Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
4500 Mount Pleasant Street NW
 North Canton, Ohio
 
44720-5450
(Address of principal executive offices)
 
(Zip Code)
234.262.3000
(Registrant’s telephone number, including area code)
 
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   ý    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   ý    No  o

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
 
ý
 
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   ý
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 September 30, 2016
 
 
Common Shares, without par value
 
77,814,737 shares
 



PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
THE TIMKEN COMPANY AND SUBSIDIARIES
Consolidated Statements of Income
(Unaudited)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
(Dollars in millions, except per share data)
 
 
 
 
 
 
 
Net sales
$
657.4

 
$
707.4

 
$
2,015.0

 
$
2,157.9

Cost of products sold
489.9

 
512.0

 
1,484.3

 
1,554.9

Gross Profit
167.5

 
195.4

 
530.7

 
603.0

Selling, general and administrative expenses
109.5

 
120.7

 
338.0

 
375.3

Impairment and restructuring charges
5.3

 
4.4

 
18.7

 
12.0

Loss on divestitures
—

 
—

 
—

 
0.3

Pension settlement charges
10.3

 
3.6

 
11.9

 
223.2

Operating Income (Loss)
42.4

 
66.7

 
162.1

 
(7.8
)
Interest expense
(8.0
)
 
(8.6
)
 
(25.1
)
 
(25.0
)
Interest income
0.4

 
0.6

 
1.1

 
2.0

Continued Dumping & Subsidy Offset Act income (expense), net
(0.2
)
 
—

 
53.6

 
—

Other (expense), net
(0.1
)
 
(0.8
)
 
(1.8
)
 
(0.8
)
Income (Loss) Before Income Taxes
34.5

 
57.9

 
189.9

 
(31.6
)
Provision (benefit) for income taxes
13.5

 
(6.6
)
 
61.1

 
1.0

Net Income (Loss)
21.0

 
64.5

 
128.8

 
(32.6
)
Less: Net income attributable to noncontrolling interest
0.4

 
1.1

 
0.3

 
2.5

Net Income (Loss) attributable to The Timken Company
$
20.6

 
$
63.4

 
$
128.5

 
$
(35.1
)
 
 
 
 
 
 
 
 
Net Income (Loss) per Common Share attributable to The
  Timken Company's Common Shareholders
 
 
 
 
 
 
 
Basic earnings (loss) per share
$
0.26

 
$
0.76

 
$
1.63


$
(0.41
)
 
 
 
 
 
 
 
 
Diluted earnings (loss) per share
$
0.26

 
$
0.75

 
$
1.62

 
$
(0.41
)
 
 
 
 
 
 
 
 
Dividends per share
$
0.26

 
$
0.26

 
$
0.78

 
$
0.77

See accompanying Notes to the Consolidated Financial Statements.


2


Consolidated Statements of Comprehensive Income
(Unaudited) 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Income (Loss)
$
21.0

 
$
64.5

 
$
128.8

 
$
(32.6
)
Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
2.2

 
(30.9
)
 
(1.4
)
 
(52.1
)
Pension and postretirement liability adjustment
15.0

 
13.0

 
27.0

 
120.5

Change in fair value of derivative financial instruments
—

 
1.2

 
(1.6
)
 
0.9

Other comprehensive (loss) income, net of tax
17.2

 
(16.7
)
 
24.0

 
69.3

Comprehensive Income, net of tax
38.2

 
47.8

 
152.8

 
36.7

Less: comprehensive income attributable to noncontrolling interest
0.9

 
—

 
2.1

 
0.9

Comprehensive Income attributable to The Timken Company
$
37.3

 
$
47.8

 
$
150.7

 
$
35.8

See accompanying Notes to the Consolidated Financial Statements.

3


Consolidated Balance Sheets
 
(Unaudited)
 
 
 
September 30,
2016
 
December 31,
2015
(Dollars in millions)
 
 
 
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
129.0

 
$
129.6

Restricted cash
2.7

 
0.2

Accounts receivable, less allowances (2016 – $18.3 million; 2015 – $16.9 million)
452.8

 
454.6

Inventories, net
575.9

 
543.2

Deferred charges and prepaid expenses
20.3

 
22.7

Other current assets
46.1

 
56.1

Total Current Assets
1,226.8

 
1,206.4

 
 
 
 
Property, Plant and Equipment, net
796.6

 
777.8

 
 
 
 
Other Assets
 
 
 
Goodwill
359.0

 
327.3

Non-current pension assets
84.5

 
86.3

Other intangible assets
274.5

 
271.3

Deferred income taxes
50.6

 
65.9

Other non-current assets
27.2

 
49.1

Total Other Assets
795.8

 
799.9

Total Assets
$
2,819.2

 
$
2,784.1

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Short-term debt
$
22.5

 
$
62.0

Current portion of long-term debt
—

 
15.1

Accounts payable, trade
184.5

 
159.7

Salaries, wages and benefits
89.3

 
102.3

Income taxes payable
12.1

 
13.1

Other current liabilities
142.1

 
153.1

Total Current Liabilities
450.5

 
505.3

 
 
 
 
Non-Current Liabilities
 
 
 
Long-term debt
641.4

 
579.4

Accrued pension cost
148.1

 
146.9

Accrued postretirement benefits cost
130.7

 
136.1

Deferred income taxes
3.3

 
3.6

Other non-current liabilities
79.0

 
68.2

Total Non-Current Liabilities
1,002.5

 
934.2

 
 
 
 
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) (2016 – 98,375,135 shares; 2015 – 98,375,135 shares)
 
 
 
Stated capital
53.1

 
53.1

Other paid-in capital
905.4

 
905.1

Earnings invested in the business
1,524.7

 
1,457.6

Accumulated other comprehensive loss
(264.8
)
 
(287.0
)
Treasury shares at cost (2016 – 20,560,398 shares; 2015 – 18,112,047 shares)
(878.9
)
 
(804.3
)
Total Shareholders’ Equity
1,339.5

 
1,324.5

Noncontrolling Interest
26.7

 
20.1

Total Equity
1,366.2

 
1,344.6

Total Liabilities and Shareholders’ Equity
$
2,819.2

 
$
2,784.1

See accompanying Notes to the Consolidated Financial Statements.

4


Consolidated Statements of Cash Flows
(Unaudited)
 
Nine Months Ended
September 30,
 
2016
 
2015
(Dollars in millions)
 
 
 
CASH PROVIDED (USED)
 
 
 
Operating Activities
 
 
 
Net income (loss) attributable to The Timken Company
$
128.5

 
$
(35.1
)
Net income attributable to noncontrolling interest
0.3

 
2.5

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
98.3

 
97.8

Impairment charges
3.8

 
3.3

Loss on sale of assets
0.8

 
2.1

Deferred income tax provision
(0.1
)
 
(81.1
)
Stock-based compensation expense
10.9

 
14.1

Excess tax benefits related to stock-based compensation
—

 
(1.5
)
Pension and other postretirement expense
38.4

 
251.5

Pension contributions and other postretirement benefit payments
(22.3
)
 
(23.5
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
12.2

 
(1.9
)
Inventories
(13.6
)
 
7.1

Accounts payable, trade
15.0

 
27.0

Other accrued expenses
(19.1
)
 
(57.6
)
Income taxes
22.9

 
23.5

Other, net
1.1

 
18.1

Net Cash Provided by Operating Activities
277.1

 
246.3

 
 
 
 
Investing Activities
 
 
 
Capital expenditures
(84.4
)
 
(65.1
)
Acquisitions, net of cash received
(62.8
)
 
(213.6
)
Proceeds from disposal of property, plant and equipment
1.5

 
11.0

Investments in short-term marketable securities, net
2.1

 
(0.6
)
Other
0.3

 
(0.5
)
Net Cash Used in Investing Activities
(143.3
)
 
(268.8
)
 
 
 
 
Financing Activities
 
 
 
Cash dividends paid to shareholders
(61.4
)
 
(65.7
)
Purchase of treasury shares
(83.3
)
 
(227.9
)
Proceeds from exercise of stock options
0.7

 
4.0

Excess tax benefits related to stock-based compensation
—

 
1.5

Proceeds from long-term debt
275.5

 
225.7

Deferred financing costs
—

 
(2.0
)
Accounts receivable facility borrowings
50.0

 
116.0

Accounts receivable facility payments
(30.1
)
 
(38.0
)
Payments on long-term debt
(290.1
)
 
(106.1
)
Short-term debt activity, net
(1.4
)
 
(1.6
)
Increase in restricted cash
(2.5
)
 
0.2

Other
4.5

 
3.7

Net Cash Used in Financing Activities
(138.1
)
 
(90.2
)
Effect of exchange rate changes on cash
3.7

 
(11.1
)
Decrease in Cash and Cash Equivalents
(0.6
)
 
(123.8
)
Cash and cash equivalents at beginning of year
129.6

 
278.8

Cash and Cash Equivalents at End of Period
$
129.0

 
$
155.0

See accompanying Notes to the Consolidated Financial Statements.

5


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(Dollars in millions, except per share data)

Note 1 - Basis of Presentation
The accompanying Consolidated Financial Statements (unaudited) for The Timken Company (the "Company") have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and notes required by the accounting principles generally accepted in the United States ("U.S. GAAP") for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) and disclosures considered necessary for a fair presentation have been included. For further information, refer to the Consolidated Financial Statements and accompanying Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

Certain amounts reported in the 2015 Consolidated Statements of Cash Flows have been reclassified to conform to the current cash flow presentation.

Note 2 - Recent Accounting Pronouncements

New Accounting Guidance Adopted:
In September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-16, "Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments." ASU 2015-16 eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, acquirers must recognize measurement-period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. This new accounting guidance does not eliminate the requirement for the measurement period to be completed within one year. On January 1, 2016, the Company adopted the provisions of ASU 2015-16. The impact of the adoption of ASU 2015-16 was immaterial to the Company's results of operations and financial condition as there was only a minor measurement-period adjustment during the first nine months of 2016.

In May 2015, the FASB issued ASU 2015-07, "Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)." ASU 2015-07 eliminates the requirement to categorize within the fair value hierarchy investments for which fair values are estimated using the net asset value ("NAV") practical expedient provided in Accounting Standards Codification ("ASC") 820, "Fair Value Measurement." Instead, entities will be required to disclose the fair values of such investments so that financial statement users can reconcile amounts reported in the fair value hierarchy table and the amounts reported on the balance sheet. On January 1, 2016, the Company adopted the provisions of ASU 2015-07. The adoption of ASU 2015-07 did not have any impact on the Company's results of operations or financial condition as the new guidance addresses disclosure only. See Note 17 - Fair Value for the new disclosures.

In April 2015, the FASB issued ASU 2015-05, "Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement." ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. Prior to the issuance of this new accounting guidance, there was no explicit guidance about a customer's accounting for fees paid in a cloud computing arrangement. On January 1, 2016, the Company adopted the provisions of ASU 2015-05 on a prospective basis. The adoption of ASU 2015-05 did not have any impact on the Company's results of operations or financial condition.

In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs." ASU 2015-03 requires that all costs incurred to issue debt be presented in the balance sheet as a direct deduction to the carrying value of debt. Prior to the issuance of this new accounting guidance, debt issuance costs were required to be presented in the balance sheet as a deferred charge (i.e., an asset), and only a debt discount was recorded as a direct deduction to the carrying value of debt. ASU 2015-03 requires that the new accounting guidance be applied on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance.




6


On January 1, 2016, the Company adopted the provisions of ASU 2015-03. The following financial statement line items at December 31, 2015 were affected by the adoption of ASU 2015-03.
 
As Originally Reported
New Presentation
Effect of Change
Assets:
 
 
 
Other non-current assets
$
50.3

$
49.1

$
1.2

 
 
 
 
Liabilities:
 
 
 
Long-term debt
$
580.6

$
579.4

$
1.2


New Accounting Guidance Issued and Not Yet Adopted:
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The new guidance will replace the current incurred loss approach with an expected loss model. The new expected credit loss impairment model will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt instruments, net investments in leases, loan commitments and standby letters of credit. Upon initial recognition of the exposure, the expected credit loss model requires entities to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments. Financial instruments with similar risk characteristics should be grouped together when estimating expected credit losses. ASU 2016-13 does not prescribe a specific method to make the estimate so its application will require significant judgment. ASU 2016-13 is effective in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the effect that ASU 2016-13 will have on the Company's results of operations and financial condition.

In March 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." ASU 2016-09 simplifies various aspects of the accounting for stock-based payments. The simplifications include:

a.
recording all tax effects associated with stock-based compensation through the income statement, as opposed to recording certain amounts in other paid-in capital, which eliminates the complications of tracking a “windfall pool,” but will increase the volatility of income tax expense;
b.
allowing entities to withhold shares to satisfy the employer’s statutory tax withholding requirement up to the highest marginal tax rate applicable to employees rather than the employer’s minimum statutory rate, without requiring liability classification for the award;
c.
modifying the requirement to estimate the number of awards that will ultimately vest by providing an accounting policy election to either estimate the number of forfeitures or recognize forfeitures as they occur; and
d.
changing certain presentation requirements in the statement of cash flows, including removing the requirement to present excess tax benefits as an inflow from financing activities and an outflow from operating activities, and requiring the cash paid to taxing authorities arising from withheld shares to be classified as a financing activity.


7


ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. If an entity adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. Amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, forfeitures, and intrinsic value should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet the minimum statutory withholding requirement should be applied retrospectively. Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement and the practical expedient for estimating expected term should be applied prospectively. An entity may elect to apply the amendments related to the presentation of excess tax benefits on the statement of cash flows using either a prospective transition method or a retrospective transition method. The Company is currently evaluating the effect that ASU 2016-09 will have on the Company's results of operations and financial condition.

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 was issued to increase transparency and comparability among entities by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about lease arrangements. ASU 2016-02 is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the effect that ASU 2016-02 will have on the Company's results of operations and financial condition.

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)." ASU 2014-09 introduces a new five-step revenue recognition model in which an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires disclosures sufficient to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments and assets recognized from the costs to obtain or fulfill a contract. On July 9, 2015, the FASB decided to delay the effective date of this new accounting guidance by one year, which will result in it being effective for annual periods beginning after December 15, 2017. The Company is currently evaluating the effect that ASU 2014-09 will have on the Company's results of operations and financial condition.


8


Note 3 - Acquisitions
Lovejoy Inc.
On July 8, 2016, the Company completed the acquisition of 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. The Company acquired cash of approximately $1.4 million as part of the acquisition. The Company incurred approximately $1.6 million of legal and professional fees to acquire Lovejoy. Based in Downers Grove, Illinois, with additional locations in the United States, Canada and Germany, Lovejoy had annual sales of approximately $55 million for the twelve months ended June 30, 2016. Substantially all of the results for Lovejoy are reported in the Process Industries segment.

The following table presents the final purchase price allocation for the Lovejoy acquisition: 
 
Initial Purchase Price Allocation
Assets:
 
Accounts receivable, net
$
7.5

Inventories, net
13.2

Other current assets
5.2

Property, plant and equipment, net
15.5

Goodwill
30.1

Other intangible assets
24.1

Other non-current assets
0.1

Total assets acquired
$
95.7

Liabilities:
 
Accounts payable, trade
$
8.1

Salaries, wages and benefits
1.2

Other current liabilities
5.3

Long term debt
2.2

Deferred income taxes
9.2

Other non-current liabilities
7.6

Total liabilities assumed
$
33.6

Net assets acquired
$
62.1


The following table summarizes the initial purchase price allocation for identifiable intangible assets acquired in 2016:
 
Initial Purchase
Price Allocation
 
 
Weighted -
Average Life
Trade name
$
3.7

Indefinite
Technology
8.9

19 years
All customer relationships
11.1

20 years
Non-competition agreements
0.2

5 years
Favorable leases
0.1

2 years
Capitalized software
0.1

4 years
Total intangible assets
$
24.1

 







9






On December 28, 2004, the United States Environmental Protection Agency (“USEPA”) sent Lovejoy a Special Notice Letter that identified Lovejoy as a potentially responsible party (“PRP”), together with at least fourteen other companies, at the Ellsworth Industrial Park Site, Downers Grove, DuPage County, Illinois (the “Site”).  Lovejoy’s Downers Grove property is situated within the Ellsworth Industrial Complex. The USEPA and the Illinois Environmental Protection Agency (“IEPA”) allege there have been one or more releases or threatened releases of hazardous substances, allegedly including but not limited to a release or threatened release on or from Lovejoy's property, at the Site. The relief sought by the USEPA and IEPA includes further investigation and potential remediation of the Site and reimbursement of response costs. Lovejoy’s allocated share of past and future costs related to the Site, including for investigation and/or remediation, could be significant. All previously pending property damage and personal injury lawsuits against Lovejoy related to the Site have been settled or dismissed. In connection with the acquisition of Lovejoy, the Company recorded an immaterial environmental remediation accrual.

Timken Belts
On September 1, 2015, the Company completed the acquisition of the membership interests of Carlstar Belt LLC ("Timken Belts") for $213.7 million, including cash acquired of approximately $0.1 million. The Company incurred approximately $1.0 million of legal and professional fees to acquire Timken Belts. Timken Belts is a leading North American manufacturer of belts used in industrial, commercial and consumer applications, and sold under multiple brand names, including Carlisle®, Ultimax® and Panther®, among others. The product portfolio includes more than 20,000 parts that utilize wrap molded, raw edge, v-ribbed and synchronous belt designs. Based in Springfield, Missouri, Timken Belts had annual sales of approximately $140 million for the twelve months ended June 30, 2015, and employs approximately 750 employees. The results of the operations for Timken Belts are reported in both the Mobile Industries and Process Industries segments based on customers served.

In June 2016, the Company paid a net purchase price adjustment of $0.7 million in connection with the Timken Belts acquisition, resulting in an adjustment to goodwill. The following table presents the final purchase price allocation for the Timken Belts acquisition: 
 
Initial Purchase Price Allocation
Adjustment
Final
Purchase Price Allocation
Assets:
 
 
 
Accounts receivable, net
$
13.3

 
$
13.3

Inventories, net
48.5

 
48.5

Other current assets
1.1

 
1.1

Property, plant and equipment, net
37.9

 
37.9

Goodwill
70.8

0.7

71.5

Other intangible assets
63.9

 
63.9

Total assets acquired
$
235.5

$
0.7

$
236.2

Liabilities:
 
 
 
Accounts payable, trade
$
10.2

 
$
10.2

Salaries, wages and benefits
1.1

 
1.1

Other current liabilities
1.3

 
1.3

Accrued pension cost
2.3

 
2.3

Accrued postretirement benefits cost
1.1

 
1.1

Other non-current liabilities
5.9

 
5.9

Total liabilities assumed
$
21.9

$
—

$
21.9

Net assets acquired
$
213.6

$
0.7

$
214.3




10


Note 4 - Inventories
The components of inventories were as follows:
 
September 30,
2016
December 31,
2015
Manufacturing supplies
$
29.6

$
24.7

Raw materials
57.5

58.8

Work in process
193.3

181.9

Finished products
322.5

296.2

Subtotal
602.9

561.6

Allowance for obsolete and surplus inventory
(27.0
)
(18.4
)
Total Inventories, net
$
575.9

$
543.2


Inventories are valued at the lower of cost or market, with approximately 54% valued by the first-in, first-out ("FIFO") method and the remaining 46% valued by the last-in, first-out ("LIFO") method. The majority of the Company's domestic inventories are valued by the LIFO method and all of the Company's international (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 must be based on management’s estimates of expected year-end inventory levels and costs. Because these calculations 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 LIFO reserves at September 30, 2016, and December 31, 2015, were $182.0 million and $188.1 million, respectively. The Company recognized a decrease in its LIFO reserve of $6.1 million during the first nine months of 2016, compared with a decrease in its LIFO reserve of $2.6 million during the first nine months of 2015.


Note 5 - Property, Plant and Equipment
The components of property, plant and equipment were as follows:
 
September 30,
2016
December 31,
2015
Land and buildings
$
426.7

$
430.3

Machinery and equipment
1,803.5

1,741.4

Subtotal
2,230.2

2,171.7

Accumulated depreciation
(1,433.6
)
(1,393.9
)
Property, plant and equipment, net
$
796.6

$
777.8


Total depreciation expense for the nine months ended September 30, 2016 and 2015, was $71.0 million and $70.8 million, respectively.








11


Note 6 - Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the nine months ended September 30, 2016, were as follows:
 
Mobile
Industries
Process
Industries
Total
Beginning balance
$
97.0

$
230.3

$
327.3

Acquisitions
0.7

30.1

30.8

Foreign currency translation adjustments
(0.2
)
1.1

0.9

Ending balance
$
97.5

$
261.5

$
359.0

The increase in goodwill was primarily due to the acquisition of Lovejoy in July 2016. None of this goodwill is deductible for tax purposes. In addition, the Company paid a net purchase price adjustment of $0.7 million in June 2016 for Timken Belts, which resulted in an adjustment to goodwill.

The following table displays intangible assets as of September 30, 2016, and December 31, 2015:
 
As of September 30, 2016
As of December 31, 2015
 
Gross
Carrying
Amount
Accumulated
Amortization
Net
Carrying
Amount
Gross
Carrying
Amount
Accumulated
Amortization
Net
Carrying
Amount
Intangible assets
subject to amortization:
 
 
 
 
 
 
Customer relationships
$
209.3

$
80.6

$
128.7

$
198.9

$
70.0

$
128.9

Know-how
40.7

8.0

32.7

31.9

6.7

25.2

Industrial license
 agreements
0.1

0.1

—

0.1

0.1

—

Land-use rights
8.1

4.8

3.3

8.3

4.7

3.6

Patents
2.1

2.1

—

2.1

2.1

—

Technology use
53.7

16.2

37.5

53.6

14.0

39.6

Trademarks
6.3

3.7

2.6

6.5

3.3

3.2

Non-compete
 agreements
0.9

0.7

0.2

2.7

2.5

0.2

Leases
0.1

—

0.1

—

—

—

Software
250.9

209.7

41.2

243.8

197.6

46.2

 
$
572.2

$
325.9

$
246.3

$
547.9

$
301.0

$
246.9

Intangible assets not subject to amortization:
 
 
 
 
 
 
Tradenames
$
19.5



$
19.5

$
15.7



$
15.7

FAA air agency certificates
8.7



8.7

8.7



8.7

 
$
28.2



$
28.2

$
24.4



$
24.4

Total intangible assets
$
600.4

$
325.9

$
274.5

$
572.3

$
301.0

$
271.3


Amortization expense for intangible assets was $27.2 million and $27.0 million for the nine months ended September 30, 2016 and 2015, respectively. Amortization expense for intangible assets is estimated to be $36.4 million in 2016; $32.8 million in 2017; $28.2 million in 2018; $24.0 million in 2019; and $19.7 million in 2020.


12


Note 7 - Financing Arrangements
Short-term debt at September 30, 2016, and December 31, 2015, was as follows:
 
September 30,
2016
December 31,
2015
Variable-rate Accounts Receivable Facility with interest rate of 1.41% at September 30, 2016 and 1.05% at December 31, 2015, respectively.
$
11.0

$
49.0

Borrowings under variable-rate lines of credit for certain of the Company’s foreign subsidiaries with various banks with interest rates ranging from 0.28% to 0.50% at September 30, 2016 and 0.31% to 0.44% at December 31, 2015, respectively.
11.5

13.0

Short-term debt
$
22.5

$
62.0

The lines of credit for certain of the Company’s foreign subsidiaries provide for short-term borrowings up to $230.3 million. Most of these lines of credit are uncommitted. At September 30, 2016, the Company’s foreign subsidiaries had borrowings outstanding of $11.5 million and bank guarantees of $3.8 million, which reduced the availability under these facilities to $215.0 million.

Long-term debt at September 30, 2016, and December 31, 2015, was as follows:
 
September 30,
2016
December 31,
2015
Fixed-rate Medium-Term Notes, Series A, maturing at various dates through
May 2028, with interest rates ranging from 6.74% to 7.76%
$
159.5

$
174.4

Fixed-rate Senior Unsecured Notes, maturing on September 1, 2024, with an
interest rate of 3.875%
345.6

344.8

Variable-rate Senior Credit Facility with an interest rate of 1.53% at September 30, 2016 and 1.45% at December 31, 2015, respectively.
76.2

75.2

Variable-rate Accounts Receivable Facility with interest rate of 1.41% at September 30, 2016
57.9

—

Other
2.2

0.1

 
$
641.4

$
594.5

Less current maturities
—

15.1

Long-term debt
$
641.4

$
579.4


The Company has a $500 million Amended and Restated Credit Agreement ("Senior Credit Facility"), which matures on June 19, 2020. At September 30, 2016, the Company had $76.2 million of outstanding borrowings under the Senior Credit Facility, which reduced the availability under this facility to $423.8 million. The Senior Credit Facility has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. At September 30, 2016, the Company was in full compliance with both of these covenants under the Senior Credit Facility.

The Company has a $100 million Amended and Restated Asset Securitization Agreement ("Accounts Receivable Facility") that matures on November 30, 2018. Under the terms of the Accounts Receivable Facility, the Company sells, on an ongoing basis, certain domestic trade receivables to Timken Receivables Corporation, a wholly-owned consolidated subsidiary, which in turn uses the trade receivables to secure borrowings, which are funded through a vehicle that issues commercial paper in the short-term market. Borrowings under the Accounts Receivable Facility are limited by certain borrowing base limitations. These limitations reduced the availability of the Accounts Receivable Facility to $72.5 million at September 30, 2016. As of September 30, 2016, there were outstanding borrowings of $68.9 million under the Accounts Receivable Facility, which reduced the availability under this facility to $3.6 million. The cost of this facility, which is the prevailing commercial paper rate plus program fees, is considered a financing cost and is included in interest expense in the Consolidated Statements of Income. The outstanding balance under the Accounts Receivable Facility was classified in accordance with the terms of the agreement and reflects the Company's expectations relative to the minimum borrowing base.


13


Note 8 - Contingencies

Product Warranties:
The Company is currently evaluating claims raised by certain customers with respect to the performance of bearings sold into the Wind energy sector. The Company recorded warranty expense related to these claims totaling $1.4 million for the three months ended September 30, 2016, and $4.8 million and $2.4 million for the nine months ended September 30, 2016 and 2015, respectively. No warranty expense was incurred during the three months ended September 30, 2015 related to these claims. Management believes that the outcome of these claims will not have a material effect on the Company’s consolidated financial position; however, the effect of any such outcome may be material to the results of operations of any particular period in which costs in excess of amounts provided, if any, are recognized.


Note 9 - Equity

The changes in the equity components for the nine months ended September 30, 2016 were as follows:
 
 
The Timken Company Shareholders
 
 
Total
Stated
Capital
Other
Paid-In
Capital
Earnings
Invested
in the
Business
Accumulated
Other
Comprehensive
(Loss)
Treasury
Stock
Non-
controlling
Interest
Balance at December 31, 2015
$
1,344.6

$
53.1

$
905.1

$
1,457.6

$
(287.0
)
$
(804.3
)
$
20.1

Net income
128.8

 
 
128.5

 
 
0.3

Foreign currency translation adjustment
(1.4
)
 
 
 
(3.2
)
 
1.8

Pension and postretirement liability
adjustment (net of the income tax
benefit of $5.1 million)
27.0

 
 
 
27.0

 
 
Change in fair value of derivative
financial instruments, net of
reclassifications
(1.6
)
 
 
 
(1.6
)
 
 
Investment in joint venture by
noncontrolling interest party
4.8

 
 
 
 
 
4.8

Dividends declared to noncontrolling
interest
(0.3
)
 
 
 
 
 
(0.3
)
Dividends – $0.78 per share
(61.4
)
 
 
(61.4
)
 
 
 
Excess tax shortfall from stock
compensation
(1.0
)
 
(1.0
)
 
 
 
 
Stock-based compensation expense
10.9

 
10.9

 
 
 
 
Stock purchased at fair market value
(83.3
)
 
 
 
 
(83.3
)
 
Stock option exercise activity
0.7

 
(1.0
)
 
 
1.7

 
Restricted shares (issued) surrendered
—

 
(8.6
)
 
 
8.6

 
Shares surrendered for taxes
(1.6
)
 
 
 
 
(1.6
)
 
Balance at September 30, 2016
$
1,366.2

$
53.1

$
905.4

$
1,524.7

$
(264.8
)
$
(878.9
)
$
26.7


On March 6, 2014, Timken Lux Holdings II S.A.R.L, a subsidiary of the Company, entered into a joint venture agreement with Holme Service Limited ("joint venture partner"). During 2015, the Company and its joint venture partner established TUBC Limited, a Cyprus entity, for the purpose of producing bearings to serve the rail market sector in Russia. During 2015, the Company and its joint venture partner amended and restated the joint venture agreement and contributed $6.9 million and $6.6 million, respectively, to TUBC Limited. During the first nine months of 2016, the Company and its joint venture partner contributed $5.0 million and $4.8 million, respectively, to TUBC Limited. The Company and its joint venture partner have a 51% controlling interest and 49% controlling interest, respectively, in TUBC Limited.


14


Note 10 - Accumulated Other Comprehensive Income (Loss)

The following tables present details about components of accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2016, respectively:
 
Foreign currency translation adjustments
Pension and postretirement liability adjustments
Change in fair value of derivative financial instruments
Total
Balance at June 30, 2016
$
(77.1
)
$
(203.1
)
$
(1.3
)
$
(281.5
)
Other comprehensive (loss) income before
reclassifications and income tax
2.2

1.4

(0.5
)
3.1

Amounts reclassified from accumulated other
comprehensive income, before income tax
—

15.3

0.5

15.8

Income tax (benefit) expense
—

(1.7
)
—

(1.7
)
Net current period other comprehensive
income, net of income taxes
2.2

15.0

—

17.2

Noncontrolling interest
(0.5
)
—

—

(0.5
)
Net current period comprehensive income, net
of income taxes and noncontrolling interest
1.7

15.0

—

16.7

Balance at September 30, 2016
$
(75.4
)
$
(188.1
)
$
(1.3
)
$
(264.8
)
 
Foreign currency translation adjustments
Pension and postretirement liability adjustments
Change in fair value of derivative financial instruments
Total
Balance at December 31, 2015
$
(72.2
)
$
(215.1
)
$
0.3

$
(287.0
)
Other comprehensive (loss) income before
reclassifications and income tax
(1.4
)
6.2

(2.5
)
2.3

Amounts reclassified from accumulated other
comprehensive income, before income tax
—

25.9

(0.1
)
25.8

Income tax (benefit) expense
—

(5.1
)
1.0

(4.1
)
Net current period other comprehensive
income (loss), net of income taxes
(1.4
)
27.0

(1.6
)
24.0

Noncontrolling interest
(1.8
)
—

—

(1.8
)
Net current period comprehensive income (loss), net
of income taxes and noncontrolling interest
(3.2
)
27.0

(1.6
)
22.2

Balance at September 30, 2016
$
(75.4
)
$
(188.1
)
$
(1.3
)
$
(264.8
)
$10.6 million of the $25.9 million before-tax reclassification of pension and postretirement liability adjustments was included in pension settlement charges in the Consolidated Statement of Income for the nine months ended September 30, 2016. The remaining before-tax reclassification of pension and postretirement liability adjustments of $15.3 million was due to the amortization of actuarial losses and prior service costs and was included in costs of products sold and selling, general and administrative expenses in the Consolidated Statement of Income. The reclassification of the remaining components of accumulated other comprehensive income (loss) was included in other (expense) income, net in the Consolidated Statement of Income.











15


The following tables present details about components of accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2015, respectively:
 
Foreign currency translation adjustments
Pension and postretirement liability adjustments
Change in fair value of derivative financial instruments
Total
Balance at June 30, 2015
$
(21.4
)
$
(373.5
)
$
(1.1
)
$
(396.0
)
Other comprehensive (loss) income before
reclassifications and income tax
(30.9
)
4.2

2.1

(24.6
)
Amounts reclassified from accumulated other
comprehensive income, before income tax
—

13.4

(0.2
)
13.2

Income tax (benefit) expense
—

(4.6
)
(0.7
)
(5.3
)
Net current period other comprehensive
income (loss), net of income taxes
(30.9
)
13.0

1.2

(16.7
)
Noncontrolling interest
1.1

—

—

1.1

Net current period comprehensive income (loss), net
of income taxes and noncontrolling interest
(29.8
)
13.0

1.2

(15.6
)
Balance at September 30, 2015
$
(51.2
)
$
(360.5
)
$
0.1

$
(411.6
)
 
Foreign currency translation adjustments
Pension and postretirement liability adjustments
Change in fair value of derivative financial instruments
Total
Balance at December 31, 2014
$
(0.7
)
$
(481.0
)
$
(0.8
)
$
(482.5
)
Other comprehensive (loss) income before
reclassifications and income tax
(52.1
)
(62.3
)
2.1

(112.3
)
Amounts reclassified from accumulated other
comprehensive income, before income tax
—

251.3

(0.7
)
250.6

Income tax (benefit) expense
—

(68.5
)
(0.5
)
(69.0
)
Net current period other comprehensive
income (loss), net of income taxes
(52.1
)
120.5

0.9

69.3

Noncontrolling interest
1.6

—

—

1.6

Net current period comprehensive income (loss), net
of income taxes and noncontrolling interest
(50.5
)
120.5

0.9

70.9

Balance at September 30, 2015
$
(51.2
)
$
(360.5
)
$
0.1

$
(411.6
)
Other comprehensive income (loss) before reclassifications and income taxes includes the effect of foreign currency.

$221.0 million of the $251.3 million before-tax reclassification of pension and postretirement liability adjustments was included in pension settlement charges in the Consolidated Statement of Income for the nine months ended September 30, 2015. The remaining before-tax reclassification of pension and postretirement liability adjustments of $30.3 million was due to the amortization of actuarial losses and prior service costs and was included in costs of products sold and selling, general and administrative expenses in the Consolidated Statement of Income. The reclassification of the remaining components of accumulated other comprehensive income (loss) was included in other (expense) income, net in the Consolidated Statement of Income.


16


Note 11 - Earnings Per Share

The following table sets forth the reconciliation of the numerator and the denominator of basic earnings per share and diluted earnings per share for the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
 
2016
2015
2016
2015
Numerator:
 
 
 
 
Net income (loss) attributable to The Timken Company
$
20.6

$
63.4

$
128.5

$
(35.1
)
  Less: undistributed earnings allocated to nonvested stock
—

—

—

—

Net income (loss) available to common shareholders for basic
earnings per share and diluted earnings per share
$
20.6

$
63.4

$
128.5

$
(35.1
)
Denominator:
 
 
 
 
Weighted average number of shares outstanding, basic
77,935,783

83,671,931

78,808,179

85,578,800

Effect of dilutive securities:
 
 
 
 
Stock options and awards based on the treasury stock method
681,693

473,820

663,577

—

  Weighted average number of shares outstanding, assuming dilution
of stock options and awards
78,617,476

84,145,751

79,471,756

85,578,800

Basic earnings (loss) per share
$
0.26

$
0.76

$
1.63

$
(0.41
)
Diluted earnings (loss) per share
$
0.26

$
0.75

$
1.62

$
(0.41
)

The exercise prices for certain stock options that the Company has awarded exceed the average market price of the Company’s common shares. Such stock options are antidilutive and were not included in the computation of diluted earnings per share. The antidilutive stock options outstanding during the three months ended September 30, 2016 and 2015, were 2,706,711 and 2,761,824, respectively. During the nine months ended September 30, 2016, the antidilutive stock options outstanding were 3,080,133. During the nine months ended September 30, 2015, the Company incurred a net loss and therefore treated all stock options and restricted stock units as antidilutive.

17


Note 12 - Segment Information

The primary measurement used by management to measure the financial performance of each segment is EBIT (earnings before interest and taxes).
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
 
2016
2015
2016
2015
Net sales:
 
 
 
 
Mobile Industries
$
353.1

$
396.4

$
1,104.1

$
1,178.0

Process Industries
304.3

311.0

910.9

979.9

 
$
657.4

$
707.4

$
2,015.0

$
2,157.9

 
 
 
 
 
Segment EBIT:
 
 
 
 
Mobile Industries
$
24.1

$
43.0

$
89.6

$
114.4

Process Industries
40.7

43.1

120.0

145.0

Total EBIT, for reportable segments
$
64.8

$
86.1

$
209.6

$
259.4

Unallocated corporate expenses
(12.2
)
(16.6
)
(37.4
)
(44.8
)
Unallocated pension settlement charges
(10.3
)
(3.6
)
(11.9
)
(223.2
)
Continued Dumping & Subsidy Offset Act income
(expense), net
(0.2
)
—

53.6

—

Interest expense
(8.0
)
(8.6
)
(25.1
)
(25.0
)
Interest income
0.4

0.6

1.1

2.0

Income (loss) before income taxes
$
34.5

$
57.9

$
189.9

$
(31.6
)


18


Note 13 - Impairment and Restructuring Charges
Impairment and restructuring charges by segment are comprised of the following:
 
For the three months ended September 30, 2016:
 
Mobile Industries
Process Industries
Corporate
Total
Impairment charges
$
1.2

$
—

$
—

$
1.2

Severance and related benefit costs
2.9

0.4

—

3.3

Exit costs
0.3

0.5

—

0.8

Total
$
4.4

$
0.9

$
—

$
5.3

For the three months ended September 30, 2015:
 
Mobile Industries
Process Industries
Corporate
Total
Severance and related benefit costs
$
2.0

$
1.7

$
0.6

$
4.3

Exit costs
0.1

—

—

0.1

Total
$
2.1

$
1.7

$
0.6

$
4.4


For the nine months ended September 30, 2016:
 
Mobile Industries
Process Industries
Corporate
Total
Impairment charges
$
3.8

$
—

$
—

$
3.8

Severance and related benefit costs
7.7

4.9

—

12.6

Exit costs
1.6

0.7

—

2.3

Total
$
13.1

$
5.6

$
—

$
18.7

For the nine months ended September 30, 2015:
 
Mobile Industries
Process Industries
Corporate
Total
Impairment charges
$
0.1

$
3.2

$
—

$
3.3

Severance and related benefit costs
2.7

1.7

0.6

5.0

Exit costs
0.7

3.0

—

3.7

Total
$
3.5

$
7.9

$
0.6

$
12.0

The following discussion explains the 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.
Mobile Industries
On September 29, 2016, the Company announced the closure of its bearing plant in Pulaski, Tennessee ("Pulaski"). The plant is expected to close in approximately one year from the announcement date. The closure of the Pulaski bearing plant is expected to affect approximately 120 employees. During the three months ended September 30, 2016, the Company recorded severance and related benefit costs of $1.7 million related to this closure.
 
In August 2016, the Company completed the consultation process to close the manufacturing operations in Benoni, South Africa ("Benoni"). South Africa will continue to recondition bearings and assemble rail bearings. Approximately 85 employees will be affected by the announcement. During the three months ended September 30, 2016, the Company recorded impairment charges of $0.5 million and severance and related benefit costs of $0.8 million related to this closure.


19


On March 17, 2016, the Company announced the closure of its bearing plant in Altavista, Virginia ("Altavista"). The plant is expected to close in approximately one year from the announcement date, with production transferring to the Company's bearing plant near Lincolnton, North Carolina. During the three months ended September 30, 2016, the Company recorded impairment charges of $0.7 million and severance and related benefits of $0.2 million related to this closure. During the first nine months of 2016, the Company recorded impairment charges of $3.1 million and severance and related benefit costs of $1.7 million related to this closure.

On September 8, 2014, the Company announced the closure of its bearing facility in Wolverhampton, United Kingdom. This facility closed during the second quarter of 2016 and the Company recorded exit costs of $0.8 million related to this closure.

In addition, the Company incurred $1.2 million of severance and related benefit costs related to the rationalization of one of its facilities in Europe during the first nine months of 2015.

Process Industries
During the first nine months of 2015, the Company recorded impairment charges of $3.0 million related to the Company's repair business in Niles, Ohio ("Niles"). See Note 17 - Fair Value for additional information on the impairment charges for the repair business. In addition, the Company recorded $3.0 million of exit costs related to the Company's termination of its relationship with one of its third-party sales representatives in Colombia.

Workforce Reductions:
During the first nine months of 2016, the Company recognized $7.7 million of severance and related benefit costs to eliminate approximately 175 positions, in the aggregate. Of the $7.7 million charge for the first nine months of 2016, $2.9 million related to the Mobile Industries segment and $4.8 million related to the Process Industries segment. During the three and nine months ended September 30, 2015, the Company recognized $4.0 million of severance and related benefit costs to eliminate approximately 65 positions. Of the $4.0 million charge for the third quarter of 2015, $1.8 million related to the Mobile Industries segment, $1.6 million related to the Process Industries segment and $0.6 million related to corporate positions.

The following is a rollforward of the consolidated restructuring accrual for the nine months ended September 30, 2016, and the twelve months ended December 31, 2015:
 
September 30,
2016
December 31,
2015
Beginning balance, January 1
$
11.3

$
9.5

Expense
14.9

11.4

Payments
(16.0
)
(9.6
)
Ending balance
$
10.2

$
11.3

The restructuring accruals at September 30, 2016, and December 31, 2015, were included in other current liabilities on the Consolidated Balance Sheets.

20


Note 14 - Retirement Benefit Plans
The following table sets forth the net periodic benefit cost for the Company’s defined benefit pension plans. The amounts for the three and nine months ended September 30, 2016, are based on calculations prepared by the Company's actuaries during the second quarter of 2016 and represent the Company’s best estimate of each period’s proportionate share of the amounts to be recorded for the year ending December 31, 2016.
 
U.S. Plans
International Plans
Total
 
Three Months Ended
September 30,
Three Months Ended
September 30,
Three Months Ended
September 30,
 
2016
2015
2016
2015
2016
2015
Components of net periodic benefit cost:
 
 
 
 
 
 
Service cost
$
3.3

$
3.9

$
0.4

$
0.4

$
3.7

$
4.3

Interest cost
6.7

11.4

2.6

3.2

9.3

14.6

Expected return on plan assets
(7.4
)
(15.8
)
(2.6
)
(4.2
)
(10.0
)
(20.0
)
Amortization of prior service cost
0.4

0.7

0.1

0.1

0.5

0.8

Amortization of net actuarial loss
3.6

7.8

0.8

1.2

4.4

9.0

Pension settlements and curtailments
—

3.5

10.2

—

10.2

3.5

Net periodic benefit cost
$
6.6

$
11.5

$
11.5

$
0.7

$
18.1

$
12.2

 
U.S. Plans
International Plans
Total
 
Nine Months Ended
September 30,
Nine Months Ended
September 30,
Nine Months Ended
September 30,
 
2016
2015
2016
2015
2016
2015
Components of net periodic benefit cost:
 
 
 
 
 
 
Service cost
$
9.9

$
11.5

$
1.1

$
1.8

$
11.0

$
13.3

Interest cost
20.0

35.6

8.2

9.4

28.2

45.0

Expected return on plan assets
(22.3
)
(49.2
)
(8.0
)
(12.6
)
(30.3
)
(61.8
)
Amortization of prior service cost
1.2

2.1

0.1

0.1

1.3

2.2

Amortization of net actuarial loss
10.9

24.1

2.4

3.9

13.3

28.0

Pension settlements and curtailments
—

219.9

10.6

1.1

10.6

221.0

Net periodic benefit cost
$
19.7

$
244.0

$
14.4

$
3.7

$
34.1

$
247.7


On September 8, 2016, the Retirement Plan for the Hourly-Rated Employees of Timken Canada LP (the "Plan") purchased a group annuity contract from The Canada Life Assurance Company ("Canada Life") to pay and administer future pension benefits for 135 Canadian Timken retirees. The Plan was associated with former employees of the St. Thomas, Ontario manufacturing facility, which closed on March 31, 2013. The Company transferred approximately $15 million of the Company's pension obligations and $15 million of pension assets to Canada Life in this transaction. In addition to the purchase of the group annuity contract, the Company made lump-sum distributions of $6.8 million to deferred vested participants in the Plan during the second and third quarters of 2016. As a result of the group annuity contract and lump-sum distributions in Canada, as well as professional fees of $1.3 million associated with the implementation of a group annuity contract in the United States, the Company incurred total pension settlement charges of $11.9 million for the nine months ended September 30, 2016.


21


On January 23, 2015, the Timken-Latrobe-MPB-Torrington Retirement Plan purchased a group annuity contract from Prudential Insurance Company of America ("Prudential") to pay and administer future pension benefits for approximately 5,000 U.S. Timken retirees. The Company transferred approximately $575 million of the Company's pension obligations and $635 million of pension assets to Prudential in this transaction. In addition to the purchase of the group annuity contract, the Company made lump-sum distributions to new retirees of $29.5 million in 2015. The Company also incurred pension settlement and curtailment charges related to one of its Canadian defined benefit pension plans. As a result of the purchase of the group annuity contract and lump-sum distributions, as well as pension settlement and curtailment charges related to the Company's Canadian pension plans, the Company incurred total pension settlement charges of $223.2 million, including professional fees of $2.2 million, for the nine months ended September 30, 2015.


Note 15 - Other Postretirement Benefit Plans
The following table sets forth the net periodic benefit cost for the Company’s other postretirement benefit plans. The amounts for the three and nine months ended September 30, 2016, are based on calculations prepared by the Company's actuaries during the second quarter of 2016 and represent the Company’s best estimate of each period’s proportionate share of the amounts to be recorded for the year ending December 31, 2016.
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
 
2016
2015
2016
2015
Components of net periodic benefit cost:
 
 
 
 
Service cost
$
0.1

$
0.1

$
0.3

$
0.3

Interest cost
2.7

2.7

8.2

8.1

Expected return on plan assets
(1.6
)
(1.8
)
(4.9
)
(5.3
)
Amortization of prior service cost
0.2

0.2

0.7

0.6

Amortization of net actuarial loss
—

0.1

—

0.1

Net periodic benefit cost
$
1.4

$
1.3

$
4.3

$
3.8



22


Note 16 - Income Taxes

The Company's provision for income taxes in interim periods is computed by applying the estimated annual effective tax rates to income or loss before income taxes for the period. In addition, non-recurring or discrete items, including interest on prior year tax liabilities, are recorded during the period(s) in which they occur.
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
 
2016
2015
2016
2015
Provision (benefit) for income taxes
$
13.5

$
(6.6
)
$
61.1

$
1.0

Effective tax rate
39.1
%
(11.4
)%
32.2
%
(3.2
)%
In accordance with ASC Topic 740, "Income Taxes," the effective tax rate in the third quarter of 2016 was calculated as the difference between the income taxes computed for the nine months, as described below, and the year-to-date income taxes recorded as of June 30, 2016. This computation resulted in an effective tax rate of 39.1% for the third quarter of 2016, including discrete items.
 
The effective tax rate in the first nine months of 2016 was computed based on an expected annual effective tax rate of 31.6%, excluding discrete items. Discrete tax items are recorded in the period in which they occur. Including the impact of discrete tax items, the effective tax rate was 32.2% in the first nine months of 2016, This rate was lower than the U.S. federal statutory rate of 35% primarily due to tax benefits related to foreign tax credits, earnings in certain foreign jurisdictions where the effective tax rate is less than 35% and other U.S. tax benefits, such as the U.S. Research and Experimentation credit and the U.S. manufacturing deduction. These factors were partially offset by U.S. taxation of foreign earnings, losses at certain foreign subsidiaries where no tax benefit could be recorded, U.S. state and local taxes and the net impact of discrete tax items.

The effective tax rate in the third quarter of 2015 was calculated as the difference between the income taxes computed for the nine months, as described below, and the year-to-date income taxes recorded as of June 30, 2015. This computation resulted in an effective tax rate of negative 11.4% for the third quarter of 2015, including discrete items. The effective tax rate of negative 11.4% was primarily due to the change in the Company's 2015 forecast and the variability caused by the large pension settlement charge recorded in the first quarter of 2015.

The effective tax rate in the first nine months of 2015 was computed based on an estimated overall annual effective tax rate of negative 3.2%, including discrete items (expected tax benefits on expected pretax income). The rate reflected an estimated full year loss in the U.S. primarily driven by pension settlement charges and earnings in foreign jurisdictions, which were expected to produce a net tax benefit on pre-tax income. The effective tax rate of negative 3.2% was lower than the U.S. federal statutory rate of 35% primarily due to earnings in certain foreign jurisdictions where the effective tax rate is less than 35%, tax benefits related to foreign tax credits, U.S. state and local tax benefits, non-taxable U.S. income and the U.S. manufacturing deduction. These factors were partially offset by U.S. taxation of foreign earnings, losses at certain foreign subsidiaries where no tax benefit could be recorded, non-deductible U.S. expenses and certain discrete tax expenses.

In the third quarter of 2016, the Company reclassified $18.6 million of tax payments in India to income taxes payable in order to apply these payments to the underlying liabilities to which they relate. This item was identified during a routine review of the balances in these accounts. Management of the Company concluded that this change from gross to net presentation of these items in the third quarter of 2016 and the presence of the gross presentation in prior periods was immaterial to all periods presented.


23


Note 17 - Fair Value
Fair value is defined as the price that would be expected to be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The FASB provides accounting rules that classify the inputs used to measure fair value into the following hierarchy:

Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 – Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.

Level 3 – Unobservable inputs for the asset or liability.

The following tables present the fair value hierarchy for those financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2016, and December 31, 2015:
 
September 30, 2016
 
Total
Level 1
Level 2
Level 3
Assets:
 
 
 
 
Cash and cash equivalents
$
112.6

$
112.6

$
—

$
—

Cash and cash equivalents measured at net asset value
16.4







Restricted cash
2.7

2.7

—

—

Short-term investments
7.0

—

7.0

—

Short-term investments measured at net asset value
0.4







Foreign currency hedges
2.8

—

2.8

—

Total Assets
$
141.9

$
115.3

$
9.8

$
—

Liabilities:
 
 
 
 
Foreign currency hedges
$
2.3

$
—

$
2.3

$
—

Total Liabilities
$
2.3

$
—

$
2.3

$
—

 
December 31, 2015
 
Total
Level 1
Level 2
Level 3
Assets:
 
 
 
 
Cash and cash equivalents
$
110.2

$
110.2

$
—

$
—

Cash and cash equivalents measured net asset value
19.4







Restricted cash
0.2

0.2

—

—

Short-term investments
8.9

—

8.9

—

Short-term investments measured at net asset value
0.8







Foreign currency hedges
8.2

—

8.2

—

Total Assets
$
147.7

$
110.4

$
17.1

$
—

Liabilities:
 
 
 
 
Foreign currency hedges
$
0.4

$
—

$
0.4

$
—

Total Liabilities
$
0.4

$
—

$
0.4

$
—

Cash and cash equivalents are highly liquid investments with maturities of three months or less when purchased and are generally valued at the redemption value. Short-term investments are investments with maturities between four months and one year and are generally valued at amortized cost. A portion of the cash and cash equivalents and short-term investment are valued based on net asset value. The Company uses publicly available foreign currency forward and spot rates to measure the fair value of its foreign currency forward contracts.

The Company does not believe it has significant concentrations of risk associated with the counterparties to its financial instruments.

24


The following table presents those assets measured at fair value on a nonrecurring basis for the nine months ended September 30, 2016, using Level 3 inputs:
 
Carrying Value
Fair Value Adjustment
Fair Value
Long-lived assets held for sale:
 
 
 
Land
$
0.2

$
(0.2
)
$
—

Total long-lived assets held for sale
$
0.2

$
(0.2
)
$
—

 
 
 
 
Long-lived assets held and used:
 
 
 
Altavista bearing plant
$
5.6

$
(3.1
)
$
2.5

Equipment at Benoni bearing plant
0.5

(0.5
)
—

Total long-lived assets held and used
$
6.1

$
(3.6
)
$
2.5

Assets held for sale of $0.2 million were written down to their fair value of zero during the first quarter of 2016, resulting in an impairment charge. The fair value of these assets was based on the price that the Company expects to receive when it disposes of these assets.

On March 17, 2016, the Company announced the closure of its Altavista bearing plant. The plant is expected to close in approximately one year from the announcement date, with production transferring to the Company's bearing plant near Lincolnton, North Carolina. The Altavista bearing plant, with a carrying value of $5.6 million, was written down to its fair value of $3.2 million during the first quarter of 2016, resulting in an impairment of $2.4 million. The fair value for the plant was based on the price that the Company expects to receive from the sale of this facility. During the third quarter of 2016, the Company reevaluated the fair value of this facility. The Altavista bearing plant was written down to its fair value of $2.5 million during the third quarter of 2016, resulting in an additional impairment of $0.7 million.

In August 2016, the Company completed the consultation process to close the manufacturing operations in Benoni. The Benoni facility will continue to recondition bearings and assemble rail bearings. Equipment at this facility, with a carrying value of $0.5 million, was written down to its fair value of zero during the third quarter of 2016, resulting in an impairment of $0.5 million. The fair value for the equipment was based on the price that the Company expects to receive from the sale of the equipment.

The following table presents those assets measured at fair value on a nonrecurring basis for the nine months ended September 30, 2015, using Level 3 inputs:
 
Carrying Value
Fair Value Adjustment
Fair Value
Long-lived assets held for sale:
 
 
 
Repair business
$
5.8

$
(3.0
)
$
2.8

Total long-lived assets held for sale
$
5.8

$
(3.0
)
$
2.8

 
 
 
 
Long-lived assets held and used:
 
 
 
Fixed assets
$
0.8

$
(0.3
)
$
0.5

Total long-lived assets held and used
$
0.8

$
(0.3
)
$
0.5

Assets held for sale of $5.8 million associated with the Company's repair business in Niles were written down to their fair value of $2.8 million during the first and second quarters of 2015, resulting in an impairment charge of $3.0 million. The fair value of these assets was based on the price that the Company expected to receive from the sale of these assets. This business was subsequently sold during the second quarter of 2015 for an immaterial loss.


25


Various items of property, plant and equipment, with a carrying value of $0.8 million, were written down to their fair value of $0.5 million during the first nine months of 2015, resulting in an impairment charge of $0.3 million. The fair value for these assets was based on the price that would be received in a current transaction to sell the assets on a standalone basis, considering the age and physical attributes of these items, as these assets had been idled.

Financial Instruments:
The Company’s financial instruments consist primarily of cash and cash equivalents, restricted cash, short-term investments, accounts receivable net, accounts payable, trade, short-term borrowings and long-term debt. Due to their short-term nature, the carrying value of cash and cash equivalents, restricted cash, short-term investments, accounts receivable net, accounts payable, trade and short-term borrowings are a reasonable estimate of their fair value. The fair value of the Company’s long-term fixed-rate debt, based on quoted market prices, was $547.4 million and $521.5 million at September 30, 2016, and December 31, 2015, respectively. The carrying value of this debt was $507.3 million and $519.2 million at September 30, 2016, and December 31, 2015, respectively. The fair value of long-term fixed-debt was measured using Level 2 inputs.

Note 18 - Derivative Instruments and Hedging Activities
The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. Forward exchange contracts on various foreign currencies are entered into in order to manage the foreign currency exchange rate risk associated with certain of the Company’s commitments denominated in foreign currencies. Forward contracts on various commodities are entered into to manage the price risk associated with forecasted purchases of natural gas used in the Company’s manufacturing process. Interest rate swaps are used to manage interest rate risk associated with the Company’s fixed and floating-rate borrowings.

The Company designates certain foreign currency forward contracts as cash flow hedges of forecasted revenues and certain interest rate hedges as fair value hedges of fixed-rate borrowings.

The Company does not purchase nor hold any derivative financial instruments for trading purposes. As of September 30, 2016, and December 31, 2015, the Company had $247.9 million and $235.7 million, respectively, of outstanding foreign currency forward contracts at notional value. Refer to Note 17 - Fair Value for the fair value disclosure of derivative financial instruments.

Cash Flow Hedging Strategy:
For certain derivative instruments that are designated as and qualify as cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any (i.e., the ineffective portion), or hedge components excluded from the assessment of effectiveness, are recognized in the Consolidated Statement of Income during the current period.

To protect against a reduction in the value of forecasted foreign currency cash flows resulting from export sales over the next year, the Company has instituted a foreign currency cash flow hedging program. The Company hedges portions of its forecasted intra-group revenue or expense denominated in foreign currencies with forward contracts. When the dollar strengthens significantly against foreign currencies, the decline in the present value of future foreign currency revenue is offset by gains in the fair value of the forward contracts designated as hedges. Conversely, when the dollar weakens, the increase in the present value of future foreign currency cash flows is offset by losses in the fair value of the forward contracts.

The maximum length of time over which the Company hedges its exposure to the variability in future cash flows for forecasted transactions is generally 18 months or less.
 

26


Fair Value Hedging Strategy:
For derivative instruments that are designated and qualify as fair value hedges (i.e., hedging the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk), the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in the same line item associated with the hedged item (i.e., in “interest expense” when the hedged item is fixed-rate debt).

Purpose for Derivative Instruments not Designated as Hedging Instruments:
For derivative instruments that are not designated as hedging instruments, the instruments are typically forward contracts.  In general, the practice is to reduce volatility by selectively hedging transaction exposures including intercompany loans, accounts payable and accounts receivable. Intercompany loans between entities with different functional currencies are typically hedged with a forward contract at the inception of the loan with a maturity date at the maturity of the loan.  The revaluation of these contracts, as well as the underlying balance sheet items, is recorded directly to the income statement so the adjustment generally offsets the revaluation of the underlying balance sheet items to protect cash payments and reduce income statement volatility.

The following table presents the fair value of the Company's hedging instruments. Those balances are presented in the other non-current assets/liabilities accounts within the Consolidated Balance Sheets.
 
Asset Derivatives
Liability Derivatives
Derivatives designated as hedging instruments
September 30, 2016
December 31, 2015
September 30, 2016
December 31, 2015
Foreign currency forward contracts
$
0.3

$
2.2

$
1.1

$
0.2

Total derivatives designated as hedging instruments
0.3

2.2

1.1

0.2

 
 
 
 
 
Derivatives not designated as hedging instruments
 
 
 
 
Foreign currency forward contracts
2.5

6.0

1.2

0.2

 
 
 
 
 
Total Derivatives
$
2.8

$
8.2

$
2.3

$
0.4


The following tables present the impact of derivative instruments and their location within the Consolidated Statements of Income:
 
Amount of gain or (loss) recognized in
 Other Comprehensive Income ("OCI") on derivative instruments
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
Derivatives in cash flow hedging relationships
2016
2015
2016
2015
Foreign currency forward contracts
$
(0.5
)
$
2.1

$
(2.5
)
$
2.1

Total
$
(0.5
)
$
2.1

$
(2.5
)
$
2.1


27


 
Amount of gain or (loss) reclassified from Accumulated Other Comprehensive Income ("AOCI") into income (effective portion)
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
Derivatives in cash flow hedging relationships
2016
2015
2016
2015
Foreign currency forward contracts
$
(0.4
)
$
0.3

$
0.4

$
1.0

Interest rate swaps
(0.1
)
(0.1
)
(0.3
)
(0.3
)
Total
$
(0.5
)
$
0.2

$
0.1

$
0.7

 
 
Amount of gain or (loss) recognized in
 income on derivative instruments
 
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
Derivatives not designated as hedging instruments
Location of gain or (loss) recognized in income on derivative
2016
2015
2016
2015
Foreign currency forward contracts
Other (expense) income, net
$
(0.2
)
$
(16.3
)
$
(4.5
)
$
9.8

Total