UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
   
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31,June 30, 2006
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)
   
OHIO34-0577130

(State or other jurisdiction of
(I.R.S. Employer

incorporation or organization)
 34-0577130
(I.R.S. Employer
Identification No.)
   
1835 Dueber Ave., SW, Canton, OH44706-2798

(Address of principal executive offices)
 44706-2798
(Zip Code)
330.438.3000
(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.
Yesþ            Noo
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filerþ                      Accelerated filero                      Non-accelerated filero
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso            Noþ
     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 MarchJuly 31, 2006
   
Common Stock, without par value 93,551,58494,001,219 shares
 
 

 


TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
THE TIMKEN COMPANY AND SUBSIDIARIES
PART I. Condensed Consolidated Balance Sheet
Consolidated Statement of Income
Condensed Consolidated Statement of Cash Flows
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Item 3. Quantitative2. Management’s Discussion and Qualitative Disclosures about Market RiskAnalysis of Financial Condition and Results of Operations
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
SIGNATURES
EX-11 Computation of Per Share Earnings
EX-12 Computation of Ratio of Earnings to Fixed Charges
EX-31.1 Certification
EX-31.2 Certification
EX-32 Certification


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
THE TIMKEN COMPANY AND SUBSIDIARIES
Condensed Consolidated Balance Sheet
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
                
 Mar 31 Dec 31  June 30, December 31, 
(Thousands of dollars) 2006 2005 
 2006 2005 
 
ASSETS
  
Current Assets
  
Cash and cash equivalents $     31,285 $     65,417  $38,752 $65,417 
Accounts receivable, less allowances: 2006- $44,694; 2005-$40,618 784,920 711,783 
Accounts receivable, less allowances: 2006-$45,472; 2005-$40,618 790,171 711,783 
Inventories, net 1,045,580 998,368  1,046,956 998,368 
Deferred income taxes 108,649 104,978  92,235 104,978 
Deferred charges and prepaid expenses 13,544 17,926  15,636 17,926 
Other current assets 99,773 84,837  87,546 84,837 
   
Total Current Assets
 2,083,751 1,983,309  2,071,296 1,983,309 
Property, Plant and Equipment 3,666,488 3,640,552 
 
Property, plant and equipment 3,720,454 3,657,641 
Less allowances for depreciation  (2,130,905)  (2,093,508)  (2,170,811)  (2,110,597)
   
Property, Plant and Equipment — net
 1,535,583 1,547,044  1,549,643 1,547,044 
 
Other Assets
  
Goodwill 204,892 204,129  207,943 204,129 
Other intangible assets 182,263 184,624  180,486 184,624 
Deferred income taxes 3,122 5,834  16,591 5,834 
Other non-current assets 74,200 68,794  69,979 68,794 
   
Total Other Assets
 464,477 463,381  474,999 463,381 
   
Total Assets
 $ 4,083,811 $ 3,993,734  $4,095,938 $3,993,734 
   
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
  
Current Liabilities
  
Accounts payable and other liabilities $    524,228 $    500,939  $515,055 $501,423 
Short-term debt and current portion of long-term debt 208,237 159,279  174,983 159,279 
Accrued expenses 365,436 414,257  399,991 410,624 
   
Total Current Liabilities
 1,097,901 1,074,475  1,090,029 1,071,326 
 
Non-Current Liabilities
  
Long-term debt 560,286 561,747  529,016 561,747 
Accrued pension cost 236,481 246,692  219,887 246,692 
Accrued postretirement benefits cost 518,047 513,771  518,544 513,771 
Other non-current liabilities 98,874 99,982  77,160 103,131 
   
Total Non-Current Liabilities
 1,413,688 1,422,192  1,344,607 1,425,341 
 
Shareholders’ Equity
  
Common stock 776,560 767,645  791,585 767,645 
Earnings invested in the business 1,104,784 1,052,871  1,165,380 1,052,871 
Accumulated other comprehensive loss  (309,122)  (323,449)  (295,663)  (323,449)
   
Total Shareholders’ Equity
 1,572,222 1,497,067  1,661,302 1,497,067 
   
Total Liabilities and Shareholders’ Equity
 $4,083,811 $3,993,734  $4,095,938 $3,993,734 
   
See accompanying Notes to Condensed Consolidated Financial Statements.

2-2-


Consolidated Statement of Income
(Dollars in thousands, except per share data)
(Unaudited)
         
  Three Months Ended 
  Mar 31  Mar 31 
(Thousands of dollars, except per share data) 2006  2005 
Net sales $1,347,080  $1,304,540 
Cost of products sold  1,059,694   1,032,690 
 
Gross Profit
  287,386   271,850 
         
Selling, administrative and general expenses  174,252   164,039 
Impairment and restructuring charges  1,040    
 
Operating Income
  112,094   107,811 
         
Interest expense  (13,065)  (12,675)
Interest income  1,463   573 
Other expense — net  (5,079)  (4,760)
 
Income Before Income Taxes
  95,413   90,949 
Provision for income taxes  29,473   32,714 
 
Net Income
 $65,940  $58,235 
   
         
Earnings Per Share*  $0.71   $0.64 
         
Earnings Per Share — assuming dilution**  $0.70   $0.63 
         
Dividends Per Share  $0.15   $0.15 
   
                
 Three Months Ended Six Months Ended
 June 30, June 30,
 2006 2005 2006 2005
 
Net sales $1,388,025 $1,324,678 $2,735,105 $2,629,218 
Cost of products sold 1,075,000 1,047,866 2,134,694 2,080,556 
Gross Profit
 313,025 276,812 600,411 548,662 
 
Selling, administrative and general expenses 176,264 161,742 350,516 325,781 
Impairment and restructuring charges 17,440  (44) 18,480  (44)
Operating Income
 119,321 115,114 231,415 222,925 
 
Interest expense  (12,718)  (13,860)  (25,783)  (26,534)
Interest income 1,021 773 2,484 1,345 
Other expense — net  (1,916)  (413)  (6,995)  (5,173)
Income Before Income Taxes
 105,708 101,614 201,121 192,563 
Provision for income taxes 31,017 34,280 60,490 66,994 
Net Income
 $74,691 $67,334 $140,631 $125,569 
        
 
Earnings Per Share* $0.80 $0.74 $1.51 $1.38 
 
Earnings Per Share — assuming dilution** $0.79 $0.73 $1.49 $1.37 
 
Dividends Per Share $0.15 $0.15 $0.30 $0.30 
        
         
* Average shares outstanding 92,942,082 90,804,936  93,261,154 91,189,208 93,117,090 90,981,208 
** Average shares outstanding — assuming dilution 94,010,483 91,871,363  94,313,670 91,817,375 94,177,549 91,828,505 
See accompanying Notes to Condensed Consolidated Financial Statements.

3-3-


Condensed Consolidated Statement of Cash Flows
(Dollars in thousands)
(Unaudited)
                
 Three Months Ended  Six Months Ended
 Mar 31 Mar 31  June 30,
 2006 2005  2006 2005
(Thousands of dollars)     
 
CASH PROVIDED (USED)
  
  
Operating Activities
  
Net income $65,940 $58,235  $140,631 $125,569 
Adjustments to reconcile net income to net cash provided by operating activities:  
Depreciation and amortization 51,601 54,100  101,586 107,699 
Loss on impairment 689  
Loss on disposals of property, plant and equipment 538 1,924  20 4,129 
Gain on divestiture  (660)  
Loss (gain) on divestiture 9,311  (2,570)
Deferred income tax credit  (73)  (3,493)  (26,062)  (8,978)
Stock-based compensation expense 3,827 1,296  8,192 3,009 
Changes in operating assets and liabilities:  
Accounts receivable  (70,316)  (82,242)  (68,890)  (123,722)
Inventories  (37,855)  (75,771)  (28,342)  (124,594)
Other assets 314  (11,870) 1,213  (28,619)
Accounts payable and accrued expenses  (43,891) 34,898   (28,529) 76,816 
Foreign currency translation (gain) loss  (6,101) 3,204   (11,007) 7,435 
Net Cash Used By Operating Activities
  (36,676)  (19,719)
Net Cash Provided By Operating Activities
 98,812 36,174 
  
Investing Activities
  
Capital expenditures  (41,073)  (32,363)  (104,929)  (83,226)
Proceeds from disposals of assets 1,518 889  1,113 2,652 
Proceeds from sale of non-strategic assets 875  
Divestments  (2,723) 10,881 
Acquisitions   (6,556)
Other  (1,205)  (601) 149 1,258 
Acquisitions   (6,556)
Net Cash Used by Investing Activities
  (39,885)  (38,631)  (106,390)  (74,991)
  
Financing Activities
  
Cash dividends paid to shareholders  (14,027)  (13,686)  (28,122)  (27,414)
Proceeds from exercise of stock options 6,132 10,075 
Net proceeds from common share activity 18,099 12,580 
Accounts receivable securitization financing borrowings  90,000  30,000 145,000 
Accounts receivable securitization financing payments   (15,000)  (30,000)  (45,000)
Payments on long-term debt  (38,346)  (137,227)  (108,297)  (242,185)
Proceeds from issuance of long-term debt 38,015 130,086  107,615 231,200 
Short-term debt activity — net 49,507  (2,397)  (11,043)  (13,083)
Net Cash Provided by Financing Activities
 41,281 61,851 
Net Cash (Used) Provided by Financing Activities
  (21,748) 61,098 
Effect of exchange rate changes on cash 1,148  (2,700) 2,661  (6,268)
(Decrease) Increase In Cash and Cash Equivalents
  (34,132) 801   (26,665) 16,013 
Cash and cash equivalents at beginning of year 65,417 50,967  65,417 50,967 
Cash and Cash Equivalents at End of Year
 $31,285 $51,768  $38,752 $66,980 
See accompanying Notes to the Condensed Consolidated Financial Statements.

4-4-


PART I. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1 — Basis of Presentation
The accompanying consolidated condensed financial statementsCondensed 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 footnotes required by the accounting principlesU.S. generally accepted in the United Statesaccounting principles 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 footnotes included in the company’s Annual Report on Form 10-K for the year ended December 31, 2005. Certain amounts in the 2005 Condensed Consolidated Financial Statements have been reclassified to conform to the 2006 presentation.
Note 2 — Stock-Based Compensation
On January 1, 2006, the company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” and elected to use the modified prospective transition method. The modified prospective method requires that compensation cost be recognized in the financial statements for all stock option awards granted after the date of adoption and for all unvested stock option awards granted prior to the date of adoption. In accordance with SFAS No. 123(R), prior period amounts were not restated. Prior to the adoption of SFAS No. 123(R), the company utilized the intrinsic-value based method of accounting under APB Opinion No. 25, “Accounting for Stock Issued to Employees”Employees,” and related interpretations, and adopted the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation.”
Under the company’s long-term incentive plan, shares of common stock have been made available to grant at the discretion of the Compensation Committee of the Board of Directors to officers and key associates in the form of stock option awards. Stock option awards have a ten yearten-year term and vest in 25% increments annually beginning on the date of grant. In addition to stock option awards, the company has granted restricted shares under the long-term incentive plan. Restricted shares vest in 25% increments annually beginning on the date of grant and have historically been expensed over the vesting period.
Prior to January 1, 2006, no stock-based compensation expense was recognized for stock option awards under the intrinsic-value based method. As a result of theThe adoption of SFAS No. 123(R), reduced operating income for the company recognized additional compensation expensesecond quarter of $1.62006 by $1.5 million, before taxes, which reduced net income for the second quarter of 2006 by $0.9 million ($.01 per basic and diluted earnings per share by $0.01share), reduced operating income for the threefirst six months ended March 31, 2006. of 2006 by $3.1 million and reduced net income for the first six months of fiscal 2006 by $2.0 million ($.02 per basic and diluted share).
The effect of net income and earnings per share as if the company had applied the fair value recognition provisions of SFAS No. 123 to all outstanding and nonvested stock option awards is as follows for the three months and six months ended March 31,June 30, 2005:
        
 Three Months Six Months
(Dollars in thousands, except earnings per share data) Ended June 30, 2005 Ended June 30, 2005
    
Net income, as reported $58,235  $67,334 $125,569 
Add: Stock-based employee compensation expense, net of related taxes 829  1,133 1,962 
Deduct: Stock-based employee compensation expense determined under fair value based methods for all awards, net of related taxes  (1,608)  (2,393)  (4,001)
Pro forma net income $57,456  $66,074 $123,530 
  
Earnings per share:  
Basic — as reported $ 0.64  $0.74 $1.38 
Basic — pro forma $ 0.63  $0.73 $1.36 
Diluted — as reported $ 0.63  $0.73 $1.37 
Diluted — pro forma $ 0.63  $0.72 $1.35 
The fair value for thesesignificant stock option awards granted during the six months ended June 30, 2006 and 2005 was estimated at the date of grant using a Black-Scholes option-pricing method.model with the following assumptions:

5-5-


Note 2 — Stock-Based Compensation (continued)
Following are the related assumptions under the Black-Scholes method:
        
 Three Months Three Months         
 Ended March Ended March  Six Months Ended Six Months Ended
 31, 2006 31, 2005  June 30, 2006 June 30, 2005
Assumptions:  
Weighted average fair value per option $9.59 $7.85 
Fair value per option $9.59 $7.85 
Risk-free interest rate  4.53%  4.12%  4.53%  4.12%
Dividend yield  2.14%  3.28%  2.14%  3.28%
Expected stock volatility 0.348 0.360  0.348 0.360 
Expected life — years 5 8  5 8 
Historical information was the primary basis for the selection of the expected dividend yield, expected volatility and the expected lives of the options. The dividend yield was revised in 2006 from five years’ quarterly dividends to the last dividend prior to the grant compared to the trailing 12 months’ daily stock prices. The risk-free interest rate was based upon yields of U.S. zero coupon issues and U.S. Treasury issues, with a term equal to the expected life of the option being valued, for 2006 and 2005, respectively. Effective January 1, 2006, forfeitures were estimated at 2%.
A summary of stock option award activity for the three-monthsix-month period ended March 31,June 30, 2006 is as follows:
                
 Weighted                   
 Weighted Average    Weighted Average  
 Average Remaining Aggregate  Weighted Average Remaining Aggregate Intrinsic
 Number of Exercise Contractual Intrinsic  Number of Shares Exercise Price Contractual Term Value (000's)
 Shares Price Term Value (000’s)   
   
Balance at December 31, 2005 5,439,913 $22.78  5,439,913 $22.78 
Granted 808,400 $30.93  817,150 $30.94 
Exercised  (256,786) $20.03   (705,525) $20.59 
Other*  (20,907) $37.48   (41,832) $32.52 
     
Outstanding at March 31, 2006 5,970,620 $23.95 6 $52,048 
Outstanding at June 30, 2006 5,509,706 $24.19 6 $50,300 
  
Exercisable at March 31, 2006 3,378,704 $22.99 5 $32,450 
Exercisable at June 30, 2006 3,553,391 $23.02 5 $36,688 
 
*Includes cancelled, expired and forfeited
The total intrinsic value of stock option awards exercised during the threesix months ended March 31,June 30, 2006 and 2005 was $3.1$9.1 million and $6.1$7.4 million, respectively. Net cash proceeds from the exercise of stock options were $4.6$14.0 million and $10.0$12.6 million for the threesix months ended March 31,June 30, 2006 and 2005, respectively. Income tax benefits of $1.1$3.7 million and $1.5$2.8 million were realized from stock option exercises during the threesix months ended March 31,June 30, 2006 and 2005, respectively.
A summary of nonvested shares as of March 31,share activity for the six-month period ended June 30, 2006 and changes during the quarter, is as follows:

-6-


         
      Weighted 
  Number of  Average Grant 
  Shares  Date Fair Value 
   
Nonvested at December 31, 2005  755,290  $24.46 
Granted  403,061  $30.99 
Vested  (89,693) $24.64 
Other*  (1,727) $25.07 
   
Nonvested at March 31, 2006  1,066,931  $26.91 
Note 2 — Stock-Based Compensation (continued)
         
      Weighted Average
      Grant Date
  Number of Shares Fair Value
   
         
Nonvested at December 31, 2005  755,290  $24.46 
Granted  431,861  $31.19 
Vested  (232,007) $25.16 
Other*  (8,330) $27.37 
   
Nonvested at June 30, 2006  946,814  $27.33 
 
*Includes cancelled, expired and forfeited
Nonvested shares consist primarily of restricted shares for key employees and directors, and also include deferred shares.
The company recognized compensation expense of $2.2$5.1 million and $1.3$3.0 million for the three monthssix-month periods ended March 31,June 30, 2006 and 2005, respectively, related to nonvested shares.

6


Note 2 — Stock-Based Compensation (continued)
As of March 31,June 30, 2006, the company had unrecognized compensation expense of $35.0$31.5 million, before taxes, related to stock option awards and nonvested shares. The unrecognized compensation expense is expected to be recognized over a total weighted average period of two years.
Note 3 — Inventories
                
 Mar 31 Dec 31  June 30, December 31,
 2006 2005 
(Dollars in thousands) 2006 2005
 (Thousands of dollars) 
Inventories:  
Manufacturing supplies $73,199 $74,188  $74,875 $74,188 
Work in process and raw materials 490,671 469,517  490,757 469,517 
Finished products 481,710 454,663  481,324 454,663 
Inventories, net $1,046,956 $998,368 
Inventories $1,045,580 $998,368 
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 necessarily be based on management’s estimates of expected year-end inventory levels and costs. Because these are subject to many forces beyond management’s control, interimannual results are subject to the final year-end LIFO inventory valuation.
Note 4 — Financing Arrangements
Short-term debt:
                
 Mar 31 Dec 31  June 30, December 31,
(Dollars in thousands) 2006 2005
 2006 2005 
 (Thousands of dollars)  
Variable-rate lines of credit for certain of the company’s European subsidiaries with various banks with interest rates ranging from 2.60% to 5.50% at March 31, 2006 $92,629 $23,884 
Variable-rate lines of credit for certain of the company’s European and Asian subsidiaries with various banks with interest rates ranging from 3.13% to 5.50% at June 30, 2006 $36,070 $23,884 
Variable-rate Ohio Water Development Authority revenue bonds for PEL  23,000   23,000 
Fixed-rate mortgage for PEL with an interest rate of 9.00% 10,472 11,491   11,491 
Fixed-rate Short-Term loans of an Asian subsidiary with interest rates ranging from 6.54% to 6.58% at June 30, 2006 10,204  
Other 9,095 5,062  1,153 5,062 
Short-term debt $112,196 $63,437  $47,427 $63,437 

-7-


Note 4 — Financing Arrangements (continued)
In January 2006, the company repaid, in full, the $23,000$23.0 million balance outstanding of the revenue bonds held by PEL Technologies LLC (PEL), an equity investment of the company. In June 2006, the company continued to liquidate assets of PEL with land and buildings exchanged for the fixed-rate mortgage. Refer to Note 10 — Equity Investments for additional discussion of PEL’s debt, which is included above.discussion.
Borrowings under the Accounts Receivable Securitization financing agreement (Asset Securitization), which provides for borrowings up to $200 million subject to certain borrowing base limitations, are secured by certain trade receivables. Under the terms of the Asset Securitization, the company sells, on an ongoing basis, certain domestic trade receivables to Timken Receivables Corporation, a wholly owned consolidated subsidiary, thatwhich in turn uses the trade receivables to secure the borrowings, which are funded through a vehicle that issues commercial paper in the short-term market. As of March 31,June 30, 2006, there were no outstanding borrowings under this facility. AAn outstanding balance outstanding related to the Asset Securitization would be reflected on the company’s Condensed Consolidated Condensed Balance Sheet in short-term debt. The yield on the commercial paper, which is the commercial paper rate plus program fees, is considered a financing cost and is included in interest expense on the Consolidated Statement of Income. As of March 31,June 30, 2006, there were letters of credit totaling $15.3$19.8 million, which reduced the availability under the Asset Securitization to $184.7$180.2 million.
The lines of credit of the company’s European and Asian subsidiaries provide for borrowings up to $159.8$165.6 million. At March 31,June 30, 2006, the company had borrowings outstanding of $92.6$36.1 million, which reduced the availability under these facilities to $67.2$129.5 million.

7


Note 4 — Financing Arrangements (continued)
Long-term debt:
                
 Mar 31 Dec 31  June 30, December 31,
(Dollars in thousands) 2006 2005
 2006 2005 
 (Thousands of dollars)  
Fixed-rate Medium-Term Notes, Series A, due at various dates through May 2028, with interest rates ranging from 6.20% to 7.76% $286,456 $286,474  $286,345 $286,474 
Variable-rate State of Ohio Air Quality and Water Development Revenue Refunding Bonds, maturing on November 1, 2025 (3.35% at March 31, 2006) 21,700 21,700 
Variable-rate State of Ohio Pollution Control Revenue Refunding Bonds, maturing on June 1, 2033 (3.35% at March 31, 2006) 17,000 17,000 
Variable-rate State of Ohio Water Development Revenue Refunding Bonds, maturing on May 1, 2007 (3.22% at March 31, 2006) 8,000 8,000 
Variable-rate State of Ohio Water Development Authority Solid Waste Revenue Bonds, maturing on July 1, 2032 (3.26% at March 31, 2006) 24,000 24,000 
Variable-rate Unsecured Canadian Note, maturing on December 22, 2010 (4.48% at March 31, 2006) 49,478 49,759 
Variable-rate State of Ohio Air Quality and Water Development Revenue Refunding Bonds, maturing on November 1, 2025 (3.95% at June 30, 2006) 21,700 21,700 
Variable-rate State of Ohio Pollution Control Revenue Refunding Bonds, maturing on June 1, 2033 (3.95% at June 30, 2006) 17,000 17,000 
Variable-rate State of Ohio Water Development Revenue Refunding Bonds, maturing on May 1, 2007 (4.00% at June 30, 2006) 8,000 8,000 
Variable-rate State of Ohio Water Development Authority Solid Waste Revenue Bonds, maturing on July 1, 2032 (4.05% at June 30, 2006) 24,000 24,000 
Variable-rate Unsecured Canadian Note, maturing on December 22, 2010 (4.95% at June 30, 2006) 51,795 49,759 
Fixed-rate Unsecured Notes, maturing on February 15, 2010 with an interest rate of 5.75% 246,952 247,651  246,255 247,651 
Other 2,741 3,005  1,477 3,005 
 656,327 657,589  656,572 657,589 
Less current maturities 96,041 95,842  127,556 95,842 
Long-term debt $560,286 $561,747  $529,016 $561,747 
The company has a $500 million Amended and Restated Credit Agreement (Senior Credit Facility) that matures on June 30, 2010. At March 31,June 30, 2006, the company had no outstanding borrowings under the Senior Credit Facility, and letters of credit totaling $65.0 million, which reduced the availability under the Senior Credit Facility to $435.0 million. Under the Senior Credit Facility, the company has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. At March 31,June 30, 2006, the company was in full compliance with the covenants under the Senior Credit Facility and its other debt agreements.
In December 2005, the company entered into a $49.8 million unsecured loan in Canada. The principal balance of the loan is payable in full in December 2010. The interest rate is variable based on the Canadian LIBOR rate and interest payments are due quarterly.
In August 2006, the company repaid, in full, the $24.0 million balance outstanding under the variable-rate State of Ohio Water Development Authority Solid Waste Revenue Bonds.

8-8-


Note 5 — Income Tax Provision
                        
 Mar 31 Mar 31 Three Months Ended Six Months Ended
 June 30, June 30,
(Dollars in thousands) 2006 2005 2006 2005
 2006 2005
 (Thousands of dollars) 
Provision for income taxes $29,473 $32,714  $31,017 $34,280 $60,490 $66,994 
Effective tax rate  30.9%  36.0%  29.3%  33.7%  30.1%  34.8%
The company’s provision for income taxes in interim periods is computed by applying an estimated annual effective tax rate against income before income taxes for the period. In addition, non-recurring or discrete items are recorded during the period in which they occur.
TheFor the first six months of 2006, the effective tax rate for the first quarter of 2006 was lowerless than the U.S. Federalfederal statutory tax rate due to tax benefits on foreign income, including the extraterritorial income exclusion on U.S. exports, tax holidays in China and the Czech Republic and earnings of certain foreign subsidiaries being taxed at a rate less than 35%, the extraterritorial income exclusion on U.S. exports and tax holidays in China and the Czech Republic, as well as tax benefits in the U.S., including a net favorable impactreduction in the company’s tax reserves related primarily to the settlement of other U.S.certain prior year tax items, including tax reserve adjustments.matters with the Internal Revenue Service (IRS) during the second quarter, accrual of the tax-free Medicare prescription drug subsidy, deductible dividends paid to the company’s Employee Stock Ownership Plan (ESOP), and the domestic manufacturing deduction provided by the American Jobs Creation Act of 2004. These benefits were offset partially by taxes incurred on foreign remittances, U.S. state and local income taxes, and the inability to record a tax benefit fortaxes on foreign remittances, losses at certain foreign subsidiaries.operations that were not available to reduce overall tax expense and other permanent differences.
TheFor the first six months of 2005, the effective tax rate for the first quarter of 2005 was higherless than the U.S. Federalfederal statutory tax rate due primarily to taxes incurred on foreign remittances, U.S. state and local income taxes, and the inability to record a tax benefit for losses at certain foreign subsidiaries. These additional taxes were offset partially by tax benefits on foreign income, including earnings of certain foreign subsidiaries being taxed at a rate less than 35%, tax holidays in China and the Czech Republic, and the extraterritorial income exclusion on U.S. exports, as well as the aggregate tax benefit of other U.S. tax items.benefits. These benefits were partially offset by losses at certain foreign operations that were not available to reduce overall tax expense, U.S. state and local income taxes, taxes on foreign remittances and other permanent differences.
The effective tax rate for the first six months of 2006 decreased from 2005 due primarily to tax reserve adjustments related to the settlement of certain prior year tax matters with the IRS during the second quarter of 2006.
In July 2006, was lower than the Financial Accounting Standards Board (FASB) issued Financial Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes.” This interpretation clarifies the accounting for uncertain tax positions recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” It prescribes requirements and other guidance for financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. This interpretation is effective rate for fiscal years beginning after December 15, 2006. The company is required to adopt this interpretation in the first quarter of 2005 due primarily to lower taxes2007. Management is currently evaluating the requirements of FIN 48 and has not yet determined the estimated impact on foreign earnings and the net favorable impact of certain discrete tax items, including tax reserve adjustments, recorded during the first quarter of 2006.its Condensed Consolidated Financial Statements.

9-9-


Note 6 — Shareholders’ Equity
               
(Thousands of dollars) 3/31/06 12/31/05
 June 30, December 31,
(Dollars in thousands) 2006 2005
Class I and Class II serial preferred stock without par value:  
Authorized — 10,000,000 shares each class  
Issued — none $ $  $ $ 
Common Stock without par value:  
Authorized — 200,000,000 shares  
Issued (including shares in treasury)  
2006 - 93,565,649 shares 
2005 - 93,160,285 shares 
2006 -94,037,676 shares 
2005 -93,160,285 shares 
Stated Capital 53,064 53,064  53,064 53,064 
Other paid-in capital 723,914 719,001  740,257 719,001 
Less cost of Common Stock in treasury  
2006 - 14,066 shares        
2006 - 52,463 shares 
2005 - 154,374 shares  (418)  (4,420)  (1,736)  (4,420)
      
 $776,560 $767,645  $791,585 $767,645 
     
An analysis of the change in capital and earnings invested in the business is as follows:
                                                
 Common Stock Earnings Accumulated      Common Stock Earnings Accumulated    
 Other Invested Other      Other Invested Other    
 Stated Paid-In in the Comprehensive Treasury    Stated Paid-In in the Comprehensive Treasury  
(Thousands of dollars) Capital Capital Business Income Stock Total 
 Capital Capital Business Income Stock Total
Balance December 31, 2005 $53,064 $719,001 $1,052,871  ($323,449)  ($4,420) $1,497,067  $53,064 $719,001 $1,052,871  ($323,449)  ($4,420) $1,497,067 
Net Income 65,940 65,940 
Net income 140,631 140,631 
Foreign currency translation adjustment 15,661 15,661  31,722 31,722 
Minimum pension adjustment  (709)  (709)  (2,524)  (2,524)
Change in fair value of derivative financial instruments, net of reclassifications  (625)  (625)  (1,412)  (1,412)
      
Total comprehensive income 80,268  168,417 
  
Dividends — $0.15 per share  (14,027)  (14,027)
Dividends — $0.30 per share  (28,122)  (28,122)
Tax benefit from exercise of stock options 1,494 1,494  4,077 4,077 
Issuance of 140,308 shares from treasury and 405,364 shares from authorized related to stock option plans 3,419 4,002 7,421 
Issuance of 101,911 shares from treasury and 877,391 shares from authorized related to stock option plans 17,179 2,684 19,863 
Balance March 31, 2006 $53,064 $723,914 $1,104,784  ($309,122)  ($418) $1,572,222 
Balance June 30, 2006 $53,064 $740,257 $1,165,380  ($295,663)  ($1,736) $1,661,302 
The total comprehensive income for the three months ended June 30, 2006 and 2005 was $88,149 and $43,535, respectively. Total comprehensive income for the six months ended June 30, 2005 was $82,915.

10-10-


Note 7 — Impairment and Restructuring Charges
Impairment and restructuring charges by segment are comprised of the following:
For the three months ended March 31,June 30, 2006:
                                
 Auto Industrial Steel Total  Auto Industrial Steel Total
(Thousands of dollars)        
(Dollars in thousands) 
Impairment $689 $ $ $689 
Severance expense and related benefit costs $966.0 $ $ $966.0  5,635   5,635 
Exit costs 19.0 55.0  $74.0  1,026 119  1,145 
Loss on divestiture   9,971 9,971 
Total $985.0 $55.0 $ $1,040.0  $7,350 $119 $9,971 $17,440 
Restructuring charges related primarily to severance and related benefit costs for associates and exit costs as a result ofFor the company’s automotive and industrial restructuring. There were no restructuring charges recorded forsix months ended June 30, 2006:
                 
  Auto Industrial Steel Total
(Dollars in thousands)
Impairment $689  $  $  $689 
Severance expense and related benefit costs  6,601         6,601 
Exit costs  1,045   174      1,219 
Loss on divestiture        9,971   9,971 
 
Total $8,335  $174  $9,971  $18,480 
 
For the three and six months ended March 31, 2005.June 30, 2005:
The rollforward of restructuring accruals is as follows:
     
 
(Millions of dollars)    
Balance at December 31, 2005 $26.0 
Add: expense  1.1 
 
     
Balance at March 31, 2006 $27.1 
 
                 
  Auto Industrial Steel Total
(Dollars in thousands)
Impairment $  $  $  $ 
Severance expense and related benefit costs  (44)        (44)
Exit costs            
Loss on divestiture            
 
Total $(44) $  $  $(44)
 
Automotive
In February 2006, the Company announced plans to rationalize production capacity at its Vierzon, France manufacturing facility in response to changes in customer demand for its products. Future service is required to receive severance and other benefits; therefore, those amounts will be accrued over the service period. No accrual has been recorded as of March 31, 2006 related to this program, which is expected to be completed in December 2006.
In 2005, the company recorded approximately $20,319 of severance and related benefit costs and $2,800 of exit costs related toannounced the closure of manufacturing facilities in Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross, Georgia. These closures areGeorgia as part of the Automotive Group’s restructuring plans. In February 2006, the company announced plans to rationalize production capacity at its Vierzon, France bearing facility in response to changes in customer demand for the Automotive Group announced in July 2005.its products. These restructuring efforts, along with other future actions, are targeted to deliver annual pretax savings of approximately $40,000$40 million by the end of 2007, with expected net workforce reductions of approximately 400 to 500 positions and pretax costs of approximately $80,000$80 to $90,000 by$90 million.
Impairment charges of $0.7 million, severance and related benefit costs of $5.6 million and exit costs of $1.0 million recorded in the endsecond quarter of 2007. An additional $985 was2006 are associated with the Automotive Group’s restructuring plans. Impairment charges of $0.7 million, severance and related benefit costs of $6.6 million and exit costs of $1.0 million recorded in the first quartersix months of 2006 primarily related to additional severance-related costs.are associated with the Automotive Group’s restructuring plans.
Including rationalization costs recorded in cost of products sold and selling, administrative and general expenses, the Automotive Group has incurred cumulative pretax costs of approximately $38 million as of June 30, 2006 for these restructuring plans.
Industrial
In addition, $770 of asset impairment and $2,239 of environmental exit costs were recorded in 2005 as a result of asset impairments relatedMay 2004, the company announced plans to the rationalization ofrationalize the company’s three bearing plants in Canton, Ohio within the Industrial Group. On September 15, 2005, the company reached a new four-year agreement with the United Steelworkers of America, which went into effect on September 26, 2005, when the prior contract expired. This initiative is expected to deliver annual pretax savings of approximately $25,000$25 million through streamlining operations and workforce reductions, with pretax costs of approximately $35,000$35 to $40,000$40 million over the next four years.

11-11-


Note 7 — Impairment and Restructuring Charges (continued)
Exit costs of $0.1 million and $0.2 million, respectively, were recorded in the second quarter and first six months of 2006 due to the Industrial Group’s rationalization program. Including rationalization costs recorded in cost of products sold and selling, administrative and general expenses, the Industrial Group has incurred cumulative pretax costs of approximately $18 million as of June 30, 2006 for these restructuring plans.
Steel
In June 2006, the company completed the divestiture of its Timken Precision Components — Europe business. This divestiture resulted in a loss of approximately $10.0 million. The results of operations and net assets of the Timken Precision Components — Europe business were immaterial to the consolidated results of operations and financial position of the company.
The rollforward of restructuring accruals is as follows:
     
 
(Dollars in millions)    
Balance at December 31, 2005 $18.1 
Add: provisions  7.8 
Less: payments  (3.7)
 
Balance at June 30, 2006 $22.2 
 
The restructuring accrual is included in accounts payable and other liabilities in the Condensed Consolidated Balance Sheet. The restructuring accrual at December 31, 2005 excludes costs related to curtailment of pension and postretirement benefit plans.
Note 8 — Segment Information
The primary measurement used by management to measure the financial performance of each Group is adjusted EBIT (earnings before interest and taxes, excluding the effect of amounts related to certain items that management considers not representative of ongoing operations such as impairment and restructuring, manufacturing rationalization expenses,/ reorganization costs, allocated receipts received or payments made under the U.S. Continued Dumping and Subsidy Offset Act (CDSOA) and gain (loss) on the sale of non-strategic assets).
                        
 Three Months Ended  Three Months Ended Six Months Ended
 Mar 31 Mar 31  June 30, June 30,
(Thousands of dollars) 2006 2005 
(Dollars in thousands) 2006 2005 2006 2005
Industrial Group
  
Net sales to external customers $503,444 $468,449  $528,606 $497,523 $1,032,050 $965,972 
Intersegment sales 435 398  462 628 897 1,026 
Depreciation and amortization 18,356 18,063  18,484 18,080 36,840 36,143 
EBIT, as adjusted 45,885 46,999  63,492 63,629 109,377 110,628 
 
Automotive Group
  
Net sales to external customers $420,984 $420,265  $426,714 $425,949 $847,698 $846,214 
Depreciation and amortization 20,818 20,699  19,159 20,560 39,977 41,259 
EBIT (loss) as adjusted  (3,141)  (5,100)  (1,960)  (1,217)  (5,101)  (6,317)
 
Steel Group
  
Net sales to external customers $422,652 $415,826  $432,705 $401,206 $855,357 $817,032 
Intersegment sales 45,530 51,605  36,442 44,131 81,972 95,736 
Depreciation and amortization 12,427 15,338  12,342 14,959 24,769 30,297 
EBIT, as adjusted 71,136 63,725  75,434 56,748 146,570 120,473 
 
Reconciliation to Income Before Income Taxes
  
Total EBIT, as adjusted, for reportable segments $113,880 $105,624  $136,966 $119,160 $250,846 $224,784 
Impairment and restructuring  (1,040)    (17,440) 44  (18,480) 44 
Manufacturing rationalization expenses  (3,413)  (1,533)  (6,262)  (6,326)  (9,674)  (7,859)
Other  (308) 386 
Other expense 2,662 2,609 2,354 2,995 
Interest expense  (13,065)  (12,675)  (12,718)  (13,860)  (25,783)  (26,534)
Interest income 1,463 573  1,021 773 2,484 1,345 
Intersegment adjustments  (2,104)  (1,426) 1,479  (786)  (626)  (2,212)
Income before income taxes $95,413 $90,949  $105,708 $101,614 $201,121 $192,563 

12-12-


Note 9 — Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the threesix months ended March 31,June 30, 2006 are as follows:
                                
 Balance Balance  Balance at Balance at June 30,
(Thousands of dollars) 12/31/05 Acquisitions Other 03/31/06 
(Dollars in thousands) December 31, 2005 Acquisitions Other 2006
Goodwill:  
Industrial $202,058 $ $757 $202,815  $202,058 $ $3,772 $205,830 
Automotive 2,071  6 2,077  2,071  42 2,113 
Total $204,129 $ $763 $204,892  $204,129 $ $3,814 $207,943 
The following table displays intangible assets as of March 31,June 30, 2006 and December 31, 2005:
                        
 As of March 31, 2006 
 Gross Net  As of June 30, 2006
 Carrying Accumulated Carrying 
(Thousands of dollars) Amount Amortization Amount 
 Gross Net
 Carrying Accumulated Carrying
(Dollars in thousands) Amount Amortization Amount
Intangible assets subject to amortization:  
  
Industrial $48,040 $9,581 $38,459  $48,442 $10,661 $37,781 
Automotive 69,869 19,499 50,370  70,265 21,098 49,167 
Steel 869 223 646  857 249 608 
    
 $118,778 $29,303 $89,475  $119,564 $32,008 $87,556 
    
  
Intangible assets not subject to amortization:  
  
Goodwill $204,892 $ $204,892  $207,943 $ $207,943 
Intangible pension asset 77,595  77,595  77,678  77,678 
Other 15,310  15,310  15,315  15,315 
    
 $297,797 $ $297,797  $300,936 $ $300,936 
    
 
Total intangible assets $416,575 $29,303 $387,272  $420,500 $32,008 $388,492 
                        
 As of December 31, 2005 
 Gross Net  As of December 31, 2005
 Carrying Accumulated Carrying 
(Thousands of dollars) Amount Amortization Amount 
 Gross Net
 Carrying Accumulated Carrying
(Dollars in thousands) Amount Amortization Amount
Intangible assets subject to amortization:  
  
Industrial $47,866 $8,574 $39,292  $47,866 $8,574 $39,292 
Automotive 69,735 17,969 51,766  69,735 17,969 51,766 
Steel 894 233 661  894 233 661 
    
 $118,495 $26,776 $91,719  $118,495 $26,776 $91,719 
    
  
Intangible assets not subject to amortization:  
  
Goodwill $204,129 $ $204,129  $204,129 $ $204,129 
Intangible pension asset 77,596  77,596  77,596  77,596 
Other 15,309  15,309  15,309  15,309 
    
 $297,034 $ $297,034  $297,034 $ $297,034 
    
 
Total intangible assets $415,529 $26,776 $388,753  $415,529 $26,776 $388,753 
Amortization expense for intangible assets was approximately $2,500$2.7 million and $5.2 million, respectively, for the three months and six months ended March 31,June 30, 2006 and is estimated to be approximately $8,400$8.4 million annually for the next five years. The intangible assets subject to amortization acquired in the Torrington acquisition have useful lives ranging from two to 20 years with a weighted-average useful life of 12 years.

13-13-


Note 10 — Equity Investments
The balances related to investments accounted for under the equity method are reported in other non-current assets on the Condensed Consolidated Balance Sheet, which were approximately $20,100$20.8 million and $19,900$19.9 million at March 31,June 30, 2006 and December 31, 2005, respectively.
Equity investments are reviewed for impairment when circumstances (such as lower-than-expected financial performance or change in strategic direction) indicate that the carrying value of the investment may not be recoverable. If impairment does exist, the equity investment is written down to its fair value with a corresponding charge to the Consolidated Statement of Income. No impairments were recorded during the second quarter and first quartersix months of 2006 relating to the company’s equity investments. In March 2006, the company sold a portion of CoLinx, LLC due to the addition of another company to the joint venture. CoLinx, a joint venture founded by Timken, SKF, INA and Rockwell Automation, provides shared e-commerce and logistics services.
During 2000, the company’s Steel Group invested in a joint venture, PEL, to commercialize a proprietary technology that converts iron units into engineered iron oxides for use in pigments, coatings and abrasives. In the fourth quarter of 2003, the company concluded its investment in PEL was impaired due to the following indicators of impairment: history of negative cash flow and losses; 2004 operating plan with continued losses and negative cash flow; and the continued required support from the company or another party.
In the fourth quarter of 2003, the company recorded a non-cash impairment loss of $45,700,$45.7 million, which iswas reported in other expense — net on the Consolidated Statement of Income.
The company concluded that PEL was a variable interest entity and that the company iswas the primary beneficiary. In accordance with FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51,” the company consolidated PEL effective March 31, 2004. The adoption of FIN 46 resulted in a charge, representing the cumulative effect of change in accounting principle, of $948,$1.0 million, which iswas reported in other expense — net on the Consolidated Statement of Income. Also,In addition, the adoption of FIN 46 increased the Condensed Consolidated Balance Sheet as follows: current assets by $1,659;$1.7 million; property, plant and equipment by $11,333;$11.3 million; short-term debt by $11,561;$11.6 million; accounts payable and other liabilities by $659;$0.7 million; and other non-current liabilities by $1,720.$1.7 million. All of PEL’s assets are collateral for its obligations. Except for PEL’s indebtedness for which the company is a guarantor, PEL’s creditors havehad no recourse to the general credit of the company.
In the first quarter of 2006, plans were finalized to liquidate the assets of PEL and the company recorded a related gain of approximately $3,550. Fixed assets were sold to third parties through negotiated sales or through auction resulting in a gain on the sale of assets of approximately $1,950. Proceeds from the sales of those assets were used to pay down certain debt facilities with the remaining unpaid balances discharged by the creditors resulting in a gain on the forgiveness of debt of approximately $1,600.$3.6 million. In January 2006, the company repaid, in full, the $23,000$23.0 million balance outstanding of the revenue bonds held by PEL. The remaining assets, approximately $9,500 ofIn June 2006, the company continued to liquidate PEL with land and buildings will be exchanged in satisfactionand the buyer’s assumption of the fixed-rate mortgage, which resulted in a gain of the assets in the third quarter of 2006.$2.8 million.

14-14-


Note 11 — Retirement and Postretirement Benefit Plans
The following table sets forth the net periodic benefit cost for the company’s retirement and postretirement benefit plans. The amounts for the three and six months ended March 31,June 30, 2006 are based on actuarial calculations prepared during 2005.calculations. Consistent with prior years, these calculations will be updated later in the year. These updated calculations may result in different net periodic benefit cost for 2006. The net periodic benefit cost recorded for the threesix months ended March 31,June 30, 2006 is the company’s best estimate of each period’s proportionate share of the amounts to be recorded for the year ended December 31, 2006.
                                
 Pension Postretirement  Pension Postretirement
 Three months ended Three months ended  Three months ended Three months ended
 Mar 31 Mar 31 Mar 31 Mar 31  June 30, June 30,
 2006 2005 2006 2005 
(Dollars in thousands) 2006 2005 2006 2005
Components of net periodic benefit cost
  
Service cost $11,948 $11,282 $1,568 $1,564  $10,745 $9,986 $1,087 $1,176 
Interest cost 40,125 39,610 12,353 12,604  38,624 37,030 9,778 10,104 
Expected return on plan assets  (43,085)  (38,472)     (43,648)  (38,587)   
Amortization of prior service cost 3,118 3,112  (485)  (1,284) 3,124 3,852  (485)  (1,249)
Recognized net actuarial loss 14,939 11,563 4,064 4,752  14,032 12,754 2,055 3,386 
Curtailment loss  202  752 
Amortization of transition asset  (42)  (28)     (44)  (29)   
Net periodic benefit cost $27,003 $27,067 $17,500 $17,636  $22,833 $25,208 $12,435 $14,169 
                 
  Pension Postretirement
  Six months ended Six months ended
  June 30, June 30,
(Dollars in thousands) 2006 2005 2006 2005
 
Components of net periodic benefit cost
                
Service cost $22,693  $21,268  $2,655  $2,740 
Interest cost  78,749   76,640   22,131   22,708 
Expected return on plan assets  (86,733)  (77,059)      
Amortization of prior service cost  6,242   6,964   (970)  (2,533)
Recognized net actuarial loss  28,971   24,317   6,119   8,138 
Curtailment loss     202      752 
Amortization of transition asset  (86)  (57)      
 
Net periodic benefit cost $49,836  $52,275  $29,935  $31,805 
 

15-15-


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Introduction
The Timken Company is a leading global manufacturer of highly engineered anti-friction bearings and alloy steels and a provider of related products and services. Timken operates under three segments: Industrial Group, Automotive Group and Steel Group.
The Industrial and Automotive Groups design, manufacture and distribute a range of bearings and related products and services. Industrial Group customers include both original equipment manufacturers and distributors for agriculture, construction, mining, energy, mill, machine tooling, aerospace and rail applications. Automotive Group customers include original equipment manufacturers and suppliers for passenger cars, light trucks, and medium- to heavy-duty trucks. Steel Group products include steels of low and intermediate alloy, vacuum-processed alloys, tool steel and some carbon grades, in both solid and tubular sections, as well as custom-made steel products for both industrial and automotive applications, including bearings.
Financial Overview
First Quarter 2006 compared to First Quarter 2005 Overview:
                
                
 1Q 2006 1Q 2005 $ Change Change  2Q 2006 2Q 2005 $ Change Change
(Dollars in millions, except earnings per share)          
Net sales $1,347.1 $1,304.5 $42.6  3.3% $1,388.0 $1,324.7 $63.3  4.8%
Net income  65.9  58.2  7.7  13.2% 74.7 67.3 7.4  11.0%
Earnings per share — diluted $0.70 $0.63 $0.07  11.1% $0.79 $0.73 $0.06  8.2%
Average number of shares — diluted 94,010,483 91,871,363   2.3% 94,313,670 91,817,375   2.7%
                 
 
  YTD 2006 YTD 2005 $ Change Change
 
(Dollars in millions, except earnings per share)                
Net sales $2,735.1  $2,629.2  $105.9   4.0%
Net income  140.6   125.6   15.0   11.9%
Earnings per share — diluted $1.49  $1.37  $0.12   8.8%
Average number of shares — diluted  94,177,549   91,828,505      2.6%
 
Net sales for the firstsecond quarter of 2006 were $1.347$1.39 billion compared to $1.305$1.32 billion in the firstsecond quarter of 2005, an increase of 3.3%4.8%. For the firstsecond quarter of 2006, earnings per diluted share were $0.70$0.79 compared to $0.63$0.73 per diluted share for the firstsecond quarter of 2005.
Net sales for the first six months of 2006 were $2.7 billion compared to $2.6 billion for the first six months of 2005, an increase of 4.0%. For the first six months of 2006, earnings per diluted share were $1.49 compared to $1.37 per diluted share for the same period last year.
The company’s firstsecond quarter and year-to-date 2006 results reflect the ongoing strength of industrial markets and the performance of the Steel Group. The company continued its focus to increase production capacity in targeted areas, including major capacity expansions for industrial products at several manufacturing locations around the world.
The company expects that the continued strength in industrial markets throughout 2006 should drive year-over-year volume and margin improvement. While global industrial markets are expected to remain strong, the improvements in the company’s operating performance will be partially constrained by investments in Project ONE and Asia growth initiatives.
In the firstsecond quarter of 2006, the Industrial Group’s net sales, excluding intersegment sales, increased 7.5%6.3% from the firstsecond quarter of 2005 to $503.4$528.6 million. The increase reflected higher volume, andFor the benefitfirst six months of 2006, the Industrial Group’s net sales, excluding intersegment sales, increased manufacturing capacity. All6.8% from the first six months of 2005 to $1,032.0 million. Most industrial end markets showed continued strength, with the highest growth in aerospace distribution and heavy industry. The Industrial Group’s profitability in the first quarter of 2006 was negatively affected by higher manufacturing costs as a result of ramping up capacity, higher raw material and energy costs and planned investments in the Asia growth initiatives.
The Automotive Group’s net sales in the first quarter of 2006 of $421.0 million were flat compared to sales in the same period a year ago. Improved pricing was offset by volume declines relating to the North American light truck business. The Automotive Group had a loss in the first quarter of 2006. The positive impact of improved pricing and manufacturing performance were more than offset by higher raw material costs and an increase in the accounts receivable reserve related to automotive industry credit exposure.
In the first quarter of 2006, the Steel Group’s net sales, excluding intersegment sales, were $422.7 million, compared toindustrial

16-16-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
$415.8distribution. The Industrial Group’s profitability in the second quarter and first six months of 2006 reflected higher volume and pricing, which was offset by higher manufacturing costs, including costs associated with ramping up new facilities to meet customer demand and investments in growth initiatives.
The Automotive Group’s net sales of $426.7 million and $847.7 million, respectively, for the second quarter and first six months of 2006 were up slightly compared to net sales in the same periods a year ago. Higher pricing was offset by lower demand from North American original equipment manufacturers and the impact of the company’s actions to exit low-margin business. The Automotive Group had a loss in the second quarter and first six months of 2006. The positive impact of higher pricing and sales mix was more than offset by higher manufacturing costs due to lower volume and higher energy costs. For the first six months of 2006, results were negatively impacted by an increase in the accounts receivable reserve related to automotive industry credit exposure.
In the second quarter of 2006, the Steel Group’s net sales, excluding intersegment sales, were $432.7 million, an increase of 7.9% compared to the same period a year ago. For the first six months of 2006, the Steel Group’s net sales, excluding intersegment sales, were $855.4 million, an increase of 4.7% from the first six months of 2005. The sales were driven by increased pricing and higher demand by customers in the aerospace, service center and energy sectors, which more than offset lower automotive sales. The Steel Group’s profitability for the second quarter and first quartersix months of 2006 increased fromcompared to the first quarter ofsame periods in 2005 as a result of price increases and favorable sales mix as well as continued strong plant utilization and manufacturing productivity.
The Statement of Income
Sales by Segment:
                
                
 1Q 2006 1Q 2005 $ Change Change  2Q 2006 2Q 2005 $ Change Change
(Dollars in millions, and exclude intersegment sales)          
Industrial Group $503.4 $468.4 $35.0  7.5% $528.6 $497.5 $31.1  6.3%
Automotive Group 421.0 420.3 0.7  0.2% 426.7 426.0 0.7  0.2%
Steel Group 422.7 415.8 6.9  1.7% 432.7 401.2 31.5  7.9%
Total Company $1,347.1 $1,304.5 $42.6  3.3% $1,388.0 $1,324.7 $63.3  4.8%
                 
 
  YTD 2006 YTD 2005 $ Change Change
 
(Dollars in millions, and exclude intersegment sales)                
Industrial Group $1,032.0  $966.0  $66.0   6.8%
Automotive Group  847.7   846.2   1.5   0.2%
Steel Group  855.4   817.0   38.4   4.7%
 
Total Company $2,735.1  $2,629.2  $105.9   4.0%
 
The Industrial Group’s net sales in the second quarter and first quartersix months of 2006 increased from the second quarter and first quartersix months of 2005 as a result of higher volume, and the benefit of increased manufacturing capacity. Allvolume. Most industrial end markets showed continued strength, with the highest growth in aerospace distribution and heavy industry.industrial distribution. The Automotive Group’s net sales in the second quarter and first quartersix months of 2006 were flatincreased slightly compared to sales in the first quartersame periods of 2005. ImprovedHigher pricing was offset by volume declines relating to the North American light truck business.declines. The Steel Group’s net sales in the second quarter and first quartersix months of 2006 increased from the same periodperiods a year ago due to increasedhigher pricing and higher demand in the aerospace, service center and energy sectors, which more than offset lower automotive sales.

-17-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Gross Profit:
                
                
 1Q 2006 1Q 2005 $ Change Change  2Q 2006 2Q 2005 $ Change Change
(Dollars in millions)          
Gross profit $287.4 $271.9 $15.5  5.7% $313.0 $276.8 $36.2  13.1%
Gross profit % to net sales  21.3%  20.8%  50bps  22.6%  20.9%   170bps
Rationalization expenses included in cost of products sold $3.0 $1.1 $1.9 NM $4.9 $6.0 $(1.1) NM
                 
  YTD 2006 YTD 2005 $ Change Change
 
(Dollars in millions)                
Gross profit $600.4  $548.7  $51.7   9.4%
Gross profit % to net sales  22.0%  20.9%     110bps
Rationalization expenses included in cost of products sold $8.0  $7.2  $0.8  NM
 
Gross profit benefited fromincreased in the second quarter and first six months of 2006 primarily due to favorable sales volume, price increases, and increased productivity and lower pension and retiree medical expense, which offset higher manufacturing and energy costs. In
Rationalization expenses recorded in the second quarter and first quartersix months of 2006 manufacturing rationalization charges related to the rationalization of the company’s Canton, Ohio Industrial Group bearing facilities, andthe rationalization of certain Automotive Group domestic manufacturing facilities.facilities and costs for certain facilities in Torrington, Connecticut. In the second quarter and first quartersix months of 2005, manufacturing rationalization chargesexpenses related primarily to the rationalization of the company’s Canton, Ohio bearing facilities.facilities and costs for certain facilities in Torrington, Connecticut.
Selling, Administrative and General Expenses:
                
                
 1Q 2006 1Q 2005 $ Change Change  2Q 2006 2Q 2005 $ Change Change
(Dollars in millions)          
Selling, administrative and general expenses $174.3 $164.0 $10.3  6.3%
Selling, administrative and general expenses: $176.3 $161.7 $14.6  9.0%
Selling, administrative and general expenses % to net sales  12.9%  12.6%  30bps  12.7%  12.2%   50bps
Rationalization expenses included in selling, administrative and general expenses $0.4 $0.4 $   $1.3 $0.3 $1.0 NM
  
                 
  YTD 2006 YTD 2005 $ Change Change
 
(Dollars in millions)                
Selling, administrative and general expenses: $350.5  $325.8  $24.7   7.6%
Selling, administrative and general expenses % to net sales  12.8%  12.4%     40bps
Rationalization expenses included in selling, administrative and general expenses $1.7  $0.7  $1.0  NM
 
The increase in selling, administrative and general expenses in the second quarter of 2006 compared to the second quarter of 2005 was primarily due to higher costs associated with performance-based compensation as well as Asia growth initiatives.
The increase in selling, administrative and general expenses in the first quartersix months of 2006 compared to the first quartersix months of 2005 was primarily due primarily to higher costs associated with investments in Project ONE and Asia growth initiatives as well as higher costs associated with performance-based compensation and an increase in the accounts receivable reserve to reflect current automotive industry credit exposure.
In the second quarter and first quartersix months of 2006, the manufacturing rationalization chargesexpenses primarily related to the rationalization of certain Automotive Group domestic manufacturing facilities. In the second quarter and first quartersix months of 2005, the manufacturing rationalization chargesexpenses related to the rationalization of the Canton, Ohio Industrial Group bearing facilities.

17-18-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Impairment and Restructuring Charges:
            
            
 1Q 2006 1Q 2005 $ Change  2Q 2006 2Q 2005 $Change
(Dollars in millions)          
Impairment charges $ $ $  $0.7 $ $0.7 
Severance and related benefit costs 0.97  0.97  5.6  5.6 
Exit costs 0.07  0.07  1.1  (0.1) 1.2 
Loss on divestiture 10.0  10.0 
Total $1.04 $ $1.04  $17.4 $(0.1) $17.5 
Restructuring costs of $0.99 million recorded in
             
 
  YTD 2006 YTD 2005 $Change
 
(Dollars in millions)            
Impairment charges $0.7  $  $0.7 
Severance and related benefit costs  6.6   (0.1)  6.7 
Exit costs  1.2      1.2 
Loss on divestiture  10.0      10.0 
 
Total $18.5  $(0.1) $18.6 
 
In 2005, the first quarter of 2006 related to severance ($0.97 million) and exit costs ($0.02 million) associated withcompany announced the closure of Automotive Group manufacturing facilities in Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross, Georgia.Georgia as part of the Automotive Group’s restructuring plans. In addition, in the first quarter ofFebruary 2006, the company announced a workforce reductionplans to rationalize production capacity at its manufacturingVierzon, France bearing facility in Vierzon, France. No restructuring costs were recordedresponse to changes in the first quarter of 2006customer demand for this workforce reduction in France.its products. These restructuring efforts, along with other future actions, are targeted to deliver annual pretax savings of approximately $40 million by the end of 2007, with expected net workforce reductions of approximately 400 to 500 positions and pretax costs of approximately $80 to $90 million.
Exit costs of $0.05 million were recorded inIn May 2004, the first quarter of 2006 duecompany announced plans to the rationalization ofrationalize the company’s three Industrial Group bearing plants in Canton, Ohio.Ohio within the Industrial Group. On September 15, 2005, the company reached a new four-year agreement with the United Steelworkers of America, which went into effect on September 26, 2005, when the prior contract expired. This initiative is expected to deliver annual pretax savings of approximately $25 million through streamlining operations and workforce reductions, with pretax restructuring costs of approximately $35 to $40 million over the next four years.
RollforwardImpairment charges of Restructuring Accruals:$0.7 million recorded in the second quarter of 2006 are associated with the Automotive Group’s restructuring plans. Severance and related benefit costs of $5.6 million and $6.6 million, respectively, recorded in the second quarter and first six months of 2006 are associated with the Automotive Group’s restructuring plans.
         
  3/31/2006  12/31/2005 
 
(Dollars in millions)            
Beginning balance, January 1 $26.0  $4.1 
Expense  1.1   25.3 
Payments     (3.4)
 
Ending balance $27.1  $26.0 
 
Exit costs of $1.0 million were recorded in the second quarter of 2006 due to the Automotive Group’s restructuring plans. In addition, exit costs of $0.1 million and $0.2 million, respectively, were recorded in the second quarter and first six months of 2006 due to the Industrial Group’s rationalization program.
The loss on divestiture of $10.0 million recorded in the second quarter of 2006 is due to the sale of Timken Precision Components — Europe business in June 2006.
The restructuring accrual for the firstsecond quarter of 2006 and 2005 is included in accounts payable and other liabilities in the Condensed Consolidated Balance Sheet.
Rollforward of Restructuring Accruals:
         
 
  6/30/2006 12/31/2005
 
(Dollars in millions)        
Beginning balance, January 1 $18.1  $4.1 
Expense  7.8   17.5 
Payments  (3.7)  (3.5)
 
Ending balance $22.2  $18.1 
 

-19-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Interest Expense and Income:
                
                
 1Q 2006 1Q 2005 $ Change % Change  2Q 2006 2Q 2005 $Change % Change
(Dollars in millions)          
Interest expense $13.1 $12.7 $0.4  3.1% $12.7 $13.9 $(1.2)  (8.6)%
Interest income $1.5 $0.6 $0.9 NM  $1.0 $0.8 $0.2  25.0%
                 
 
  YTD 2006 YTD 2005 $Change % Change
 
(Dollars in millions)                
Interest expense $25.8  $26.5  $(0.7)  (2.6)%
Interest income $2.5  $1.3  $1.2   92.3%
 
Interest expense for the second quarter and first quartersix months of 2006 increased slightly,decreased $1.2 million and $0.7 million, respectively, compared to the same periodperiods a year ago due to higher effective interest rates.lower average debt outstanding in 2006 compared to 2005. Interest income increased due to higher cash balances and higher interest rates.
                 
  1Q 2006  1Q 2005  $ Change  % Change 
 
(Dollars in millions)            
Gain on divestitures of non-strategic assets $(4.2) $(0.3) $(3.9) NM 
Loss on dissolution of subsidiary  4.3   (0.1)  4.4  NM 
Other  5.0   5.2   (0.2)  (3.8)%
 
Other expense — net $5.1  $4.8  $0.3   6.2%
 
Other Income and Expense:
                 
 
  2Q 2006 2Q 2005 $Change % Change
 
(Dollars in millions)                
Gain on sale of non-strategic assets, net $(2.8) $(2.6) $(0.2)  7.7%
Loss on dissolution of subsidiary  0.1      0.1  NM
Other  4.6   3.0   1.6   53.3%
 
Other expense — net $1.9  $0.4  $1.5  NM
 
                 
 
  YTD 2006 YTD 2005 $Change % Change
 
(Dollars in millions)                
Gain on sale of non-strategic assets, net $(6.8) $(2.9) $(3.9)  134.5%
Loss on dissolution of subsidiary  4.4   (0.1)  4.5  NM
Other  9.4   8.2   1.2   14.6%
 
Other expense — net $7.0  $5.2  $1.8   34.6%
 
In the second quarter and first quartersix months of 2006, $3.5 million of the gain on divestituressale of non-strategic assets primarily related to the sale of assets of PEL. In 2000, the company’s Steel Group invested in PEL, a joint venture to commercialize a proprietary technology that convertsconverted iron units into engineered iron oxide for use in pigments, coatings and abrasives. The company consolidated PEL effective March 31, 2004 in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 46.46 (FIN  46). In 2006, the company will wind down the joint venture. Refer to Note 10 — Equity Investments for additional discussion.

18


Management’s DiscussionIn the second quarter and Analysisfirst six months of Financial Condition and Results2005, the gain on sale of Operations (continued)non-strategic assets primarily related to the sale of the Industrial Group’s Linear Motion Systems.
In 2004, the company began the process of liquidating one of its inactive subsidiaries, British Timken Ltd., located in Duston, England. The company recorded additional non-cash charges on dissolution of $4.3$0.1 million and $4.4 million, respectively, in the second quarter and first quartersix months of 2006.
For the second quarter and first quartersix months of 2006 and 2005, respectively, other expense included donations, losses on disposal of assets, losses from equity investments, minority interests and foreign currency exchange losses.exchange.

-20-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Income Tax Expense:
                
                
 1Q 2006 1Q 2005 $ Change Change  2Q 2006 2Q 2005 $Change Change
(Dollars in millions)          
Income tax expense $29.5 $32.7 $(3.2)  (9.8)% $31.0 $34.3 $(3.3)  (9.6)%
Effective tax rate  30.9%  36.0%  (510)bps  29.3%  33.7%   (440)bps
The
                 
 
  YTD 2006 YTD 2005 $Change Change
 
(Dollars in millions)                
Income tax expense $60.5  $67.0  $(6.5)  (9.7)%
Effective tax rate  30.1%  34.8%     (470)bps
 
For the first six months of 2006, the effective tax rate for the first quarter of 2006 was lowerless than the U.S. Federalfederal statutory tax rate due to tax benefits on foreign income, including the extraterritorial income exclusion on U.S. exports, tax holidays in China and the Czech Republic and earnings of certain foreign subsidiaries being taxed at a rate less than 35%, the extraterritorial income exclusion on U.S. exports and tax holidays in China and the Czech Republic, as well as tax benefits in the U.S., including a net favorable impactreduction in the company’s tax reserves related primarily to the settlement of other U.S.certain prior year tax items, including tax reserve adjustments.matters with the Internal Revenue Service (IRS) during the second quarter, accrual of the tax-free Medicare prescription drug subsidy, deductible dividends paid to the company’s Employee Stock Ownership Plan (ESOP), and the domestic manufacturing deduction provided by the American Jobs Creation Act of 2004. These benefits were offset partially by taxes incurred on foreign remittances, U.S. state and local income taxes, and the inability to record a tax benefit fortaxes on foreign remittances, losses at certain foreign subsidiaries.operations that were not available to reduce overall tax expense and other permanent differences.
TheFor the first six months of 2005, the effective tax rate for the first quarter of 2005 was higherless than the U.S. Federalfederal statutory tax rate due primarily to taxes incurred on foreign remittances, U.S. state and local income taxes, and the inability to record a tax benefit for losses at certain foreign subsidiaries. These additional taxes were offset partially by tax benefits on foreign income, including earnings of certain foreign subsidiaries being taxed at a rate less than 35%, tax holidays in China and the Czech Republic and the extraterritorial income exclusion on U.S. exports, as well as the aggregate tax benefit of other U.S. tax items.benefits. These benefits were partially offset by losses at certain foreign operations that were not available to reduce overall tax expense, U.S. state and local income taxes, taxes on foreign remittances and other permanent differences.
The effective tax rate for the first quartersix months of 2006 was lower than the effective rate for the first quarter ofdecreased from 2005 due primarily to lower taxes on foreign earnings and the net favorable impact of certain discrete tax items, including tax reserve adjustments recordedrelated to the settlement of certain prior year tax matters with the IRS during the firstsecond quarter of 2006.
Business Segments:
The primary measurement used by management to measure the financial performance of each segment is adjusted EBIT (earnings before interest and taxes, excluding the effect of amounts related to certain items that management considers not representative of ongoing operations such as impairment and restructuring, manufacturing rationalization/rationalization / reorganization costs, allocated receipts received or payments made under the U.S. Continued Dumping and Subsidy Offset Act (CDSOA) and gain (loss) on the sale of non-strategic assets.) Refer to Note 8 — Segment Information for the reconciliation of adjusted EBIT by Group to consolidated income before income taxes.

19-21-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Industrial Group:
                
                
 1Q 2006 1Q 2005 $ Change Change  2Q 2006 2Q 2005 $Change Change
(Dollars in millions)          
Net sales, including intersegment sales $503.9 $468.8 $35.1  7.5% $529.1 $498.2 $30.9  6.2%
Adjusted EBIT $45.9 $47.0 $(1.1)  (2.3)% $63.5 $63.6 $(0.1)  (0.2)%
Adjusted EBIT margin  9.1%  10.0%  (90)bps  12.0%  12.8%   (80)bps
                 
 
  YTD 2006 YTD 2005 $Change Change
 
(Dollars in millions)                
Net sales, including intersegment sales $1,032.9  $967.0  $65.9   6.8%
Adjusted EBIT $109.4  $110.6  $(1.2)  (1.1)%
Adjusted EBIT margin  10.6%  11.4%     (80)bps
 
Sales by the Industrial Group include global sales of bearings and other products and services (other than steel) to a diverse customer base, including:including industrial equipment, construction and agriculture, rail, and aerospace and defense customers. The Industrial Group also includes aftermarket distribution operations, including automotive applications, for products other than steel. The Industrial Group’s net sales for the second quarter of 2006 compared to the same period a year ago increased primarily due to stronger demand across most end markets, particularly the aerospace and industrial distribution markets. While net sales increased in the second quarter of 2006, profitability for the Industrial Group was comparable to the second quarter of 2005. Increases in profitability due to higher volume and increased pricing were offset by increased manufacturing costs, including costs associated with ramping up new facilities to meet customer demand and investments in growth initiatives.
The Industrial Group’s net sales for the first quartersix months of 2006 compared to the first six months of 2005 increased 7.5% fromprimarily due to stronger demand across most end markets, particularly the aerospace and industrial distribution markets. Profitability for the first six months of 2006 compared to the same period a year ago reflecting increasesdecreased due to manufacturing costs associated with ramping up new facilities, higher energy costs and investments in growth initiatives, partially offset by higher volume and the benefit of increased manufacturing capacity. All industrial end markets showed continued strength, with the highest growth in aerospace, distribution and heavy industry. While net sales increased in the first quarter of 2006, adjusted EBIT margin was lower than the first quarter of 2005, as profitability was negatively impacted by higher manufacturing costs resulting from ramping up of capacity to meet customer demand and higher energy costs. The Industrial Group continues to focus on improving capacity utilization, product availability and customer service in response to strong industrial demand. During the first quarter of 2006, the Industrial Group continued its major capacity expansions at two large-bore bearings operations located in Ploiesti, Romania, and Randleman (Asheboro), North Carolina as well as the expansion of operations in Wuxi, China.pricing. The company expects the Industrial Group to benefit in the remainder of 2006 from continued strength in global industrial markets and full-year margins to improve over 2005 levels as a result of volume, manufacturing performance and pricing actions.
Automotive Group:
                
                
 1Q 2006 1Q 2005 $ Change Change  2Q 2006 2Q 2005 $Change Change
(Dollars in millions)          
Net sales, including intersegment sales $421.0 $420.3 $0.7  0.2% $426.7 $426.0 $0.7  0.2%
Adjusted EBIT (loss) $(3.1) $(5.1) $2.0  39.2% $(2.0) $(1.2) $(0.8)  (66.7)%
Adjusted EBIT (loss) margin  -0.7%  -1.2%  50bps  -0.5%  -0.3%   (20)bps
                 
 
  YTD 2006 YTD 2005 $Change Change
 
(Dollars in millions)                
Net sales, including intersegment sales $847.7  $846.2  $1.5   0.2%
Adjusted EBIT (loss) $(5.1) $(6.3) $1.2   19.0%
Adjusted EBIT (loss) margin  -0.6%  -0.7%     10bps
 
The Automotive Group includes sales of bearings and other products and services (other than steel) to automotive original equipment manufacturers and suppliers. The Automotive Group’s net sales in the firstsecond quarter of 2006 were comparableincreased slightly compared to sales infor the same period a year ago. ImprovedHigher pricing was mostly offset by volume declines relating to thelower demand from North American light truckoriginal equipment manufacturers and the impact of the company’s actions to exit low-margin business. WhileProfitability for the Automotive Group improved its control ofdecreased primarily due to higher manufacturing costs profitabilitydue to lower volume and higher energy costs, partially offset by higher pricing and better sales mix.

-22-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The increase in the Automotive Group’s net sales for the first quartersix months of 2006 compared to the first six months of 2005 was primarily due to improved pricing, mostly offset by lower volume. Profitability for the first six months of 2006 compared to the same period in the prior year improved primarily due to improved pricing, partially offset by lower volumes. Profitability for the first six months of 2006 was also negatively impacted by thea $3.5 million increase in reserves for automotive industry credit exposure of $3.5 million.exposure. The company expects the Automotive Group to improve performance throughout the rest of 2006 and anticipates that the Group will be profitable for the entire 2006 year.2006.
During 2005, the company announced a restructuring plan as part of its effort to improve Automotive Group performance and address challenges in automotive markets. For the first quarter ofthree months and six months ended June 30, 2006, the company recorded approximately $1.0$1.8 million and $2.8 million, respectively, of restructuring costs related to the closure of manufacturing facilities in Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross, Georgia. In addition,February 2006, the company announced a workforce reduction at its manufacturing facility in Vierzon, France in response to changes in customer demand for its product.products. The company has recorded restructuring costs of approximately $5.5 million, related to severance and exit costs, for the three months and six months ended June 30, 2006. The Automotive Group’s adjusted EBIT (loss) excludes these restructuring costs, as they are not representative of ongoing operations.

20


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Steel Group:
                
                
 1Q 2006 1Q 2005 $ Change Change  2Q 2006 2Q 2005 $Change Change
(Dollars in millions)          
Net sales, including intersegment sales $468.2 $467.4 $0.8  0.2% $469.1 $445.3 $23.8  5.3%
Adjusted EBIT $71.1 $63.7 $7.4  11.6% $75.4 $56.7 $18.7  33.0%
Adjusted EBIT margin  15.2%  13.6%  160bps  16.1%  12.7%   340bps
                 
 
  YTD 2006 YTD 2005 $Change Change
 
(Dollars in millions)                
Net sales, including intersegment sales $937.3  $912.8  $24.5   2.7%
Adjusted EBIT $146.6  $120.5  $26.1   21.7%
Adjusted EBIT margin  15.6%  13.2%     240bps
 
The Steel Group sells steels of low and intermediate alloy, vacuum-processed alloys, tool steel and some carbon grades in both solid and tubular sections, as well as custom-made steel products for both automotive and industrial applications, including bearings. In the first quarter of 2006,The increase in the Steel Group’s net sales were slightly higherin the second quarter of 2006 compared to the firstsecond quarter of 2005. Net2005 was due to increased pricing and surcharges and higher demand by customers in the aerospace, service center, bearing and energy sectors, partially offset by lower automotive sales. The increase in the Steel Group’s profitability was primarily due to increased pricing, favorable sales were driven bymix and improved manufacturing productivity.
The increase in the Steel Group’s net sales in the first six months of 2006 compared to the same period in 2005 was due to increased pricing and higher demand by customers in the aerospace, service center, and energy sectors, which more thanpartially offset by lower automotive sales. AlthoughThe increase in profitability for the Steel Group invoiced lower surcharges infirst six months of 2006 compared to the first quartersix months of 2005 was due to increased pricing, favorable sales mix and improved manufacturing productivity. The increase was also due to lower raw material costs compared to the Steel Group’s profitability forsame period a year ago. For the first quarterremainder of 2006, increased from the first quarter of 2005 as a result of price increases, favorable sales mix and continued strong plant utilization and manufacturing productivity. The company expects the rest of 2006Steel Group to showbenefit from continued strength in industrial markets,sectors, especially in aerospace and energy. While scrap costs are expected to continue to decline,energy, offset by normal seasonality. Scrap and alloy and energy costs are expected to remain at historically high levels, whichlevels. Energy costs will continue to remain high, but lower than the record high levels experienced last winter. However, these costs are expected to be offset withrecovered through surcharges and price increases. Other costs, including labor and benefits, will also be higher in the second half of 2006, and will only be partially offset by higher manufacturing productivity.

-23-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The Balance Sheet
Total assets as shown on the Condensed Consolidated Balance Sheet at March 31,June 30, 2006 increased by $90.1$102.2 million from December 31, 2005. This increase was due primarily to increased working capital required to support higher sales and foreign currency impact offset by lower property, plant and equipment — net.translation impact.
Current Assets:
                
                
 3/31/2006 12/31/2005 $ Change % Change  6/30/2006 12/31/2005 $ Change % Change
(Dollars in millions)          
Cash and cash equivalents $31.3 $65.4 $(34.1)  (52.1)% $38.8 $65.4 $(26.6)  (40.7)%
Accounts receivable, less allowances: 2006 - $44,694; 2005 - $40,618 784.9 711.8 73.1  10.3%
Accounts receivable, net 790.2 711.8 78.4  11.0%
Inventories, net 1,045.6 998.4 47.2  4.7% 1,047.0 998.4 48.6  4.9%
Deferred income taxes 108.7 105.0 3.7  3.5% 92.2 105.0  (12.8)  (12.2)%
Deferred charges and prepaid expenses 13.5 17.9  (4.4)  (24.6)% 15.6 17.9  (2.3)  (12.8)%
Other current assets 99.8 84.8 15.0  17.7% 87.5 84.8 2.7  3.2%
Total current assets $2,083.8 $1,983.3 $100.5  5.1% $2,071.3 $1,983.3 $88.0  4.4%
Refer to the Condensed Consolidated Statement of Cash Flows for a discussion of the decrease in cash and cash equivalents. Net accounts receivable increased as a result of the higher sales in the firstsecond quarter of 2006 as compared to fourth quarter of 2005 and the impact of foreign currency translation, partially offset by the higher allowance for doubtful accounts. The increase in inventories for the first six months of 2006 was primarily due primarily to higher volume, increased raw material costs and the impact of foreign currency translation. The decrease in deferred income taxes was the result of the utilization of certain loss carryforwards and tax credits.
Property, Plant and Equipment — Net:
                 
 
  6/30/2006 12/31/2005 $ Change % Change
 
(Dollars in millions)                
Property, plant and equipment $3,720.4  $3,657.6  $62.8   1.7%
Less: allowances for depreciation  (2,170.8)  (2,110.6)  (60.2)  2.9%
 
Property, plant and equipment — net $1,549.6  $1,547.0  $2.6   0.2%
 
The increase in property, plant and equipment — net from December 2005 to June 2006 was primarily due to foreign currency translation offset by the divestment of assets. Capital expenditures slightly exceeded depreciation expense.
Other Non-Current Assets:
                 
 
  6/30/2006 12/31/2005 $ Change % Change
 
(Dollars in millions)                
Goodwill $207.9  $204.1  $3.8   1.9%
Other intangible assets  180.5   184.6   (4.1)  (2.2)%
Deferred income taxes  16.6   5.8   10.8   186.2%
Other non-current assets  70.0   68.9   1.1   1.6%
 
Total other non-current assets $475.0  $463.4  $11.6   2.5%
 
The increase in goodwill was due to foreign currency translation. The decrease in other currentintangible assets was driven by reclassificationdue to the amortization expense recognized in the first six months of PEL assets as “held for sale.”2006. The increase in deferred income taxes was the result of the reclassification of certain loss carryforwards from non-current deferred income tax asset.
Property, Plant and Equipment — Net:
                 
  3/31/2006  12/31/2005  $ Change  % Change 
 
(Dollars in millions)            
Property, plant and equipment $3,666.5  $3,640.5  $26.0   0.7%
Less: allowances for depreciation  (2,130.9)  (2,093.5)  (37.4)  1.8%
 
Property, plant and equipment — net $1,535.6  $1,547.0  $(11.4)  (0.7)%
 
The decrease in property, plant and equipment — net inliabilities to income taxes payable during the firstsecond quarter of 2006, was due primarily to depreciation more than offsetting the impact of capital spending and foreign currency translation.which resulted in a net non-current deferred income tax asset at June 30, 2006.

21-24-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Other Non-Current Assets:
                 
  3/31/2006  12/31/2005  $ Change  % Change 
 
(Dollars in millions)            
Goodwill $204.9  $204.1  $0.8   0.4%
Other intangible assets  182.3   184.6   (2.3)  (1.2)%
Deferred income taxes  3.1   5.8   (2.7)  (46.6)%
Other non-current assets  74.2   68.8   5.4   7.8%
 
Total other non-current assets $464.5  $463.3  $1.2   0.3%
 
The decrease in other intangible assets was due to the amortization expense recognized in the first quarter of 2006. The decrease in deferred income taxes was the result of reclassification of certain loss carryforwards to current deferred income tax asset. The majority of the increase in other non-current assets was due to an increase in long-term cash investments.
Current Liabilities:
                
                
 3/31/2006 12/31/2005 $ Change % Change  6/30/2006 12/31/2005 $ Change % Change
(Dollars in millions)          
Short-term debt and current portion of long-term debt $208.2 $159.3 $48.9  30.7%
Short-term debt $175.0 $159.2 $15.8  9.9%
Accounts payable and other liabilities 524.2 500.9 23.3  4.7% 515.0 501.4 13.6  2.7%
Accrued expenses 313.4 375.3  (61.9)  (16.5)% 310.5 375.3  (64.8)  (17.3)%
Income taxes 52.1 39.0 13.1  33.6% 89.5 35.4 54.1  152.8%
Total current liabilities $1,097.9 $1,074.5 $23.4  2.2% $1,090.0 $1,071.3 $18.7  1.7%
The increase in short-term debt was due to higher seasonal working capital requirements and increased sales volume. The increase in accounts payable and other liabilities was primarily due primarily to the increase in purchasing volume to meet the higher production demand and the timing of payments to suppliers.non-income tax related payments. The decrease in accrued expenses was the result of the payout of 2005 performance-based compensation in the first quarter of 2006 and the decrease in the current portion of accrued pension cost, based on the company’s estimate of contributions to pension plans in the next twelve months. The increase in income taxes iswas primarily due primarily to accrued income taxes on current-year income and the domesticreclassification of certain tax items from deferred income taxes as a result of the settlement of certain prior year tax accrual and no payments being made in the first quarter of 2006.matters.
Non-Current Liabilities:
                
                
 3/31/2006 12/31/2005 $ Change % Change  6/30/2006 12/31/2005 $ Change % Change
(Dollars in millions)          
Long-term debt $560.3 $561.7 $(1.4)  (0.2)% $529.0 $561.7 $(32.7)  (5.8)%
Accrued pension cost 236.5 246.7  (10.2)  (4.1)% 219.9 246.7  (26.8)  (10.9)%
Accrued postretirement benefits cost 518.0 513.8 4.2  0.8% 518.5 513.8 4.7  0.9%
Deferred income taxes 42.2 42.9  (0.7)  (1.6)% 12.9 42.9  (30.0)  (69.9)%
Other non-current liabilities 56.7 57.1  (0.4)  (0.7)% 64.3 60.2 4.1  6.8%
Total non-current liabilities $1,413.7 $1,422.2 $(8.5)  (0.6)% $1,344.6 $1,425.3 $(80.7)  (5.7)%
The decrease in accrued pension cost in the first quartersix months of 2006 was primarily due primarily to U.S.-based pension plan contributions partially offset bya reclassification to current year accruals for pension expense.liabilities. The increase in accrued postretirement benefits cost was primarily due primarily to higher expense accrued versus disbursements made in the first quartersix months of 2006.

22


Management’s Discussion and Analysis The decrease in deferred income taxes was the result of Financial Condition and Resultsa reclassification of Operations (continued)certain non-current deferred income tax liabilities to income taxes payable in the second quarter as a result of the settlement of certain prior year tax matters.
Shareholders’ Equity:
                
                
 3/31/2006 12/31/2005 $ Change % Change  6/30/2006 12/31/2005 $ Change % Change
(Dollars in millions)          
Common stock $776.6 $767.7 $8.9  1.2% $791.6 $767.7 $23.9  3.1%
Earnings invested in the business 1,104.8 1,052.9 51.9  4.9% 1,165.4 1,052.9 112.5  10.7%
Accumulated other comprehensive loss  (309.2)  (323.5) 14.3  4.4%  (295.7)  (323.5) 27.8  8.6%
Total shareholders’ equity $1,572.2 $1,497.1 $75.1  5.0% $1,661.3 $1,497.1 $164.2  11.0%
The increase in common stock related to stock option exercises by employees and the related income tax benefits. Earnings invested in the business were increased in the first quartersix months of 2006 by net income of $65.9$140.6 million, partially reduced by dividends declared of $14.0$28.1 million. The decrease in accumulated other comprehensive loss was primarily due primarily to the positive impact of the foreign currency translation. The increase in the foreign currency translation adjustment of $15.7$31.7 million was due to the weakening of the U.S. dollar relative to other currencies, such as the Romanian lei, the Brazilian real and the Euro. See “Foreign Currency” for further discussion regarding the impact of foreign currency translation
Cash Flows
             
  3/31/2006  3/31/2005  $ Change 
 
(Dollars in millions)            
Net cash used by operating activities $(36.6) $(19.7) $(16.9)
Net cash used by investing activities  (39.9)  (38.6)  (1.3)
Net cash provided by financing activities  41.3   61.8   (20.5)
Effect of exchange rate changes on cash  1.1   (2.7)  3.8 
 
(Decrease) increase in cash and cash equivalents $(34.1) $0.8  $(34.9)
 
The net cash used by operating activities of $36.6 million increased from first quarter 2005 primarily as a result of a higher use of cash for accounts payable and accrued expenses. This use of cash in the first quarter of 2006 was due primarily to the payout of 2005 performance-based compensation in the first quarter and the contributions to the company’s U.S.-based pension plans, which more than offset the increase in payables to meet higher production volume. Excluding cash contributions to the company’s U.S.-based pension plans, accounts payable and accrued expenses were a source of cash of $15.7 million in the first quarter of 2006, compared to a source of cash of $71.5 million in the first quarter of 2005. The company made cash contributions to its U.S.-based pension plans in the first quarter of 2006 of $59.6 million, compared to $36.6 million in the first quarter of 2005. Accounts receivable was a use of cash of $70.3 million in the first quarter of 2006, compared to a use of cash of $82.2 million in the first quarter of 2005. Inventory was a use of cash of $37.9 million in the first quarter of 2006, compared to a use of cash of $75.8 million in the first quarter of 2005. Accounts receivable and inventory increased in the first quarter of 2006 due to higher sales volume.
The increase in net cash used by investing activities was due to higher capital expenditures in the first quarter of 2006.
Net cash provided by financing activities of $41.3 million related primarily to net borrowings on the company’s credit facilities offset by dividends paid in the first quarter of 2006. While the dividends paid in the first quarter of 2006 and 2005 were comparable, the proceeds from the exercise of stock options and the net borrowings on credit facilities were lower in the first quarter of 2006, compared to the first quarter of 2005.
Liquidity and Capital Resources
Total debt was $768.5 million at March 31, 2006, compared to $720.9 million at December 31, 2005. Net debt was $737.2 million at March 31, 2006, compared to $655.5 million at December 31, 2005. The net debt to capital ratio was 31.9% at March 31, 2006, compared to 30.5% at December 31, 2005.translation.

23-25-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Cash Flows
             
 
  YTD 2006 YTD 2005 $ Change
 
(Dollars in millions)            
Net cash provided by operating activities $98.8  $36.2  $62.6 
Net cash used by investing activities  (106.4)  (75.0)  (31.4)
Net cash (used) provided by financing activities  (21.8)  61.1   (82.9)
Effect of exchange rate changes on cash  2.7   (6.3)  9.0 
 
(Decrease) increase in cash and cash equivalents  (26.7)  16.0   (42.7)
 
The net cash provided by operating activities of $98.8 million for the first six months of 2006 increased from the same period in the prior year as a result of the reduction in the use of cash for working capital requirements, primarily inventories and accounts receivable, partially offset by accounts payable and accrued expenses. Inventory was a use of cash of $28.3 million in the first six months of 2006 compared to a use of cash of $124.6 million in the first six months of 2005. Accounts receivable was a use of cash of $68.9 million in the first six months of 2006, compared to a use of cash of $123.7 million in the first six months of 2005. Accounts receivable and inventory increased in the first six months of 2006 due to higher sales volume. Accounts payable and accrued expenses were a use of cash of $28.5 million in the first six months of 2006 after providing cash of $76.8 million for the same period of 2005. This use of cash in the first six months of 2006 was due primarily to the payout of 2005 performance-based compensation in the first quarter of 2006 and the contributions to the company’s U.S.-based pension plans, which more than offset the increase in accounts payable. The company made cash contributions to its U.S.-based pension plans in the first six months of 2006 of $116.8 million compared to $73.2 million in the first six months of 2005.
The net cash used by investing activities of $106.4 million for the first six months of 2006 increased from the prior year primarily due to higher capital expenditures to fund Industrial growth initiatives and Project ONE.
Cash flows from financing activities used cash of $21.8 million during the first six months of 2006 after providing cash of $61.1 million during the first six months of 2005. The company decreased its net borrowings on the company’s credit facilities during the first six months of 2006 after increasing its net borrowings during the same period last year. In addition, proceeds from the exercise of stock options increased during the first six months of 2006 compared to the first six months of 2005.
Liquidity and Capital Resources
Total debt was $704.0 million at June 30, 2006 compared to $720.9 million at December 31, 2005. Net debt was $665.2 million at June 30, 2006 compared to $655.5 million at December 31, 2005. The net debt to capital ratio was 28.6% at June 30, 2006 compared to 30.5% at December 31, 2005.
Reconciliation of total debt to net debt and the computation of the ratio of net debt to capital:capital follows:
Net Debt:
        
        
 3/31/2006 12/31/2005  6/30/2006 12/31/2005
(Dollars in millions)          
Short-term debt $208.2 $159.2  $175.0 $159.2 
Long-term debt 560.3 561.7  529.0 561.7 
Total debt 768.5 720.9  704.0 720.9 
Less: cash and cash equivalents  (31.3)  (65.4)  (38.8)  (65.4)
Net debt $737.2 $655.5  $665.2 $655.5 
Ratio of Net Debt to Capital:
        
        
 3/31/2006 12/31/2005  6/30/2006 12/31/2005
(Dollars in millions)          
Net debt $737.2 $655.5  $665.2 $655.5 
Shareholders’ equity 1,572.2 1,497.1  1,661.3 1,497.1 
Net debt + shareholders’ equity (capital) $2,309.4 $2,152.6  $2,326.5 $2,152.6 
Ratio of net debt to capital  31.9%  30.5%  28.6%  30.5%

-26-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The company presents net debt because it believes net debt is more representative of the company’s indicative financial position.
At March 31,June 30, 2006, the company had no outstanding borrowings under its $500 million Amended and Restated Credit Agreement (Senior Credit Facility), and letters of credit outstanding totaling $65.0 million, which reduced the availability under the Senior Credit Facility to $435.0 million. The Senior Credit Facility matures on June 30, 2010. Under the Senior Credit Facility, the company has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. At March 31,June 30, 2006, the company was in full compliance with the covenants under the Senior Credit Facility and its other debt agreements. Refer to Note 4 — Financing Arrangements for further discussion.
There were no outstanding borrowings as of March 31,June 30, 2006 under the company’s Asset Securitization, which provides for borrowings up to $200 million, limited to certain borrowing base calculations, and is secured by certain domestic trade receivables of the company. ThereAs of June 30, 2006, there were letters of credit outstanding totaling $15.3$19.8 million, which reduced the availability under the Asset Securitization to $184.7$180.2 million.
The company expects that any cash requirements in excess of cash generated from operating activities will be met by the availability under its Asset Securitization and Senior Credit Facility. The company believes it has sufficient liquidity to meet its obligations through 2006.

24


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Financing Obligations and Other Commitments
The company’s contractual debt obligations and contractual commitments outstanding as of March 31,June 30, 2006 are as follows:
                     
      Less than          More than 
Contractual Obligations Total  1 Year  1-3 Years  3-5 Years  5 Years 
(Dollars in millions)                    
Interest payments $388.0  $37.6  $63.2  $53.3  $233.9 
Long-term debt  656.3   96.0   26.2   296.1   238.0 
Short-term debt  112.2   112.2          
Operating leases  133.1   27.7   43.7   28.9   32.8 
Supply agreement  2.3   2.3          
 
Total $1,291.9  $275.8  $133.1  $378.3  $504.7 
Payments due by Period:
                     
 
      Less than         More than
Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years
 
(Dollars in millions)                    
Interest payments $373.0  $36.6  $62.6  $52.6  $221.2 
Long-term debt  656.6   127.5   17.7   297.6   213.8 
Short-term debt  47.4   47.4          
Operating leases  119.2   25.9   39.1   28.3   25.9 
 
Total $1,196.2  $237.4  $119.4  $378.5  $460.9 
 
The interest payments are related primarily to medium-term notes that mature over the next 28 years.
The company expects to make cash contributions of $160.2 million to its global defined benefit pension plans in 2006. In connection with the sale of the company’s Ashland, Ohio tooling plant in 2002, the company entered into a $25.9 million four-year supply agreement that expires on June 30, 2006, pursuant to which the company is obliged to purchase tooling.
During the first quartersix months of 2006, the company did not purchase any shares of its common stock as authorized under the company’s 2000 common stock purchase plan. This plan authorizes the company to buy in the open market or in privately negotiated transactions up to four million shares of its common stock, which are to be held as treasury shares and used for specified purposes. This plan authorizes purchases up to an aggregate of $180 million. The company may exercise this authorization until December 31, 2006. The company does not expect to be active in repurchasing its shares under the plan in the near-term.
The company does not have any off-balance sheet arrangements with unconsolidated entities or other persons.

-27-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Recent Accounting Pronouncements:
In November 2004, the FASB issued Statement of Financial Accounting Standard No. 151 (SFAS No. 151), “Inventory Costs, an amendment of ARB 43, Chapter 4.” SFAS No. 151 requires certain inventory costs to be recognized as current period expenses. SFAS No. 151 also provides guidance for the allocation of fixed production costs. This standard is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Accordingly, the company adopted this standard in 2006. The adoption of this standard did not have a material impact on the financial statements of the company.
In December 2004, FASB issued SFAS No. 123 (revised 2004), (SFAS No. 123(R)), “Share-Based Payment,” which requires the measurement and recognition of compensation expense based on estimated fair value for all share-based payment awards including grants of employee stock options. SFAS No. 123(R) supersedes the company’s previous accounting under Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees”.Employees.”
The company adopted the provisions of SFAS No. 123(R) using the modified prospective transition method beginning January 1, 2006. In accordance with that transition method, the company did not restate prior periods for the effect of compensation expense calculated under SFAS No. 123(R). The company selected the Black-Scholes option-pricing model as the most appropriate method for determining the estimated fair value of all of its awards. The adoption of SFAS No. 123(R) reduced income before income taxes for the second quarter and first quartersix months of 2006 by $1.6 million.$1.5 million and $3.1 million, respectively, and reduced net income for the second quarter and first six months of 2006 by $0.9 million and $2.0 million, respectively. The adoption of SFAS No. 123(R) had no material effect on the Condensed Statement of Cash Flows for the threesix months ended March 31,June 30, 2006. See Note 2 — Stock-Based Compensation for more information on the impact of this new standard.
In November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3 (FSP 123(R)), Transition“Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. FSP 123(R)-3 provides an elective alternative transition

25


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
method for calculating the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R). Companies may take up to one year from the effective date of FSP 123(R)-3 to evaluate the available transition alternatives and make a one-time election as to which method to adopt. The company is currently in the process of evaluating the alternative methods.
In May 2005, the FASB issued SFAS No. 154 (SFAS No. 154), “Accounting Changes and Error Corrections,” which changes the accounting for and reporting of a change in accounting principle. This statement also carries forward the guidance from APB No. 20 regarding the correction of an error and changes in accounting estimates. This statement requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific or cumulative effects of the change. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of this standard did not have a material impact on the financial statements of the company.

26


Management’s DiscussionIn July 2006, the FASB issued Financial Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes.” This interpretation clarifies the accounting for uncertain tax positions recognized in an entity’s financial statements in accordance with SFAS No. 109 (FAS 109), “Accounting for Income Taxes.” It prescribes requirements and Analysisother guidance for financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006. The company is required to adopt this interpretation in the first quarter of 2007. Management is currently evaluating the requirements of FIN 48 and has not yet determined the estimated impact on the company’s Condensed Consolidated Financial Condition and Results of Operations (continued)Statements.
Critical Accounting Policies and Estimates:
The company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The company reviews its critical accounting policies throughout the year. The company has concluded that there have been no changes to its critical accounting policies or estimates, as described in its Annual Report on Form 10-K for the year ended December 31, 2005, during the threesix months ended March 31,June 30, 2006.

-28-


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Other Matters:
Foreign Currency:
Assets and liabilities of subsidiaries are translated at the rate of exchange in effect on the balance sheet date; income and expenses are translated at the average rates of exchange prevailing during the quarter. Related translation adjustments are reflected as a separate component of accumulated other comprehensive loss. Foreign currency gains and losses resulting from transactions are included in the consolidated statementCondensed Consolidated Statement of income.Income.
Foreign currency exchange losses included in the company’s operating results for the three months ended March 31,June 30, 2006 totaled $0.3 million compared to a gain of $1.0$3.7 million during the three months ended March 31,June 30, 2005. Foreign currency exchange losses included in the company’s operating results for the six months ended June 30, 2006 totaled $1.5 million compared to a gain of $4.7 million during the six months ended June 30, 2005. For the three months ended March 31,June 30, 2006, the company recorded a positive non-cash foreign currency translation adjustment of $15.7$16.0 million that increased shareholders’ equity compared to a negative non-cash foreign currency translation adjustment of $21.6$27.1 million that decreased shareholders’ equity in the three months ended March 31,June 30, 2005. For the six months ended June 30, 2006, the company recorded a positive non-cash foreign currency translation adjustment of $31.7 million that increased shareholders’ equity compared to a negative non-cash foreign currency translation adjustment of $48.7 million that decreased shareholders’ equity in the six months ended June 30, 2005. The foreign currency translation adjustment for the three months and six months ended March 31,June 30, 2006 were positively impacted by the weakening of the U.S. dollar relative to other currencies, such as the Romanian lei, the Brazilian real and the Euro.
Trade Law Enforcement:
The U.S. government previously had eight antidumping duty orders in effect covering ball bearings from France, Germany, Italy, Japan, Singapore and the United Kingdom, tapered roller bearings from China and spherical plain bearings from France. The company is a producer of all of these products in the United States. The U.S. government has been conducting five-year sunset reviews on each of these eight antidumping duty orders in order to determine whether or not each should remain in effect. On April 18,August 3, 2006, the U.S. International Trade Commission continued six of the eight antidumping orders under review. Two antidumping orders, relating to spherical plain bearings from France and ball bearings from Singapore, will not remain in effect. The other six orders, covering ball bearings from France, Germany, Italy, Japan and the United Kingdom and tapered roller bearings from China, will remain in effect for an additional five years, when another sunset review process will take place. The non-renewal of the two antidumping orders is not expected to have a material adverse impact on the company’s revenues or profitability.
Continued Dumping and Subsidy Offset Act (CDSOA)
The CDSOA provides for distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic producers where the domestic producers have continued to invest in their technology, equipment and people. The company reported CDSOA receipts, net of expenses, of $77.1 million, $44.4 million and $65.6 million in 2005, 2004 and 2003, respectively. Amounts received in 2003 were net of a one-time repayment, due to a miscalculation by the U.S. Treasury Department, of funds received by the company in 2002.
In September 2002, the World Trade Organization (WTO) ruled that such payments are not consistent with international trade rules. In February 2006, U.S. legislation was enacted that would end CDSOA distributions for imports covered by antidumping duty orders entering the U.S. after September 30, 2007. Instead, any such antidumping duties collected would remain with the U.S. Treasury. This legislation is not expected to have a significant effect on potential CDSOA distributions in 2006 or 2007, but would be expected to reduce likely distributions in years beyond 2007, with distributions eventually ceasing.
In July 2006, the U.S. Court of International Trade (CIT) ruled that the procedure for determining recipients eligible to receive CDSOA distributions is unconstitutional. The CIT has not ruled on other matters, including any remedy as a result of its ruling. The company expects that the ruling of the CIT will be appealed. The company is unable to determine, at this time, if this ruling will have a material adverse impact on the company’s financial results.
In addition to the CIT ruling, there are a number of other factors that can affect whether the company receives any CDSOA distributions and the amount of such distributions in any year. These factors include, among other things, potential additional changes in the law, ongoing and potential additional legal challenges to the law, the administrative operation of the law and the status of the underlying antidumping orders. Accordingly, the company cannot reasonably estimate the amount of CDSOA distributions it will receive in future years, if any.
Quarterly Dividend:
On August 4, 2006, the company’s Board of Directors declared a quarterly cash dividend of $0.15$0.16 per share. The dividend will be paid on June 2,September 6, 2006 to shareholders of record as of May 19,August 18, 2006. This was the 336th337th consecutive dividend paid on the common stock of the company.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Forward Looking Statements
Certain statements set forth in this document (including the company’s forecasts, beliefs and expectations) that are not historical in nature are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, the Management’s Discussion and Analysis contain numerous forward-looking statements. The company cautions readers that actual results may differ materially from those expressed or implied in forward-looking statements made by or on behalf of the company due to a variety of important factors, such as:
a) changes in world economic conditions, including additional adverse effects from terrorism or hostilities. This includes, but is not limited to, political risks associated with the potential instability of governments and legal systems in countries in which the company or its customers conduct business and significant changes in currency valuations;
 
b) the effects of fluctuations in customer demand on sales, product mix and prices in the industries in which the company operates. This includes the ability of the company to respond to the rapid improvements in the industrial market, the effects of customer strikes, the impact of changes in industrial business cycles and whether conditions of fair trade continue in the U.S. market;
 
c) competitive factors, including changes in market penetration, increasing price competition by existing or new foreign and domestic competitors, the introduction of new products by existing and new competitors and new technology that may impact the way the company’s products are sold or distributed;
 
d) changes in operating costs. This includes: the effect of changes in the company’s manufacturing processes; changes in costs associated with varying levels of operations; higher cost and availability of raw materials and energy; the company’s ability to mitigate the impact of higher material costs through surcharges and/or price increases; changes resulting from inventory management and cost reduction initiatives and different levels of customer demands; the effects of unplanned work stoppages; and changes in the cost of labor and benefits;

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
e) the success of the company’s operating plans, including its ability to achieve the benefits from its ongoing continuous improvement and rationalization programs; the ability of acquired companies to achieve satisfactory operating results; and the company’s ability to maintain appropriate relations with unions that represent company associates in certain locations in order to avoid disruptions of business;
 
f) unanticipated litigation, claims or assessments. This includes, but is not limited to, claims or problems related to intellectual property, product liability or warranty and environmental issues;
 
g) changes in worldwide financial markets, including interest rates to the extent they affect the company’s ability to raise capital or increase the company’s cost of funds, have an impact on the overall performance of the company’s pension fund investments and/or cause changes in the economy which affect customer demand; and
 
h) those items identified under Item 1A. Risk Factors as discussed in the company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Additional risks relating to the company’s business, the industries in which the company operates or the company’s common stock may be described from time to time in the company’s filings with the SEC. All of these risk factors are difficult to predict, are subject to material uncertainties that may affect actual results and may be beyond the company’s control.
Except as required by the federal securities laws, the company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Refer to information appearing under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q. Furthermore, a discussion of market risk exposures is included in Part II, Item 7A. Quantitative and Qualitative Disclosure about Market Risk, of the company’s Annual Report on Form 10-K for the year ended December 31, 2005. There have been no material changes in reported market risk since the inclusion of this discussion in the Company’scompany’s Annual Report on Form 10-K referenced above.
Item 4. Controls and Procedures
As of the end of the period covered by this report, the company carried out an evaluation, under the supervision and with the participation of the company’s management, including the company’s principal executive officer and principal financial officer, of the effectiveness of the design and operation of the company’s disclosure controls and procedures (as defined by in Exchange Act Rule 13a-15(e)). Based upon that evaluation, the principal executive officer and principal financial officer concluded that the company’s disclosure controls and procedures were effective as of the end of the period covered by this report. During the company’s most recent fiscal quarter there have been no changes in the company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The company is normally involved in various claims and legal actions arising in the ordinary course of its business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the company’s consolidated financial position or results of operations.
TheIn July 2006, the company is currently in discussionsentered into a settlement agreement with the State of Ohio concerning both a violation of Ohio air pollution control laws, which was discovered by the company and voluntarily disclosed to the State of Ohio approximately eightmore than nine years ago. Although no finalago, as well as a failed grinder bag house stack test, which was corrected within three days. Pursuant to the terms of the settlement has been reached,agreement, the company believes thathas agreed to pay $200,000. The company may receive a credit of up to $110,000 of the finaltotal settlement will not be material toamount if the company or have a material adverse effect on the company’s consolidated financial position or resultsinvests in approved supplemental environmental projects. The company intends to apply for approval of operations.supplemental environmental projects. The company has also agreed to conduct additional testing of certain equipment.
Item 1A. Risk Factors
There have been no material changes to the risk factors included in the company’sOur Annual Report on Form 10-K for the fiscal year ended December 31, 2005.2005 includes a detailed discussion of our risk factors. The information presented below amends and updates those risk factors and should be read in conjunction with the risk factors and information disclosed in that Form 10-K.
Due to developments set forth under "Other Matters, Trade Law Enforcement" in Part I, Item 2 of this Form 10-Q, the risk factor entitled "Expiration of antidumping orders may materially adversely affect our business" is no longer applicable.
Due to developments set forth under "Other Matters, Trade Law Enforcement" in Part I, Item 2 of this Form 10-Q, the risk factor entitled "Any reduction of CDSOA distributions in the future would reduce our earnings" has been updated as set forth below:
Any reduction of CDSOA distributions in the future would reduce our earnings and cash flow.
CDSOA provides for distribution of monies collected by U.S. Customs from antidumping cases to qualifying domestic producers where the domestic producers have continued to invest in their technology, equipment and people. The company reported CDSOA receipts, net of expenses, of $77.1 million, $44.4 million, and $65.6 million in 2005, 2004 and 2003, respectively. In February 2006, U.S. legislation was enacted that would end CDSOA distributions for imports covered by antidumping duty orders entering the U.S. after September 30, 2007. Instead, any such antidumping duties collected would remain with the U.S. Treasury. This legislation is not expected to have a significant effect on potential CDSOA distributions in 2006 or 2007, but would be expected to reduce any distributions in years beyond 2007, with distributions eventually ceasing.
In July 2006, the U.S. Court of International Trade (CIT) ruled that the procedure for determining recipients eligible to receive CDSOA distributions is unconstitutional. The CIT has not ruled on other matters, including any remedy as a result of its ruling. The company expects that the ruling of the CIT will be appealed. The company is unable to determine, at this time, if this ruling will have a material adverse impact on the company’s financial results.
In addition to the CIT ruling, there are a number of other factors that can affect whether the company receives any CDSOA distributions and the amount of such distributions in any year. These factors include, among other things, potential additional changes in the law, other ongoing and potential additional legal challenges to the law, the administrative operation of the law and the status of the underlying antidumping orders. It is possible that the CIT ruling might prevent us from receiving any CDSOA distributions in 2006. Any reduction of CDSOA distributions would reduce our earnings and cash flow.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer of Purchases of Common Stock
The following table provides information about purchases by the company during the quarter ended March 31,June 30, 2006 of its common stock.
                 
 
          Total number Maximum
          of shared number of
          purchased as shares that
          part of publicly may yet
  Total number Average announced be purchased
  of shares price paid plans or under the plans
Period purchased(1) per share(2) programs or programs(3)
 
1/1/06 - 1/31/06  6,823  $35.19   213,123   3,786,877 
2/1/06 - 2/28/06  36,305   34.15   249,428   3,750,572 
3/1/06 - 3/31/06  1,988   29.38   251,416   3,748,584 
 
Total  45,116  $34.10         
 
                 
          Total number  
          of shares Maximum
          purchased as number of
          part of publicly shares that
  Total number Average announced may yet
  of shares price paid plans or be purchased under
Period purchased(1) per share(2) programs the plans or programs(3)
 
 
4/1/06 — 4/30/06  34,748  $34.19      3,793,700 
5/1/06 — 5/31/06           3,793,700 
6/1/06 — 6/30/06  151   33.20      3,793,700 
 
Total  34,899  $34.19      3,793,700 
 
(1) Represents shares of the company’s common stock that are owned and tendered by employees to satisfy tax withholding obligations in connection with the vesting of restricted sharedshares and the exercise of stock options.
 
(2) The average price paid per share is calculated using the daily high and low sales prices of the company’s common stock on the New York Stock Exchange at the time the employee tenders the shares.
 
(3) Pursuant to the company’s 2000 common stock purchase plan, it may purchase up to four million shares of common stock at an amount not to exceed $180 million in the aggregate. The company may purchase shares under its 2000 common stock purchase plan until December 31, 2006. The company did not purchase any shares under its 2000 common stock purchase plan during the periods listed above.

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Item 4. Submission of Matters to a Vote of Security Holders
At the 2006 Annual Meeting of Shareholders of The Timken Company held on April 18, 2006, the shareholders of the company elected the three individuals set forth below as Directors in Class III to serve a term of three years expiring at the Annual Meeting in 2009 (or until their respective successors are elected and qualified).
         
  Affirmative Votes Withheld Votes
   
Joseph W. Ralston  83,082,518   4,587,915 
John M. Timken, Jr.  78,242,643   9,427,790 
Jacqueline F. Woods  87,064,454   605,979 
Item 6. Exhibits
 Exhibit
Number
Description
  
10.1Form of Severance Agreement*
10.2Form of Termination of Employee Death Benefit Agreement*
11 Computation of Per Share Earnings
 
 
12 Computation of Ratio of Earnings to Fixed Charges
 
 
31.1 Certification of James W. Griffith, President and Chief Executive Officer of The Timken Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2 Certification of Glenn A. Eisenberg, Executive Vice President — Finance and Administration (principal financial officer)(Principal Financial Officer) of The Timken Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32 Certifications of James W. Griffith, President and Chief Executive Office, and Glenn A. Eisenberg, Executive Vice President — Finance and Administration (principal financial officer)(Principal Financial Officer) of The Timken Company, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*Incorporated herein by reference to the appropriate exhibit to the company’s Form 8-K filed on June 9, 2006.

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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
   
 THE TIMKEN COMPANY
Date August 8, 2006 By /s/ James W. Griffith  
James W. Griffith 
President, Chief Executive Officer and Director 
   
Date May 09,August 8, 2006 By /s/ James W. Griffith
Glenn A. Eisenberg   
 James W. Griffith
President, Chief Executive Officer and Director
Glenn A. Eisenberg  
Date May 09, 2006By /s/ Glenn A. Eisenberg
Glenn A. Eisenberg
 Executive Vice President — Finance
and Administration (Principal Financial Officer)

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