4

Net Cash Provided by Operating Activities

     211.7        312.7        587.7   

Investing Activities

      

Capital expenditures

     (205.3     (115.8     (114.1

Acquisitions, net of cash acquired of $0.8 million in 2010

     (292.1     (22.6     (0.4

Proceeds from disposals of property, plant and equipment

     5.7        1.9        2.6   

Divestitures, net of cash divested of $1.2 million in 2009

     4.8        -        303.6   

Investments in short-term marketable securities, net

     (22.7     (15.0     -   

Other

     1.6        (1.4     4.9   

Net Cash (Used) Provided by Investing Activities - Continuing Operations

     (508.0     (152.9     196.6   

Net Cash Used by Investing Activities - Discontinued Operations

     -        -        (2.4

Net Cash (Used) Provided by Investing Activities

     (508.0     (152.9     194.2   

Financing Activities

      

Cash dividends paid to shareholders

     (76.0     (51.3     (43.2

Purchase of treasury shares

     (43.8     (29.2     -   

Net proceeds from common share activity

     23.8        50.4        0.9   

Proceeds from issuance of long-term debt

     9.5        18.2        255.0   

Deferred financing costs

     (3.0     -        (10.8

Payments on long-term debt

     (8.9     (13.7     (305.7

Short-term debt activity – net

     1.0        (3.8     (74.2

Increase in restricted cash

     (3.6     -        -   

Other

     (5.6     (3.5     -   

Net Cash Used by Financing Activities

     (106.6     (32.9     (178.0

Effect of exchange rate changes on cash

     (9.4     (5.3     18.2   

(Decrease) Increase In Cash and Cash Equivalents

     (412.3     121.6        622.1   

Cash and cash equivalents at beginning of year

     877.1        755.5        133.4   

Cash and Cash Equivalents at End of Year

   $       464.8      $       877.1      $       755.5   

See accompanying Notes to the Consolidated Financial Statements.

 

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Table of Contents

Consolidated Statements of Shareholders’ Equity

 

           The Timken Company Shareholders        
      Total     Stated
Capital
     Other
Paid-In
Capital
    Earnings
Invested
in the
Business
    Accumulated
Other
Comprehensive
Income (Loss)
    Treasury
Stock
    Non-
controlling
Interest
 

(Dollars in millions, except per share data)

                                           

Year Ended December 31, 2009

               

Balance at January 1, 2009

   $ 1,663.0      $ 53.1       $ 838.3      $ 1,580.1      $ (819.7   $ (11.6   $ 22.8   

Net loss

     (138.6          (134.0         (4.6

Foreign currency translation adjustments

     39.8               39.8       

Pension and postretirement liability adjustment (net of income tax of $64.6 million)

     62.0               62.1          (0.1

Change in fair value of derivative financial instruments, net of reclassifications

     0.7               0.7       

Total comprehensive loss

     (36.1             

Change in ownership of noncontrolling interest

     1.0                   1.0   

Dividends declared to noncontrolling interest

     (1.1                (1.1

Dividends – $0.45 per share

     (43.2          (43.2      

Excess tax benefit from stock compensation

     0.1           0.1           

Stock-based compensation expense

     14.9           14.9           

Stock option exercise activity

     10.4           0.8            9.6     

Restricted shares (issued) surrendered

     (11.6        (10.7         (0.9  

Shares surrendered for taxes

     (1.8                                      (1.8        

Balance at December 31, 2009

   $ 1,595.6      $ 53.1       $ 843.4      $ 1,402.9      $ (717.1   $ (4.7   $ 18.0   

Year Ended December 31, 2010

               

Net income

     276.9             274.8            2.1   

Foreign currency translation adjustments

     (5.2            (5.2    

Pension and postretirement liability adjustment (net of income tax of $22.1 million)

     98.5               98.6          (0.1

Unrealized loss on marketable securities

     (0.2            (0.2    

Change in fair value of derivative financial instruments, net of reclassifications

     (0.8            (0.8    

Total comprehensive income

     369.2                

Change in ownership of noncontrolling interest

     (3.5        (1.0           (2.5

Dividends declared to noncontrolling interest

     (0.7                (0.7

Dividends – $0.53 per share

     (51.3          (51.3      

Excess tax benefit from stock compensation

     5.8           5.8           

Stock-based compensation expense

     16.9           16.9           

Stock purchased at fair market value

     (29.2              (29.2  

Stock option exercise activity

     45.0           14.5            30.5     

Restricted shares (issued) surrendered

     0.7           2.1