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Section 1: 10-K (10-K)

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tkr:Positions

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, 2016
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from______to_______            
Commission file number: 1-1169
THE TIMKEN COMPANY
(Exact name of registrant as specified in its charter)
Ohio
 
34-0577130
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
4500 Mt. Pleasant St. NW, North Canton, Ohio
 
44720-5450
(Address of principal executive offices)
 
(Zip Code)
234.262.3000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Shares, without par value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
    Yes  x    No  o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  o    No  x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   
 Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   
 Yes  x    No  o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of June 30, 2016, the aggregate market value of the registrant’s common shares held by non-affiliates of the registrant was $2,097,179,228 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, 2017
Common Shares, without par value
 
77,565,732 shares
DOCUMENTS INCORPORATED BY REFERENCE
Document
 
Parts Into Which Incorporated
Proxy Statement for the Annual Meeting of Shareholders to be held on or about May 9, 2017 (Proxy Statement)
 
Part III


Table of Contents


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


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

The Company was founded in 1899 by Henry Timken, who received two patents on the design of a tapered roller bearing. Timken later became, and continues to be, the world's largest manufacturer of tapered roller bearings, leveraging its expertise to develop a full portfolio of industry-leading products and services. Timken built its reputation as a global leader by applying its knowledge of metallurgy, friction management and mechanical power transmission to increase the reliability and efficiency of its customers' equipment across a diverse range of industries. Today, the Company's global footprint consists of 73 manufacturing facilities/service centers, 15 technology and engineering centers, and 25 distribution centers and warehouses, supported by a team comprised of more than 14,000 employees. Timken operates in 28 countries around the globe.

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

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

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

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

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

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


1



Table of Contents


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

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

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

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

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

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

Couplings. The Company offers a full range of industrial couplings within its mechanical power transmission products portfolio. The Lovejoy brand is widely known for its flexible coupling design and as the creator of the jaw-style coupling. Lovejoy® couplings are available in curved jaw, jaw in-shear, s-flex, gear-torsional and disc style configurations. These components are used in a wide range of industries such as steel, pulp and paper, power generation, food processing, mining and construction.

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

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


2

Table of Contents


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

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

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

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

Services accounted for approximately 7% of the Company’s net sales for the year ended December 31, 2016.

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

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

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

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

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

3

Table of Contents


Joint Ventures:
Investments in affiliated companies accounted for under the equity method were approximately $3.1 million and $2.6 million, respectively, at December 31, 2016 and 2015. The investment balance at December 31, 2016 was reported in other non-current assets on the Consolidated Balance Sheets.

Backlog:
The following table provides the backlog of orders for the Company's domestic and overseas operations at December 31, 2016 and 2015:
 
December 31,
(Dollars in millions)
2016
2015
Segment:
 
 
Mobile Industries
$
644.7

$
587.1

Process Industries
398.4

356.1

Total Company
$
1,043.1

$
943.2


Approximately 90% of the Company’s backlog at December 31, 2016, is scheduled for delivery in the succeeding twelve months. Actual shipments depend upon customers' ever-changing production schedules. Accordingly, Timken does not believe that its backlog data and comparisons thereof, as of different dates, reliably indicate future sales or shipments.

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

Expenditures for research and development amounted to approximately $31.8 million, $32.6 million and $38.8 million in 2016, 2015 and 2014, respectively. $0.3 million of the 2014 amount was funded by others. No amounts were funded by others in 2016 and 2015.

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 2016, 16 of the Company’s plants had obtained ISO 14001 certification.

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The Company believes it has established appropriate reserves to cover its environmental expenses and has a well-established environmental compliance audit program for its domestic and international units. This program measures performance against applicable laws, as well as against internal standards that have been established for all units worldwide. It is difficult to assess the possible effect of compliance with future requirements that differ from existing requirements.
 
The Company and certain of its United Stated ("U.S.") subsidiaries previously have been and could in the future be identified as potentially responsible parties for investigation and remediation at off-site disposal or recycling facilities under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), known as the Superfund, or state laws similar to CERCLA. In general, such claims for investigation and remediation have also been asserted against numerous other entities.

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

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

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

Employment:
At December 31, 2016, Timken had more than 14,000 employees. Approximately 7% of Timken’s U.S. employees are covered under collective bargaining agreements.

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


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

Risk Relating to our Business

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

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

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

Our business operations are capital intensive, and we devote a significant amount of capital to certain industries. Our profitability is dependent on factors such as labor compensation and productivity and inventory management, which are subject to risks that we may not be able to control. If there are downturns in the industries that we serve, we may be forced to significantly curtail or suspend our operations with respect to those industries, including laying-off employees, reducing production, recording asset impairment charges and other measures, which may adversely affect our results of operations and profitability.

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

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


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

Global financial markets have experienced volatility in recent years, including volatility in securities prices and diminished liquidity and credit availability. Our access to the financial markets cannot be assured and is dependent on, among other things, market conditions and company performance. Accordingly, we may be forced to delay raising capital, issue shorter tenors than we prefer or pay unattractive interest rates, which could increase our interest expense, decrease our profitability and significantly reduce our financial flexibility.
If a customer becomes insolvent or files for bankruptcy, our ability to recover accounts receivable from that customer would be adversely affected and any payment we received during the preference period prior to a bankruptcy filing may be potentially recoverable by the bankruptcy estate. Furthermore, if certain of our customers liquidate in bankruptcy, we may incur impairment charges relating to obsolete inventory and machinery and equipment.

In addition, financial instability of certain companies in the supply chain could disrupt production in any particular industry. A disruption of production in any of the industries where we participate could have a material adverse effect on our financial condition and earnings. If any of our suppliers are unable or unwilling to provide the products or services that we require or materially increase their costs, our ability to offer and deliver our products on a timely and profitable basis could be impaired. We cannot assure you that any or all of our relationships will not be terminated or that such relationships will continue as presently in effect. Furthermore, if any of our suppliers were to become subject to bankruptcy, receivership or similar proceedings, we may be unable to arrange for alternate or replacement relationships on favorable terms, which could harm our sales and operating results.


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

Moreover, future disruptions in the supply of our raw materials could impair our ability to manufacture our products for our customers or require us to pay higher prices in order to obtain these raw materials from other sources. Any significant increase in the prices for such raw materials could adversely affect our results of operations and profit margins.


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

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


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

We have taken approximately $188 million in impairment and restructuring charges in the aggregate during the last five years. Changes in business or economic conditions, or our business strategy, may result in additional restructuring programs and may require us to take additional charges in the future, which could have a material adverse effect on our earnings.


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

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

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


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

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


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

We are exposed to the risks of 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 ("FCPA");
difficulty in staffing and managing geographically diverse operations; and
tax exposures related to cross-border intercompany transfer pricing and other tax risks unique to international operations.

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


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

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 or require us to record charges that could be significant and would cause a reduction in our shareholders' equity. We may be legally required to make contributions to the pension plans in the future in excess of our current expectations, and those contributions could be material.


Future actions involving our defined benefit and other postretirement plans, such as annuity purchases, lump sum payouts, and/or plan terminations could cause us to incur significant pension and postretirement settlement and curtailment charges.
 
We have purchased annuities and offered lump sum payouts to defined benefit plan and other postretirement plan participants and retirees in the past. If we were to take similar actions in the future, we could incur significant pension settlement and curtailment charges related to the reduction in pension and postretirement obligations from annuity purchases, lump sum payouts of benefits to plan participants, and/or plan terminations. Pursuing these types of actions could require us to make additional contributions to the defined plans to maintain a legally required funded status.


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

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


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

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

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

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


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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 types of employees is intense, and we could experience difficulty from time to time in hiring and retaining the personnel necessary to support our business. If we do not succeed in retaining our current employees and attracting new high quality employees, our business could be materially adversely affected.


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

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


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

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


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

Our most recent evaluation resulted in our conclusion that, as of December 31, 2016, our internal control over financial reporting was effective. We believe that we currently have adequate internal control procedures in place for future periods, including processes related to newly acquired businesses; however, increased risk of internal control breakdowns generally exists in a business environment that is decentralized. In addition, if our internal control over financial reporting is found to be ineffective, investors may lose confidence in the reliability of our financial statements, which may adversely affect our stock price.


Changes in accounting guidance could have an adverse effect on our results of operations, as reported in our financial statements.
 
Our consolidated financial statements are prepared in accordance with U.S. GAAP, which is periodically revised and/or expanded.  Accordingly, from time to time we are required to adopt new or revised accounting guidance and related interpretations issued by recognized authoritative bodies, including the Financial Accounting Standards Board and the SEC.  The impact of accounting pronouncements that have been issued but not yet implemented is disclosed in this annual report on Form 10-K and our quarterly reports on Form 10-Q.  It is possible that future accounting guidance we are required to adopt, or future changes in accounting principles, could change the current accounting treatment that we apply to our consolidated financial statements and that such changes could have an adverse effect on our results of operations, as reported in our consolidated financial statements.


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Risks Relating to the Spinoff of Our Steel Business

If the spinoff of TimkenSteel Corporation (TimkenSteel) into a separate independent publicly traded company on June 30, 2014 (the Spinoff) does not qualify as a tax-free transaction, the Company and its shareholders could be subject to substantial tax liabilities.

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


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

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



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Item 1B. Unresolved Staff Comments
None.

Item 2. Properties
Timken has manufacturing facilities at multiple locations in the United States and in a number of countries outside the United States. The aggregate floor area of these facilities worldwide is approximately 10.7 million square feet, all of which, except for approximately 1.7 million square feet, is owned in fee. The facilities not owned in fee are leased. The buildings occupied by Timken are principally made of brick, steel, reinforced concrete and concrete block construction. The Company believes all buildings are in satisfactory operating condition to conduct business.

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

Timken’s Mobile Industries segment’s manufacturing plants and service centers outside the United States are located in Belo Horizonte, Curitiba, and Sorocaba, Brazil; Yantai, China; Cheltenham, Northampton and Plymouth England; Colmar, France; Jamshedpur, India; Villa Carcina, Italy; Sosnowiec, Poland; and Benoni, South Africa. These facilities, including warehouses at plant locations, have an aggregate floor area of approximately 2.3 million square feet.

Timken's Process Industries segment's manufacturing plants and service centers in the United States are located in Hueytown, Alabama; Sante Fe Springs, California; Broomfield and Denver, Colorado; New Haven, Connecticut; New Castle, Delaware; Downers Grove, Fulton and Mokena, Illinois; Mishawaka, Indiana; Fort Scott, Kansas; Augusta and Portland, Maine; Springfield, Massachusetts, South Haven, Michigan, Springfield, Missouri; Randleman, and Rutherfordton, North Carolina; Union, South Carolina; Ferndale, Pasco and Vancouver, Washington; Princeton, West Virginia; and Casper, Wyoming. These facilities, including warehouses at plant locations and a wind center in North Canton, Ohio have an aggregate floor area of approximately 2.8 million square feet.     

Timken's Process Industries segment's manufacturing plants and service centers outside the United States are located in Mississauga, Prince George and Sasakatoon, Canada; Chengdu, Jiangsu and Wuxi, China; Dudley, England; Werdohl, Germany; Chennai and Durg, India; and Ploiesti, Romania. These facilities, including warehouses at plant locations have an aggregate floor area of approximately 2.1 million square feet.

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

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

Item 3. Legal Proceedings
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

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

Item 4. Mine Safety Disclosures
Not applicable.

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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 21, 2017 are as follows:
Name
 
Age
 
Current Position and Previous Positions During Last Five Years
William R. Burkhart
 
51
 
2014 Executive Vice President, General Counsel and Secretary
 
 
 
 
2000 Senior Vice President and General Counsel
Christopher A. Coughlin
 
56
 
2014 Executive Vice President, Group President
 
 
 
 
2012 Group President
 
 
 
 
2011 President - Process Industries
Philip D. Fracassa
 
48
 
2014 Executive Vice President and Chief Financial Officer
 
 
 
 
2012 Senior Vice President - Planning and Development
 
 
 
 
2010 Senior Vice President and Controller - B&PT
Richard G. Kyle
 
51
 
2014 President and Chief Executive Officer
 
 
 
 
2013 Chief Operating Officer - B&PT; Director
 
 
 
 
2012 Group President
 
 
 
 
2011 President - Mobile Industries & Aerospace
Ronald J. Myers
 
58
 
2015 Vice President of Human Resources
 
 
 
 
2014 Vice President of Organizational Advancement Operations
 
 
 
 
2012 Vice President - Operational Organizational Advancement


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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 shares are traded on the New York Stock Exchange under the symbol “TKR.” The estimated number of record holders of the Company’s common shares at December 31, 2016 was 4,238. The estimated number of beneficial shareholders at December 31, 2016 was 43,458.
The following table provides information about the high and low sales prices for the Company’s common shares and dividends paid for each quarter for the last two fiscal years.
 
 
2016
 
2015
 
Stock prices
Dividends
 
Stock prices
Dividends
 
High
Low
per share
 
High
Low
per share
First quarter
$
33.64

$
22.22

$
0.26

 
$
43.56

$
37.65

$
0.25

Second quarter
$
37.07

$
28.72

$
0.26

 
$
43.06

$
36.24

$
0.26

Third quarter
$
35.28

$
29.31

$
0.26

 
$
36.95

$
26.31

$
0.26

Fourth quarter
$
41.15

$
31.60

$
0.26

 
$
32.89

$
26.84

$
0.26


Issuer Purchases of Common Shares:
The following table provides information about purchases of its common shares by the Company during the quarter ended December 31, 2016.
 
Period
Total number
of shares purchased (1)
Average
price paid per share (2)
Total number of
shares purchased as
part of publicly
announced
plans or programs
Maximum number
of shares that may
yet be purchased
under the
plans or programs (3)
10/1/2016 - 10/31/2016
46,901

$
34.62

46,199

2,566,180

11/1/2016 - 11/30/2016
282,902

35.93

277,500

2,288,680

12/1/2016 - 12/31/2016
156,855

39.52

154,200

2,134,480

Total
486,658

$
36.96

477,899

2,134,480

 
(1)
Of the shares purchased in October, November and December, 702, 5,402 and 2,655, respectively, represent common shares of the Company that were owned and tendered by employees to exercise stock options, and to satisfy withholding obligations in connection with the exercise of stock options and vesting of restricted shares.
(2)
For shares tendered in connection with the vesting of restricted shares, the average price paid per share is an average calculated using the daily high and low of the Company’s common shares as quoted on the New York Stock Exchange at the time of vesting. For shares tendered in connection with the exercise of stock options, the price paid is the real-time trading share price at the time the options are exercised.
(3)
On January 29, 2016, the Board of Directors of the Company approved a share purchase plan pursuant to which the Company may purchase up to five million of its common shares, in the aggregate. This share purchase plan expired on January 31, 2017. Under this plan the Company purchased shares from time to time in open market purchases or privately negotiated transactions and was able to make all or part of the purchases pursuant to accelerated share repurchases or Rule 10b5-1 plans. On February 6, 2017, the Company's Board of Directors approved a new share repurchase plan pursuant to which the Company may purchase up to ten million of its common shares, in the aggregate. This new share purchase plan expires on February 28, 2021.


15

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

 38154686_tkr10k1231_chart-57120.jpg
*Total return assumes reinvestment of dividends. Fiscal years ending December 31.


 
2012
2013
2014
2015
2016
Timken
$
126

$
148

$
163

$
112

$
161

S&P 500
116

154

175

177

198

S&P 400 Industrials
122

175

178

172

222

 
The line graph compares the cumulative total shareholder returns over five years for The Timken Company, the S&P 500 Stock Index and the S&P 400 Industrials Index. The graph assumes, in each case, an initial investment of $100 on January 1, 2011, in Timken common shares, S&P 500 Index and S&P 400 Industrials Index, based on market prices at the end of each fiscal year through and including December 31, 2016, and reinvestment of dividends (and taking into account the value of the TimkenSteel common shares distributed in the Spinoff).


16

Table of Contents


Item 6. Selected Financial Data
Summary of Operations and Other Comparative Data:
(Dollars in millions, except per share and per employee data)
2016
2015
2014
2013
2012
Statements of Income
 
 
 
 
 
Net sales
$
2,669.8

$
2,872.3

$
3,076.2

$
3,035.4

$
3,359.5

Gross profit
694.8

793.9

898.0

868.4

1,028.0

Selling, general and administrative expenses
450.0

494.3

542.5

546.6

554.5

Impairment and restructuring charges
21.7

14.7

113.4

8.7

29.5

Operating income (loss) (1)
195.0

(151.4
)
208.4

305.9

444.0

Continued Dumping and Subsidy Offset Act income (expense), net

59.6





Other (expense) income, net
(0.9
)
(7.5
)
19.9

6.7

102.0

Interest expense, net
31.6

30.7

24.3

22.5

28.2

(Loss) income from continuing operations
152.9

(68.0
)
149.3

175.5

331.5

Income from discontinued operations, net of income taxes


24.0

87.5

164.4

Net income (loss) attributable to The Timken Company
$
152.6

$
(70.8
)
$
170.8

$
262.7

$
495.5

Balance Sheets
 
 
 
 
 
Inventories, net
$
545.8

$
543.2

$
585.5

$
582.6

$
611.5

Property, plant and equipment, net
804.4

777.8

780.5

855.8

834.1

Total assets
2,758.3

2,784.1

3,001.4

4,477.9

4,244.2

Total debt:
 
 
 
 
 
Short-term debt
19.2

62.0

7.4

18.6

14.3

Current portion of long-term debt
5.0

15.1

0.6

250.7

9.6

Long-term debt
635.0

579.4

518.4

175.6

423.4

Total debt
$
659.2

$
656.5

$
526.4

$
444.9

$
447.3

Net debt (cash)
 
 
 
 
 
Total debt
659.2

656.5

526.4

444.9

447.3

Less: cash and cash equivalents and restricted cash
(151.5
)
(129.8
)
(294.1
)
(399.7
)
(601.5
)
 Net debt (cash): (2)
$
507.7

$
526.7

$
232.3

$
45.2

$
(154.2
)
Total liabilities
1,452.3

1,439.5

1,408.7

1,828.4

1,996.2

Shareholders’ equity
$
1,306.0

$
1,344.6

$
1,589.1

$
2,648.6

$
2,246.6

Capital:
 
 
 
 
 
Net debt (cash)
507.7

526.7

232.3

45.2

(154.2
)
Shareholders’ equity
1,306.0

1,344.6

1,589.1

2,648.6

2,246.6

Net debt (cash) + shareholders’ equity (capital)
$
1,813.7

$
1,871.3

$
1,821.4

$
2,693.8

$
2,092.4

Other Comparative Data
 
 
 
 
 
Income (loss) from continuing operations / Net sales
5.7
%
(2.4
%)
4.9
%
5.8
%
9.9
%
Net income (loss) attributable to The Timken Company / Net sales
5.7
%
(2.5
%)
5.6
%
8.7
%
14.7
%
Return on equity (3)
11.7
%
(5.1
%)
9.4
%
6.6
%
14.8
%
Net sales per employee (4)
$
189.2

$
197.5

$
210.9

$
203.1

$
218.0

Capital expenditures
137.5

105.6

126.8

133.6

118.3

Depreciation and amortization
131.7

130.8

137.0

142.4

149.6

Capital expenditures / Net sales
5.2
%
3.7
%
4.1
%
4.4
%
3.5
%
Dividends per share
$
1.04

$
1.03

$
1.00

$
0.92

$
0.92

Basic earnings (loss) per share - continuing operations (5)
1.94

(0.84
)
1.62

1.84

3.41

Diluted earnings (loss) per share - continuing operations (5)
1.92

(0.84
)
1.61

1.82

3.38

Basic earnings (loss) per share (6)
1.94

(0.84
)
1.89

2.76

5.11

Diluted earnings (loss) per share (6)
1.92

(0.84
)
1.87

2.74

5.07

Net debt (cash) to capital (2)
28.0
%
28.1
%
12.8
%
1.7
%
(7.4
%)
Number of employees at year-end (7)
14,111

14,709

14,378

14,794

15,093

Number of shareholders (8)
43,458

40,257

44,271

52,218

50,783

(1)
Operating (loss) income included pension settlement charges of $28.1 million during 2016.
(2)
The Company presents net debt (cash) because it believes net debt (cash) is more representative of the Company’s financial position than total debt due to the amount of cash and cash equivalents.
(3)
Return on equity is defined as (loss) income from continuing operations divided by ending shareholders’ equity.
(4)
Based on average number of employees employed during the year.
(5)
Based on average number of shares outstanding during the year.
(6)
Based on average number of shares outstanding during the year and includes discontinued operations for 2012 through 2014.
(7)
Adjusted to exclude temporary employees for all periods.
(8)
Includes an estimated count of shareholders having common shares held for their accounts by banks, brokers and trustees for benefit plans.

17

Table of Contents


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

OVERVIEW

Introduction:

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

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

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

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




18

Table of Contents


The Timken Business Model is the specific framework for how the Company evaluates opportunities and differentiates itself in the market.
38154686_timkenbusinessmodela11.jpg
The Company’s Strategy is to apply the Timken Business Model and leverage the Company’s competitive differentiators and strengths to create customer value and drive increased growth and profitability by:

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

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

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


19

Table of Contents


The following items highlight certain of the Company's more significant strategic accomplishments in 2016:

Business Highlights

The Company continued to advance its manufacturing footprint initiatives with:
The announced closures of its bearing plants in Pulaski, Tennessee ("Pulaski") and Altavista, Virginia ("Altavista") and its manufacturing facility in Benoni, South Africa ("Benoni"), which are expected to be completed in 2017. Production from Altavista will be transferring to the Company's bearing plant near Lincolnton, North Carolina; and
The closure of its bearing facility in the United Kingdom ("U.K.").
Received a multi-year contract from the U.S. Department of Defense ("DoD") to provide engineering and supply Philadelphia Gear main reduction gears for the Navy's next generation of Arleigh Burke DDG 51 class ships. The fixed price contract includes options that, if exercised, could bring the cumulative value of the contract to more than $1 billion over its estimated 10-year life; and
Completed the installation of aerospace transmission overhaul and repair equipment at its plant in Manchester, Connecticut. This equipment adds new capabilities and will support a contract secured in 2015 to overhaul and repair up to roughly 220 Apache AH64D main transmissions for the DoD over a three-year period.

Share Repurchases

On February 6, 2017, the Company's Board of Directors approved a new share repurchase plan pursuant to which the Company may purchase up to ten million of its common shares, in the aggregate. This new share purchase plan expires on February 28, 2021.

Acquisitions
 
On October 31, 2016, the Company acquired EDT Corp. ("EDT"), a manufacturer of polymer housed units and stainless steel ball bearings used widely by the food and beverage industry, for $10 million in cash. Headquartered in Vancouver, Washington, EDT had sales of less than $10 million for the twelve months ended September 30, 2016.

On July 8, 2016, the Company acquired Lovejoy Inc. ("Lovejoy"), a manufacturer of premium industrial couplings and universal joints, for $63.5 million in cash and assumed debt of $2.2 million. Headquartered in Downers Grove, Illinois, with additional locations in the U.S., Canada and Germany, Lovejoy had sales of approximately $55 million for the twelve months ended June 30, 2016.






20

Table of Contents


RESULTS OF OPERATIONS
2016 vs. 2015

Overview: 
 
2016
2015
$ Change
% Change
Net sales
$
2,669.8

$
2,872.3

$
(202.5
)
(7.1
%)
Net income (loss)
152.9

(68.0
)
220.9

(324.9
%)
Net income attributable to noncontrolling interest
0.3

2.8

(2.5
)
(89.3
%)
Net income (loss) attributable to The Timken Company
$
152.6

$
(70.8
)
$
223.4

(315.5
%)
Diluted earnings (loss) per share
$
1.92

$
(0.84
)
$
2.76

(328.6
%)
Average number of shares—diluted
79,234,324

84,631,778


(6.4
%)
The decrease in net sales was primarily due to lower end-market demand and the impact of foreign currency exchange rate changes, partially offset by the net benefit of acquisitions and divestitures. The increase in net income in 2016 compared with 2015 was primarily due to pretax pension settlement charges that were $436.9 million lower than 2015 and pretax U.S. Continued Dumping and Subsidy Offset Act ("CDSOA") income of $59.6 million recorded in 2016. In addition, the Company's net income in 2016 was impacted by lower volume across most market sectors, unfavorable price/mix, higher restructuring charges and the impact of foreign currency exchange rate changes, partially offset by lower material and manufacturing costs, and lower selling, general and administrative ("SG&A") expenses compared with 2015. The prior year also included a gain from the divestiture of Timken Alcor Aerospace Technologies, Inc. ("Alcor") and higher discrete income tax benefits.

Outlook:

The Company expects 2017 full-year sales to be flat compared with 2016, as the benefit of acquisitions is offset by the estimated negative impact of foreign currency exchange rate changes. The Company's earnings are expected to be lower in 2017 than 2016, primarily due to no expected CDSOA income in 2017, partially offset by lower pension settlement charges. Timken plans to adopt mark-to-market accounting for its defined benefit pension and other postretirement benefit plans in the first quarter of 2017, which will impact earnings before interest and taxes ("EBIT")for 2017 and prior years on a retrospective basis. Refer to Change in Accounting Principle in the Other Disclosures section for additional information.

The Company expects to generate operating cash of approximately $310 million in 2017, a decrease from 2016 of approximately $92 million or 23%, as the Company anticipates lower net income (including no expected CDSOA receipts), lower benefit from working capital and higher income tax payments. The Company expects capital expenditures to be approximately 4% of sales in 2017, compared with 5% of sales in 2016.




21

Table of Contents


THE STATEMENTS OF INCOME

Sales:
 
2016
2015
$ Change
% Change
Net sales
$
2,669.8

$
2,872.3

$
(202.5
)
(7.1
%)
Net sales decreased in 2016 compared with 2015 primarily due to lower organic sales of $239 million, the effect of foreign currency exchange rate changes of $47 million and divestitures of $15 million, partially offset by the benefit of acquisitions of $99 million. The decrease in organic sales was driven by lower demand across most market sectors, partially offset by growth in the automotive market sector.

Gross Profit:
 
2016
2015
$ Change
Change
Gross profit
$
694.8

$
793.9

$
(99.1
)
(12.5
%)
Gross profit % to net sales
26.0
%
27.6
%

(160) bps

Rationalization expenses included in cost of products sold
$
11.6

$
6.4

$
5.2

81.3
%
Gross profit decreased in 2016 compared with 2015, primarily due to the impact of lower volume of $91 million, unfavorable price/mix of $65 million, higher restructuring charges and the impact of foreign currency exchange rate changes. These factors were partially offset by lower material and manufacturing costs net of manufacturing underutilization of $61 million and the benefit of acquisitions.

Selling, General and Administrative Expenses:
 
2016
2015
$ Change
Change
Selling, general and administrative expenses
$
450.0

$
494.3

$
(44.3
)
(9.0%
)
Selling, general and administrative expenses % to net sales
16.9
%
17.2
%

(30) bps

The decrease in SG&A expenses in 2016 compared with 2015 was primarily due to the benefit of cost reduction initiatives of $41 million, the impact of foreign currency exchange rate changes, lower depreciation expense and lower non-income tax expense, partially offset by additional expenses from Carlstar Belts LLC ("Timken Belts"), Lovejoy and EDT acquired in September 2015, July 2016, and October 2016, respectively.

Impairment and Restructuring Charges:
 
2016
2015
$ Change
Impairment charges
$
3.9

$
3.3

$
0.6

Severance and related benefit costs
15.3

7.7

7.6

Exit costs
2.5

3.7

(1.2
)
Total
$
21.7

$
14.7

$
7.0

Impairment and restructuring charges of $21.7 million in 2016 were primarily comprised of severance and related benefit costs associated with initiatives to reduce headcount and right-size the Company's manufacturing footprint, including the planned closures of the Altavista, Pulaski and Benoni bearing plants. In addition, the Company recognized impairment charges of $3.9 million during 2016 associated with the planned closures of the Altavista and Benoni bearing plants.

Impairment and restructuring charges of $14.7 million in 2015 were primarily due to severance and related benefit costs associated with initiatives to reduce headcount, impairment charges of $3.0 million related to the Company's service center in Niles, Ohio and exit costs of approximately $3.0 million related to the Company's termination of its relationship with one of its third-party sales representatives in Colombia.
 

22

Table of Contents


Pension Settlement Charges:
 
2016
2015
$ Change
Pension settlement charges
$
28.1

$
465.0

$
(436.9
)
Pension settlement charges in 2016 were primarily related to $19 million of lump–sum distributions to new retirees and deferred vested participants that triggered remeasurements, as well as $7 million related to the purchase of a group annuity contract from The Canada Life Assurance Company ("Canada Life") for one of the Company's Canadian defined benefit pension plans, which was executed in September 2016. These actions resulted in a decrease in the Company's pension obligations of approximately $70 million.

Pension settlement charges in 2015 were primarily due to the purchase of group annuity contracts from Prudential Insurance Company of America ("Prudential") by two of the Company's U.S. defined benefit pension plans. The two group annuity contracts require Prudential to pay and administer future pension benefits for approximately 8,400 U.S. Timken retirees in the aggregate. The Company transferred a total of approximately $1.1 billion of its pension obligations and a total of approximately $1.2 billion of pension assets to Prudential in these transactions. In addition to the purchase of the group annuity contracts, the Company made lump-sum distributions of $37.2 million to new retirees. The Company also incurred pension settlement and curtailment charges related to one of its Canadian defined benefit pension plans. As a result of the group annuity contracts, lump-sum distributions as well as pension settlement and curtailment charges related to the Canadian pension plan, the Company incurred total pension settlement and curtailment charges of $465.0 million, including professional fees of $2.6 million, in 2015.

Gain on Divestiture:
 
2016
2015
$ Change
Gain on divestiture
$

$
28.7

$
(28.7
)
Gain on divestiture in 2015 was primarily related to the gain on the sale of Alcor of $29.0 million in the fourth quarter of 2015.

Interest Income (Expense):
 
2016
2015
$ Change
% Change
Interest (expense)
$
(33.5
)
$
(33.4
)
$
(0.1
)
0.3
%
Interest income
1.9

2.7

(0.8
)
(29.6
%)

Other (Expense) Income:
 
2016
2015
$ Change
% Change
CDSOA income, net
$
59.6

$

$
59.6

NM

Fixed asset write-off

(9.7
)
9.7

(100.0
%)
Other income (expense), net
(0.9
)
2.2

(3.1
)
(140.9
%)
Total other income (expense)
$
58.7

$
(7.5
)
$
66.2

NM

CDSOA income, net in 2016 represents income recorded in connection with funds awarded to the Company from monies collected by U.S. Customs and Border Protection ("U.S. Customs") from antidumping cases, net of related professional fees. Refer to Note 21 - Continued Dumping and Subsidy Offset Act for further discussion.

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

23

Table of Contents


Income Tax Expense:
 
2016
2015
$ Change
Change
Income tax expense (benefit)
$
69.2

$
(121.6
)
$
190.8

(156.9%
)
Effective tax rate
31.2
%
64.1
%

(3,290
) bps
The effective tax rate for 2016 was favorable relative to the U.S. federal statutory rate primarily due to U.S. foreign tax credits, earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, the U.S. manufacturing deduction, and certain discrete tax benefits (net). These favorable impacts were partially offset by U.S. taxation of foreign income and losses at certain foreign subsidiaries where no tax benefit could be recorded.
The effective tax rate for 2015 was 64.1%, which reflects a tax benefit on pretax loss. The tax benefit rate of 64.1% was greater than the U.S. statutory rate of 35% primarily due to the tax benefits of reversals of certain valuation allowances in foreign jurisdictions, U.S. foreign tax credits, earnings in certain foreign jurisdictions where the effective tax rate was less than 35%, reversals of reserves for uncertain tax positions, state and local taxes, the U.S. manufacturing deduction, the U.S. research tax credit and other U.S. tax benefits. These factors were offset by U.S. taxation of foreign earnings, recording of deferred tax liabilities related to foreign branch operations, and losses at certain foreign subsidiaries where no tax benefit could be recorded.
The change in the effective tax rate for 2016 compared with 2015 was primarily due to reduced valuation allowance releases in 2016, partially offset by increased US foreign tax credits, the US manufacturing deduction, and discrete tax items occurring in 2016. Refer to the table below for additional detail of the impact of each item on income tax expense.
 
2015 to 2016 $ Change
Impact of global earnings at the U.S. statutory rate of 35%
$
144.1

Foreign taxation impact
4.4

U.S. taxation (1)
10.6

Other discrete items, net
31.7

Total
$
190.8

(1) U.S. taxation includes the impact of foreign tax credits, U.S. Manufacturing deductions, U.S. Research and Experimentation credit, U.S. state and local taxation, U.S. taxation of foreign earnings and other U.S. items.
Refer to Note 17 - Income Taxes for more information on the computation of the income tax expense in interim periods.


24

Table of Contents


BUSINESS SEGMENTS

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

The presentation of segment results below includes a reconciliation of the changes in net sales for each segment reported in accordance with U.S. GAAP to net sales adjusted to remove the effects of acquisitions and divestitures completed in 2016 and 2015 and foreign currency exchange rate changes. The effects of acquisitions, divestitures and foreign currency exchange rate changes on net sales are removed to allow investors and the Company to meaningfully evaluate the percentage change in net sales on a comparable basis from period to period.

The following items highlight the Company's acquisitions and divestitures completed in 2016 and 2015:
The Company acquired EDT during the fourth quarter of 2016. Results for EDT are reported in the Process Industries segment.
The Company acquired Lovejoy during the third quarter of 2016. Substantially all of the results for Lovejoy are reported in the Process Industries segment based on the customers and underlying markets served.
The Company sold Alcor during the fourth quarter of 2015. Results for Alcor prior to the sale were reported in the Mobile Industries segment.
The Company acquired Timken Belts during the third quarter of 2015. Results for Timken Belts are reported in the Mobile Industries and Process Industries segments based on the customers and underlying markets served.

Mobile Industries Segment:
 
2016
2015
$ Change
Change
Net sales
$
1,446.4

$
1,558.3

$
(111.9
)
(7.2%
)
EBIT
$
108.8

$
173.3

$
(64.5
)
(37.2%
)
EBIT margin
7.5
%
11.1
%

(360
) bps
 
 
 
 
 
 
 
 
 
 
  
2016
2015
$ Change
% Change
Net sales
$
1,446.4

$
1,558.3

$
(111.9
)
(7.2%
)
Less: Acquisitions
46.8


46.8

NM

     Divestitures
(15.7
)

(15.7
)
NM

     Currency
(22.8
)

(22.8
)
NM

Net sales, excluding the impact of acquisitions, divestitures and currency
$
1,438.1

$
1,558.3

$
(120.2
)
(7.7%
)
The Mobile Industries segment's net sales, excluding the effects of acquisitions, divestitures and foreign currency exchange rate changes, decreased $120.2 million or 7.7% in 2016 compared with 2015. The decline in net sales was primarily driven by a decrease in the rail, off-highway, aerospace and heavy truck market sectors, partially offset by organic growth in the automotive market sector. EBIT decreased by $64.5 million or 37.2% in 2016 compared with 2015 primarily due to unfavorable price/mix of $52 million, the impact of lower volume of $35 million, higher restructuring charges, the impact of foreign currency exchange rate changes and the net unfavorable impact of acquisitions and divestitures, partially offset by lower material and manufacturing costs net of manufacturing underutilization of $53 million and lower SG&A expenses. EBIT for 2015 also included a gain on the sale of Alcor of $29 million.
Full-year sales for the Mobile Industries segment are expected to be down approximately 4% to 5% in 2017 compared with 2016. This reflects lower expected volume in the rail, agriculture and heavy truck market sectors and the unfavorable impact of foreign currency exchange rate changes of approximately 1.5%, partially offset by the benefit of acquisitions. EBIT for the Mobile Industries segment is expected to decrease in 2017 compared with 2016 due to lower volume, unfavorable price/mix and the impact of foreign currency exchange rate changes.

25

Table of Contents


Process Industries Segment:
 
2016
2015
$ Change
Change
Net sales
$
1,223.4

$
1,314.0

$
(90.6
)
(6.9%
)
EBIT
$
163.2

$
190.2

$
(27.0
)
(14.2%
)
EBIT margin
13.3
%
14.5
%

(120) bps

 
 
 
 
 
 
 
 
 
 
  
2016
2015
$ Change
% Change
Net sales
$
1,223.4

$
1,314.0

$
(90.6
)
(6.9%
)
Less: Acquisitions
52.4


52.4

NM

     Currency
(23.8
)

(23.8
)
NM

Net sales, excluding the impact of acquisitions and currency
$
1,194.8

$
1,314.0

$
(119.2
)
(9.1%
)
The Process Industries segment's net sales, excluding the effects of acquisitions and foreign currency exchange rate changes, decreased $119.2 million or 9.1% in 2016 compared with 2015. The decline was primarily due to lower demand across the heavy industries (mainly oil and gas), industrial aftermarket, military marine and wind energy market sectors. EBIT decreased $27.0 million or 14.2% in 2016 compared with 2015 primarily due to the impact of lower volume of $56 million and unfavorable price/mix, partially offset by lower SG&A expenses of $24 million and lower material and manufacturing costs net of manufacturing underutilization. EBIT in 2015 also included a charge of $8.2 million related to the write-off of certain CIP balances.  Refer to Note 8 - Property, Plant and Equipment for additional information.
Full-year sales for the Process Industries segment are expected to be up approximately 4% to 5% in 2017 compared with 2016. This reflects higher expected demand in the industrial aftermarket and wind energy sectors and the benefit of acquisitions, partially offset by the unfavorable impact of foreign currency exchange rate changes of approximately 1.5%. EBIT for the Process Industries segment is expected to increase in 2017 compared with 2016 primarily due to the impact of higher volume and the impact of improved manufacturing underutilization and the benefit of acquisitions, partially offset by foreign currency exchange rate changes.

Corporate:
 
2016
2015
$ Change
Change
Corporate expenses
$
49.8

$
57.4

$
(7.6
)
(13.2%
)
Corporate expenses % to net sales
1.9
%
2.0
%

(10) bps

Corporate expenses decreased in 2016 compared with 2015 primarily due to cost reduction initiatives.

26

Table of Contents


RESULTS OF OPERATIONS:
2015 vs. 2014

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

$
3,076.2

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

(217.3
)
(145.5
%)
Income from discontinued operations

24.0

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

2.5

0.3

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

$
(241.6
)
(141.5
%)
Diluted (loss) earnings per share:
 
 
 
 
Continuing operations
$
(0.84
)
$