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 September 30, 2006

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

For the transition period from                                          to                                          

THE TIMKEN COMPANY

(Exact name of registrant as specified in its charter)

OHIO		34-0577130
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
1835 Dueber Ave., SW, Canton, OH		44706-2798
(Address of principal executive offices)		(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                                                                                                                  Yes þ           No o

     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 filer þ           Accelerated filer o           Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o           No þ

     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 October 31, 2006
Common Stock, without par value		94,135,297 shares

 

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

THE TIMKEN COMPANY AND SUBSIDIARIES

Condensed Consolidated Balance Sheet
(Dollars in thousands)
(Unaudited)

		September 30,				December 31,
		2006				2005
ASSETS
Current Assets
Cash and cash equivalents		$	54,069			$	65,417
Accounts receivable, less allowances: 2006- $45,352; 2005-$40,618			734,631				711,783
Inventories, net			1,077,792				998,368
Deferred income taxes			92,369				104,978
Deferred charges and prepaid expenses			16,077				17,926
Other current assets			88,569				84,837
Total Current Assets			2,063,507				1,983,309
Property, plant and equipment			3,809,742				3,657,641
Less allowances for depreciation			(2,202,960	)			(2,110,597	)
Property, Plant and Equipment — net			1,606,782				1,547,044
Other Assets
Goodwill			216,961				204,129
Other intangible assets			180,114				184,624
Deferred income taxes			16,705				5,834
Other non-current assets			59,985				68,794
Total Other Assets			473,765				463,381
Total Assets		$	4,144,054			$	3,993,734
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts payable and other liabilities		$	506,866			$	501,423
Short-term debt and current portion of long-term debt			204,166				159,279
Accrued expenses			373,708				410,624
Total Current Liabilities			1,084,740				1,071,326
Non-Current Liabilities
Long-term debt			548,611				561,747
Accrued pension cost			209,052				246,692
Accrued postretirement benefits cost			519,792				513,771
Other non-current liabilities			84,556				103,131
Total Non-Current Liabilities			1,362,011				1,425,341
Shareholders’ Equity
Common stock			799,053				767,645
Earnings invested in the business			1,196,878				1,052,871
Accumulated other comprehensive loss			(298,628	)			(323,449	)
Total Shareholders’ Equity			1,697,303				1,497,067
Total Liabilities and Shareholders’ Equity		$	4,144,054			$	3,993,734

See accompanying Notes to Condensed Consolidated Financial Statements.

Consolidated Statement of Income
(Dollars in thousands, except per share data)
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Net sales		$	1,272,922			$	1,258,133			$	4,008,027			$	3,887,351
Cost of products sold			1,024,438				1,005,722				3,159,132				3,086,278
Gross Profit			248,484				252,411				848,895				801,073
Selling, administrative and general expenses			163,999				163,021				514,515				488,802
Impairment and restructuring charges			2,682				24,451				21,162				24,407
Operating Income			81,803				64,939				313,218				287,864
Interest expense			(11,704	)			(12,842	)			(37,487	)			(39,376	)
Interest income			854				874				3,338				2,219
Other expense — net			(1,942	)			(4,273	)			(8,937	)			(9,446	)
Income Before Income Taxes			69,011				48,698				270,132				241,261
Provision for income taxes			22,465				8,867				82,955				75,861
Net Income		$	46,546			$	39,831			$	187,177			$	165,400
Earnings Per Share*		$	0.50			$	0.43			$	2.01			$	1.81
Earnings Per Share — assuming dilution**		$	0.49			$	0.43			$	1.99			$	1.79
Dividends Per Share		$	0.16			$	0.15			$	0.46			$	0.45
* Average shares outstanding			93,500,491				91,688,231				93,239,292				91,238,444
** Average shares outstanding — assuming dilution			94,376,937				92,821,344				94,238,413				92,181,013

See accompanying Notes to Condensed Consolidated Financial Statements.

Condensed Consolidated Statement of Cash Flows
(Dollars in thousands)
(Unaudited)

		Nine Months Ended
		September 30,
		2006				2005
CASH PROVIDED (USED)
Operating Activities
Net income		$	187,177			$	165,400
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			151,226				160,765
Loss on impairment			1,792				—
Loss on disposals of property, plant and equipment			2,130				7,374
Loss (gain) on divestiture			9,311				(2,832	)
Deferred income tax credit			(26,541	)			(13,143	)
Stock-based compensation expense			11,760				4,398
Changes in operating assets and liabilities:
Accounts receivable			(14,082	)			(110,262	)
Inventories			(57,837	)			(162,106	)
Other assets			(8,732	)			(28,671	)
Accounts payable and accrued expenses			(73,963	)			79,190
Foreign currency translation (gain) loss			(9,891	)			5,581
Net Cash Provided By Operating Activities			172,350				105,694
Investing Activities
Capital expenditures			(179,419	)			(128,605	)
Proceeds from disposals of assets			6,243				3,661
Divestments			(2,723	)			11,729
Acquisitions			(4,299	)			(6,629	)
Other			(85	)			3,186
Net Cash Used by Investing Activities			(180,283	)			(116,658	)
Financing Activities
Cash dividends paid to shareholders			(43,170	)			(41,238	)
Net proceeds from common share activity			22,066				30,740
Accounts receivable securitization financing borrowings			140,000				185,000
Accounts receivable securitization financing payments			(50,000	)			(106,500	)
Payments on long-term debt			(291,477	)			(257,977	)
Proceeds from issuance of long-term debt			191,615				246,700
Short-term debt activity — net			24,984				(28,824	)
Net Cash (Used) Provided by Financing Activities			(5,982	)			27,901
Effect of exchange rate changes on cash			2,567				(4,799	)
(Decrease) Increase In Cash and Cash Equivalents			(11,348	)			12,138
Cash and cash equivalents at beginning of year			65,417				50,967
Cash and Cash Equivalents at End of Period		$	54,069			$	63,105

See accompanying Notes to the Condensed Consolidated Financial Statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1 – Basis of Presentation

The accompanying Condensed 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 U.S. generally accepted accounting 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) (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,” 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 typically have a ten-year term and generally 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 typically 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. The adoption of SFAS No. 123(R) reduced operating income for the third quarter of 2006 by $1.5 million, reduced net income for the third quarter of 2006 by $0.9 million ($.01 per basic and diluted share), reduced operating income for the first nine months of 2006 by $4.6 million and reduced net income for the first nine months of 2006 by $2.9 million ($.03 per basic and diluted share).

The effect on 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 and nine months ended September 30, 2005:

		Three Months Ended				Nine Months Ended
(Dollars in thousands, except earnings per share data)		September 30, 2005				September 30, 2005
Net income, as reported		$	39,831			$	165,400
Add: Stock-based employee compensation expense, net of related taxes			1,055				3,017
Deduct: Stock-based employee compensation expense determined under fair value based methods for all awards, net of related taxes			(2,355	)			(6,356	)
Pro forma net income		$	38,531			$	162,061
Earnings per share:
Basic – as reported		$	0.43			$	1.81
Basic – pro forma		$	0.42			$	1.78
Diluted – as reported		$	0.43			$	1.79
Diluted – pro forma		$	0.42			$	1.76

The fair value for significant stock option awards granted during the nine months ended September 30, 2006 and 2005 was estimated at the date of grant using a Black-Scholes option-pricing model with the following assumptions:

Note 2 – Stock-Based Compensation (continued)

		Nine Months Ended				Nine Months Ended
		September 30, 2006				September 30, 2005
Assumptions:
Fair value per option		$	9.59			$	7.85
Risk-free interest rate			4.53	%			4.12	%
Dividend yield			2.14	%			3.28	%
Expected stock volatility			0.348				0.360
Expected life — years			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 nine-month period ended September 30, 2006 is as follows:

										Weighted
						Weighted				Average
						Average				Remaining				Aggregate
		Number of				Exercise				Contractual				Intrinsic
		Shares				Price				Term				Value (000’s)
Balance at December 31, 2005			5,439,913			$	22.78
Granted			817,150			$	30.94
Exercised			(858,052	)		$	21.06
Other*			(58,670	)		$	30.83
Outstanding at September 30, 2006			5,340,341			$	24.21				6			$	39,240
Exercisable at September 30, 2006			3,407,051			$	23.01				5			$	29,542

*		Includes cancelled, expired and forfeited

The total intrinsic value of stock option awards exercised during the nine months ended September 30, 2006 and 2005 was $10.6 million and $15.3 million, respectively. Net cash proceeds from the exercise of stock options were $17.6 million and $32.9 million for the nine months ended September 30, 2006 and 2005, respectively. Income tax benefits of $3.8 million and $4.4 million were realized from stock option exercises during the nine months ended September 30, 2006 and 2005, respectively.

A summary of nonvested restricted share activity for the nine-month period ended September 30, 2006 is as follows:

						Weighted Average
						Grant Date
		Number of Shares				Fair Value
Nonvested at December 31, 2005			755,290			$	24.46
Granted			433,861			$	31.19
Vested			(237,760	)		$	25.21
Other*			(16,918	)		$	27.81
Nonvested at September 30, 2006			934,473			$	27.34

*		Includes cancelled, expired and forfeited

Note 2 – Stock-Based Compensation (continued)

Nonvested shares consist primarily of restricted shares for key employees and directors, and also include deferred shares.

The company recognized compensation expense of $7.2 million and $4.4 million for the nine-month periods ended September 30, 2006 and 2005, respectively, related to nonvested shares. As of September 30, 2006, the company had unrecognized compensation expense of $27.8 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

		September 30				December 31,
(Dollars in thousands)		2006				2005
Inventories:
Manufacturing supplies		$	79,759			$	74,188
Work in process and raw materials			490,701				469,517
Finished products			507,332				454,663
Inventories, net		$	1,077,792			$	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, annual results are subject to the final year-end LIFO inventory valuation.

Note 4 – Financing Arrangements

Short-term debt:

		September 30,				December 31,
(Dollars in thousands)		2006				2005
Variable-rate Accounts Receivable Asset Securitization with an interest rate of 5.82% at September 30, 2006		$	90,000			$	—
Variable-rate lines of credit for certain of the company’s European and Asian subsidiaries with various banks with interest rates ranging from 3.44% to 5.75% at September 30, 2006			68,090				23,884
Variable-rate Ohio Water Development Authority revenue bonds for PEL			—				23,000
Fixed-rate mortgage for PEL with an interest rate of 9.00%			—				11,491
Fixed-rate Short-term loans of an Asian subsidiary with interest rates ranging from 6.58% to 6.84% at September 30, 2006			10,213				—
Other			4,973				5,062
Short-term debt		$	173,276			$	63,437

In January 2006, the company repaid, in full, the $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.

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, which 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 September 30, 2006, outstanding borrowings under this facility totaled $90.0 million. 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 September 30, 2006, the company had issued letters of credit totaling $16.7 million under the Asset Securitization, which further reduced the availability under this facility to $93.3 million.

Note 4 – Financing Arrangements (continued)

The lines of credit of the company’s European and Asian subsidiaries provide for borrowings up to $196.5 million. At September 30, 2006, the company had borrowings outstanding of $68.1 million, which reduced the availability under these facilities to $128.4 million.

Long-term debt:

		September 30,				December 31,
(Dollars in thousands)		2006				2005
Fixed-rate Medium-term Notes, Series A, due at various dates through May 2028, with interest rates ranging from 6.20% to 7.76%		$	211,644			$	286,474
Variable-rate State of Ohio Air Quality and Water Development Revenue Refunding Bonds, maturing on November 1, 2025 (3.62% at September 30, 2006)			21,700				21,700
Variable-rate State of Ohio Pollution Control Revenue Refunding Bonds, maturing on June 1, 2033 (3.62% at September 30, 2006)			17,000				17,000
Variable-rate State of Ohio Water Development Revenue Refunding Bonds, maturing on May 1, 2007 (3.62% at September 30, 2006)			8,000				8,000
Variable-rate State of Ohio Water Development Authority Solid Waste Revenue Bonds, maturing on July 1, 2032			—				24,000
Variable-rate Unsecured Canadian Note, maturing on December 22, 2010 (4.91% at September 30, 2006)			51,722				49,759
Fixed-rate Unsecured Notes, maturing on February 15, 2010 with an interest rate of 5.75%			247,875				247,651
Variable-rate credit facility with US Bank for Advanced Green Products, LLC, maturing on July 18, 2008 (6.33% at September 30, 2006)			12,240				—
Other			9,320				3,005
			579,501				657,589
Less current maturities			30,890				95,842
Long-term debt		$	548,611			$	561,747

The company has a $500 million Amended and Restated Credit Agreement (Senior Credit Facility) that matures on June 30, 2010. At September 30, 2006, the company had no outstanding borrowings under the Senior Credit Facility, and had issued letters of credit under this facility totaling $35.2 million, which reduced the availability under the Senior Credit Facility to $464.8 million. Under the Senior Credit Facility, the company has two financial covenants: a consolidated leverage ratio and a consolidated interest coverage ratio. At September 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 57.8 million Canadian dollar unsecured loan in Canada. The principal balance of the loan is payable in full on December 22, 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.

Advanced Green Components, LLC (AGC) is a joint venture of the company formerly accounted for using the equity method. The company is the guarantor of $6.1 million of AGC’s credit facility. Effective September 30, 2006, the company consolidated AGC and its outstanding debt. Refer to Note 10 – Equity Investments for additional discussion.

Note 5 – Income Tax Provision

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Dollars in thousands)		2006				2005				2006				2005
Provision for income taxes		$	22,465			$	8,867			$	82,955			$	75,861
Effective tax rate			32.6	%			18.2	%			30.7	%			31.4	%

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.

For the first nine months of 2006, the effective tax rate was less than the U.S. federal statutory tax rate due to the favorable impact of taxes on foreign income, including 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. In addition, the effective tax rate was favorably impacted by certain U.S. tax benefits, including a net reduction in the company’s tax reserves related primarily to the settlement of certain prior year tax matters with the Internal Revenue Service 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 U.S. state and local income taxes, taxes on foreign remittances, losses at certain foreign operations that were not available to reduce overall tax expense, and other permanent differences.

For the first nine months of 2005, the effective tax rate was less than the U.S. federal statutory tax rate primarily due to beneficial foreign tax rates, tax holidays and other U.S. tax benefits, including export tax incentives. These benefits were partially offset by losses at certain foreign operations that were not available to reduce overall tax expense, taxes paid to U.S. state and local jurisdictions, tax on foreign remittances, and other permanent differences.

In July 2006, 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 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 Consolidated Financial Statements.

Note 6 – Shareholders’ Equity

		September 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 - 94,192,311 shares 2005 - 93,160,285 shares
Stated Capital			53,064				53,064
Other paid-in capital			748,004				719,001
Less cost of Common Stock in treasury 2006 - 61,145 shares 2005 - 154,374 shares			(2,015	)			(4,420	)
		$	799,053			$	767,645

     An analysis of the change in capital and earnings invested in the business is as follows:

		Common Stock								Earnings				Accumulated
						Other				Invested				Other
		Stated				Paid-In				in the				Comprehensive				Treasury
		Capital				Capital				Business				Income				Stock				Total
Balance December 31, 2005		$	53,064			$	719,001			$	1,052,871				($323,449	)			($4,420	)		$	1,497,067
Net income											187,177												187,177
Foreign currency translation adjustment															30,744								30,744
Minimum pension adjustment															(5,462	)							(5,462	)
Change in fair value of derivative financial instruments, net of reclassifications															(461	)							(461	)
Total comprehensive income																							211,998
Dividends — $0.46 per share											(43,170	)											(43,170	)
Tax benefit from exercise of stock options							4,635																4,635
Issuance of 93,229 shares from treasury and 1,032,026 shares from authorized related to stock option plans							24,368												2,405				26,773
Balance September 30, 2006		$	53,064			$	748,004			$	1,196,878				($298,628	)			($2,015	)		$	1,697,303

The total comprehensive income for the three months ended September 30, 2006 and 2005 was $43,581 and $54,103, respectively. Total comprehensive income for the nine months ended September 30, 2005 was $137,018.

Note 7 – Impairment and Restructuring Charges

Impairment and restructuring charges by segment are comprised of the following:

For the three months ended September 30, 2006:

(Dollars in thousands)		Industrial				Auto				Steel				Total
Impairment		$	592			$	—			$	485			$	1,077
Severance expense and related benefit costs			—				1,647				—				1,647
Exit costs			189				(231	)			—				(42	)
Loss on divestiture			—				—				—				—
Total		$	781			$	1,416			$	485			$	2,682

For the nine months ended September 30, 2006:

(Dollars in thousands)		Industrial				Auto				Steel				Total
Impairment		$	592			$	689			$	485			$	1,766
Severance expense and related benefit costs			—				8,248				—				8,248
Exit costs			363				814				—				1,177
Loss on divestiture			—				—				9,971				9,971
Total		$	955			$	9,751			$	10,456			$	21,162

For the three months ended September 30, 2005:

(Dollars in thousands)		Industrial				Auto				Steel				Total
Impairment		$	—			$	—			$	—			$	—
Severance expense and related benefit costs			—				21,651				—				21,651
Exit costs			—				2,800				—				2,800
Loss on divestiture			—				—				—				—
Total		$	—			$	24,451			$	—			$	24,451

For the nine months ended September 30, 2005:

(Dollars in thousands)		Industrial				Auto				Steel				Total
Impairment		$	—			$	—			$	—			$	—
Severance expense and related benefit costs			—				21,607				—				21,607
Exit costs			—				2,800				—				2,800
Loss on Divestiture			—				—				—				—
Total		$	—			$	24,407			$	—			$	24,407

Industrial

In May 2004, the company announced plans to rationalize 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 million through streamlining operations and workforce reductions, with pretax costs of approximately $35 to $40 million over the next four years.

Impairment charges of $0.6 million and exit costs of $0.2 million recorded in the third quarter are associated with the Industrial Group’s rationalization plans. Impairment charges of $0.6 million and exit costs of $0.4 million recorded in the first nine months of 2006 are associated with the Industrial Group’s rationalization plans. 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 $20 million as of September 30, 2006 for these restructuring plans.

Note 7 – Impairment and Restructuring Charges (continued)

Automotive

In 2005, the company disclosed detailed plans for its Automotive Group to restructure its business. These plans included the closure of manufacturing facilities in Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross, Georgia. In February 2006, the company announced additional plans to rationalize production capacity at its Vierzon, France bearing facility in response to changes in customer demand for 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 million to $90 million.

In September 2006, the company announced further reductions in workforce of approximately 700 associates. The company will announce further details of these plans once they have been finalized. These additional plans are targeted to deliver annual pretax savings of approximately $35 million, with expected pretax costs of approximately $25 million.

Severance and related benefit costs of $1.6 million and exit costs of a negative $0.2 million recorded in the third quarter of 2006 are associated with the Automotive Group’s restructuring plans. Impairment charges of $0.7 million, severance and related benefit costs of $8.2 million and exit costs of $0.8 million recorded in the first nine months of 2006 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 $43 million as of September 30, 2006 for these restructuring plans.

Steel

Impairment charges of $0.5 million, related to the write-down of property, plant and equipment at one of the Steel Group’s facilities, were recorded in the third quarter of 2006.

In June 2006, the company completed the divestiture of its Timken Precision Components – Europe business. This divestiture resulted in a loss on divestiture of approximately $10.0 million in the first nine months of 2006. 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 the consolidated restructuring accrual is as follows:

(Dollars in millions)
Balance at December 31, 2005		$	18.1
Add: provisions			9.4
Less: payments			(8.2	)
Balance at September 30, 2006		$	19.3

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 / 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								Nine Months Ended
		September 30,								September 30,
(Dollars in thousands)		2006				2005				2006				2005
Industrial Group
Net sales to external customers		$	501,347			$	467,774			$	1,533,397			$	1,433,746
Intersegment sales			469				435				1,366				1,461
Depreciation and amortization			18,514				17,863				55,354				54,006
EBIT, as adjusted			48,180				47,444				157,557				158,072
Automotive Group
Net sales to external customers		$	363,586			$	407,959			$	1,211,284			$	1,254,173
Depreciation and amortization			19,457				21,156				59,434				62,415
EBIT (loss) as adjusted			(26,276	)			(6,040	)			(31,377	)			(12,357	)
Steel Group
Net sales to external customers		$	407,989			$	382,400			$	1,263,346			$	1,199,432
Intersegment sales			34,584				45,512				116,556				141,248
Depreciation and amortization			11,669				14,047				36,438				44,344
EBIT, as adjusted			63,010				49,698				209,580				170,171
Reconciliation to Income Before Income Taxes
Total EBIT, as adjusted, for reportable segments		$	84,914			$	91,102			$	335,760			$	315,886
Impairment and restructuring			(2,682	)			(24,451	)			(21,162	)			(24,407	)
Manufacturing rationalization expenses			(4,463	)			(3,807	)			(14,137	)			(11,666	)
Other expense			76				(8	)			2,430				2,987
Interest expense			(11,704	)			(12,842	)			(37,487	)			(39,376	)
Interest income			854				874				3,338				2,219
Intersegment adjustments			2,016				(2,170	)			1,390				(4,382	)
Income before income taxes		$	69,011			$	48,698			$	270,132			$	241,261

Note 9 – Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill for the nine months ended September 30, 2006 are as follows:

		Balance at December 31,												Balance at September 30,
(Dollars in thousands)		2005				Acquisitions				Other				2006
Goodwill:
Industrial		$	202,058			$	—			$	2,860			$	204,918
Automotive			2,071				—				9,972				12,043
Total		$	204,129			$	—			$	12,832			$	216,961

“Other” includes $9.9 million of goodwill related to the consolidation of AGC, a joint venture. The goodwill recognized for AGC is a preliminary estimate. A valuation will be completed during the fourth quarter of 2006, which may require a subsequent adjustment. Refer to Note 10 – Equity Investments for additional discussion. The remaining portion of “Other” primarily includes foreign currency translation adjustments.

Note 9 – Goodwill and Other Intangible Assets (continued)

The following table displays intangible assets as of September 30, 2006 and December 31, 2005:

		As of September 30, 2006
		Gross								Net
		Carrying				Accumulated				Carrying
(Dollars in thousands)		Amount				Amortization				Amount
Intangible assets subject to amortization:
Industrial		$	49,783			$	11,670			$	38,113
Automotive			71,125				22,691				48,434
Steel			870				283				587
		$	121,778			$	34,644			$	87,134
Intangible assets not subject to amortization:
Goodwill		$	216,961			$	—			$	216,961
Intangible pension asset			77,673				—				77,673
Other			15,316				—				15,316
		$	309,950			$	—			$	309,950
Total intangible assets		$	431,728			$	34,644			$	397,084

		As of December 31, 2005
		Gross								Net
		Carrying				Accumulated				Carrying
(Dollars in thousands)		Amount				Amortization				Amount
Intangible assets subject to amortization:
Industrial		$	47,866			$	8,574			$	39,292
Automotive			69,735				17,969				51,766
Steel			894				233				661
		$	118,495			$	26,776			$	91,719
Intangible assets not subject to amortization:
Goodwill		$	204,129			$	—			$	204,129
Intangible pension asset			77,596				—				77,596
Other			15,309				—				15,309
		$	297,034			$	—			$	297,034
Total intangible assets		$	415,529			$	26,776			$	388,753

Amortization expense for intangible assets was approximately $2.6 million and $7.8 million, respectively, for the three months and nine months ended September 30, 2006 and is estimated to be approximately $8.5 million annually for the next five years.

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 $11.5 million and $19.9 million at September 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 third quarter and first nine months of 2006 relating to the company’s equity investments.

CoLinx, LLC

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.

PEL

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 $45.7 million, which was 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 was 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 $1.0 million, which was reported in other expense — net on the Consolidated Statement of Income. In addition, the adoption of FIN 46 increased the Consolidated Balance Sheet as follows: current assets by $1.7 million; property, plant and equipment by $11.3 million; short-term debt by $11.6 million; accounts payable and other liabilities by $0.7 million; and other non-current liabilities by $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 had 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 $3.6 million. In January 2006, the company repaid, in full, the $23.0 million balance outstanding of the revenue bonds held by PEL. In June 2006, the company continued to liquidate PEL with land and buildings exchanged and the buyer’s assumption of the fixed-rate mortgage, which resulted in a gain of $2.8 million.

Advanced Green Components, LLC

During 2002, the company’s Automotive Group formed a joint venture, Advanced Green Components, LLC (AGC), with Sanyo Special Steel Co., Ltd. (Sanyo) and Showa Seiko Co., Ltd. (Showa). AGC is engaged in the business of converting steel to machined rings for tapered bearings and other related products. The company has been accounting for its investment in AGC under the equity method since AGC’s inception. During the third quarter of 2006, AGC refinanced its long-term debt of $12.2 million. The company guaranteed half of this obligation, and Sanyo has letters of credit outstanding on the other half of this obligation. The company concluded the refinancing represented a reconsideration event to evaluate whether AGC was a variable interest entity under FIN 46 (revised December 2003). The company concluded that AGC was a variable interest entity, and the company was the primary beneficiary. Therefore, the company consolidated AGC effective September 30, 2006. As of September 30, 2006, the net assets of AGC were $9.0 million, primarily consisting of the following: property, plant and equipment of $31.4 million; goodwill of $9.9 million; short-term and long-term debt of $20.3 million and other non-current liabilities of $7.4 million. All of AGC’s assets are collateral for its obligations. Except for AGC’s indebtedness for which the company is a guarantor, AGC’s creditors have no recourse to the general credit of the company.

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 nine months ended September 30, 2006 are based on actuarial 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 nine months ended September 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
		Three months ended								Three months ended
		September 30,								September 30,
(Dollars in thousands)		2006				2005				2006				2005
Components of net periodic benefit cost
Service cost		$	11,388			$	10,633			$	1,327			$	1,385
Interest cost			39,562				38,320				11,066				11,677
Expected return on plan assets			(43,546	)			(38,528	)			—				—
Amortization of prior service cost			3,122				3,481				(486	)			(802	)
Recognized net actuarial loss			14,540				12,157				3,060				4,068
Curtailment loss			—				698				—				7,088
Amortization of transition asset			(43	)			(29	)			—				—
Net periodic benefit cost		$	25,023			$	26,732			$	14,967			$	23,416

		Pension								Postretirement
		Nine months ended								Nine months ended
		September 30,								September 30,
(Dollars in thousands)		2006				2005				2006				2005
Components of net periodic benefit cost
Service cost		$	34,081			$	31,901			$	3,982			$	4,125
Interest cost			118,311				114,960				33,197				34,385
Expected return on plan assets			(130,279	)			(115,587	)			—				—
Amortization of prior service cost			9,364				10,445				(1,456	)			(3,335	)
Recognized net actuarial loss			43,511				36,474				9,179				12,206
Curtailment loss			—				900				—				7,840
Amortization of transition asset			(129	)			(86	)			—				—
Net periodic benefit cost		$	74,859			$	79,007			$	44,902			$	55,221

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132(R).” SFAS No. 158 requires a company to (a) recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under funded status, (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year, and (c) recognize changes in the funded status of a defined postretirement plan in the year in which the changes occur (reported in comprehensive income). The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006. The requirement to measure the plan assets and benefit obligations as of the date of the employer’s fiscal year–end statement of financial position is effective for fiscal years ending after December 15, 2008. The company is in the process of evaluating the impact of the adoption of this interpretation on the company’s results of operations and financial condition.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

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

		3Q 2006				3Q 2005				$ Change				Change
(Dollars in millions, except earnings per share)
Net sales		$	1,272.9			$	1,258.1			$	14.8				1.2	%
Net income			46.5				39.8				6.7				16.8	%
Earnings per share — diluted		$	0.49			$	0.43			$	0.06				14.0	%
Average number of shares — diluted			94,376,937				92,821,344				—				1.7	%

		YTD 2006				YTD 2005				$ Change				Change
(Dollars in millions, except earnings per share)
Net sales		$	4,008.0			$	3,887.4			$	120.6				3.1	%
Net income			187.2				165.4				21.8				13.2	%
Earnings per share — diluted		$	1.99			$	1.79			$	0.20				11.2	%
Average number of shares — diluted			94,238,413				92,181,013				—				2.2	%

Net sales for the third quarter of 2006 were $1.27 billion compared to $1.26 billion in the third quarter of 2005, an increase of 1.2%. For the third quarter of 2006, earnings per diluted share were $0.49 compared to $0.43 per diluted share for the third quarter of 2005.

Net sales for the first nine months of 2006 were $4.0 billion compared to $3.9 billion for the first nine months of 2005, an increase of 3.1%. For the first nine months of 2006, earnings per diluted share were $1.99 compared to $1.79 per diluted share for the same period last year.

The company’s third 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 the remainder of 2006 should drive year-over-year volume increases.

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. Project ONE is a five-year program, which commenced in 2005, designed to improve business processes and systems. The objective of Asia growth initiatives is to increase market share, influence major design centers and expand the company’s network of sources of globally competitive friction management products.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

In the third quarter of 2006, the Industrial Group’s net sales, excluding intersegment sales, increased 7.2% from the third quarter of 2005 to $501.3 million. For the first nine months of 2006, the Industrial Group’s net sales, excluding intersegment sales, increased 6.9% from the first nine months of 2005 to $1.53 billion. Most industrial end markets showed continued strength, with the highest growth in aerospace, industrial distribution and heavy industry. The Industrial Group recorded a profit in the third quarter and first nine months of 2006 of $48.2 million and $157.6 million, respectively. The Industrial Group’s profitability in the third quarter and first nine months of 2006 reflected better 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 company’s strategy for the Industrial Group is to grow in global industrial markets. In October, the company announced the investment in a new technology center in Mesa, Arizona. The new facility, which will include manufacturing and engineering functions, more than doubles the capacity of the company’s previous aerospace aftermarket operations in Gilbert, Arizona. In addition, the company is increasing capacity in plants in Romania, China and the United States producing large bore bearings to serve heavy industrial markets, and the company is expanding its line of industrial seals to include large-bore seals to provide a more complete line of friction management products to the company’s distribution channels.

The Automotive Group’s net sales of $363.6 million and $1.21 billion, respectively, for the third quarter and first nine months of 2006 declined compared to net sales in the same periods a year ago. Sales decreased primarily due to significantly lower volume, driven by reductions in vehicle production by North American original equipment manufacturers, partially offset by improved pricing. The Automotive Group recorded a loss in the third quarter and first nine months of 2006 of $26.3 million and $31.4 million, respectively. The Automotive Group’s results were negatively impacted by lower volume, leading to underutilization of manufacturing capacity, and an increase in warranty reserves, partially offset by a better sales mix, improved pricing and lower performance-based compensation.

The company’s strategy for the Automotive Group is to make structural changes to its business to return the Automotive Group to profitability. In 2005, the company disclosed detailed plans for its Automotive Group to restructure its business. These plans included the closure of its automotive engineering center in Torrington, Connecticut and its manufacturing engineering center in Norcross, Georgia. These facilities were consolidated into a new low-cost technology facility in Greenville, South Carolina. Additionally, the company announced the closure of its manufacturing facility in Clinton, South Carolina. In February 2006, the company announced plans to downsize its manufacturing plant in Vierzon, France. These restructuring plans 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.

In September 2006, the company announced further reductions in its Automotive Group workforce of approximately 700 associates. The company will announce further details of these plans once they have been finalized. These additional plans are targeted to deliver annual pretax savings of approximately $35 million by the middle of 2007, with pretax costs of approximately $25 million.

In the third quarter of 2006, the Steel Group’s net sales, excluding intersegment sales, were $408.0 million, an increase of 6.7% compared to the same period a year ago. For the first nine months of 2006, the Steel Group’s net sales, excluding intersegment sales, were $1.26 billion, an increase of 5.3% from the first nine months of 2005. The sales were driven by increased pricing and surcharges and higher demand by customers in the aerospace, service center and energy sectors, which more than offset lower automotive sales. The Steel Group recorded a profit in the third quarter and first nine months of 2006 of $63.0 million and $209.6 million, respectively. The Steel Group’s profitability for the third quarter and first nine months of 2006 increased compared to the same periods in 2005 as a result of price increases, surcharges, favorable sales mix and strong manufacturing productivity.

The company’s strategy for the Steel Group is to focus on business in markets where the company either has or can achieve product differentiation while driving profitable growth including exiting non-strategic businesses. During the third quarter, the Steel Group announced plans to invest in a new induction heat-treat line in Canton, Ohio, which will increase capacity and the ability to provide differentiated product to more customers in its global energy markets. In October 2006, the Steel Group announced plans to exit its seamless steel tube manufacturing operations located in Desford, England. The company has begun consultations with representatives of the approximately 400 associates located at the Desford facility to explore alternative

Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

solutions to closure. The company will announce the details of these plans once they have been finalized.

The Statement of Income

		3Q 2006				3Q 2005				$ Change				% Change
(Dollars in millions, and exclude intersegment sales)
Industrial Group		$	501.3			$	467.8			$	33.5				7.2	%
Automotive Group			363.6				407.9				(44.3	)			(10.9	)%
Steel Group			408.0				382.4				25.6				6.7	%
Total Company		$	1,272.9			$	1,258.1			$	14.8				1.2	%

		YTD 2006				YTD 2005				$ Change				% Change
(Dollars in millions, and exclude intersegment sales)
Industrial Group		$	1,533.4			$	1,433.8			$	99.6				6.9	%
Automotive Group			1,211.3				1,254.2				(42.9	)			(3.4	)%
Steel Group			1,263.3				1,199.4				63.9				5.3	%
Total Company		$	4,008.0			$	3,887.4			$	120.6				3.1	%

The Industrial Group’s net sales in the third quarter and first nine months of 2006 increased from the third quarter and first nine months of 2005 as a result of higher volume. Most industrial end markets showed continued strength, with the highest growth in aerospace, industrial distribution and heavy industry. The Automotive Group’s net sales in the third quarter and first nine months of 2006 decreased primarily due to significantly lower volume, driven by reductions in vehicle production by North American original equipment manufacturers, partially offset by improved pricing. The Steel Group’s net sales in the third quarter and first nine months of 2006 increased from the same periods a year ago due to higher pricing and surcharges and higher demand in the aerospace, service center and energy sectors, which were offset by lower automotive sales.

Gross Profit:

		3Q 2006				3Q 2005				$ Change				Change
(Dollars in millions)
Gross profit		$	248.5			$	252.4			$	(3.9	)			(1.5	)%
Gross profit % to net sales			19.5	%			20.1	%			—			(60		)bps
Rationalization expenses included in cost of products sold		$	3.4			$	3.0			$	0.4				13.3	%

		YTD 2006				YTD 2005				$ Change				Change
(Dollars in millions)
Gross profit		$	848.9			$	801.1			$	47.8				6.0	%
Gross profit % to net sales			21.2	%			20.6	%			—			60		bps
Rationalization expenses included in cost of products sold		$	11.4			$	10.2			$	1.2				11.8	%

Gross profit decreased in the third quarter of 2006 primarily due to the impact of significantly lower volume in the Automotive Group, driven by reductions in vehicle production by North American original equipment manufacturers, leading to underutilization of manufacturing capacity. The impact of lower volumes in the Automotive Group more than offset favorable sales volume, price increases, and increased productivity in the company’s other businesses. Gross profit increased for the first nine months of 2006 primarily due to favorable sales volume from the Industrial and Steel businesses, price increases and increased productivity and lower pension and retiree medical expense, partially offset by the impact of lower volume in the Automotive Group.

Rationalization expenses recorded in the third quarter and first nine months of 2006 related to the rationalization of the company’s Canton, Ohio Industrial Group bearing facilities, the rationalization of certain Automotive Group domestic manufacturing facilities and costs for certain facilities in Torrington,

Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Connecticut. In the third quarter and first nine months of 2005, rationalization expenses related primarily to the rationalization of the company’s Canton, Ohio bearing facilities and costs for certain facilities in Torrington, Connecticut.

Selling, Administrative and General Expenses:

		3Q 2006				3Q 2005				$ Change				Change
(Dollars in millions)
Selling, administrative and general expenses:		$	164.0			$	163.0			$	1.0				0.6	%
Selling, administrative and general expenses % to net sales			12.9	%			13.0	%			—			(10		)bps
Rationalization expenses included in selling, administrative and general expenses		$	1.0			$	0.8			$	0.2				25.0	%

		YTD 2006				YTD 2005				$ Change				Change
(Dollars in millions)
Selling, administrative and general expenses:		$	514.5			$	488.8			$	25.7				5.3	%
Selling, administrative and general expenses % to net sales			12.8	%			12.6	%			—			20		bps
Rationalization expenses included in selling, administrative and general expenses		$	2.7			$	1.5			$	1.2				80.0	%

The increase in selling, administrative and general expenses in the third quarter of 2006 compared to the third quarter of 2005 was primarily due to higher costs associated with investments in Asia growth initiatives and Project ONE, offset by lower costs associated with performance-based compensation. The increase in selling, administrative and general expenses in the first nine months of 2006 compared to the first nine months of 2005 was primarily due to higher costs associated with investments in Asia growth initiatives and Project ONE.

In the third quarter and first nine months of 2006, the rationalization expenses, included in selling, general and administrative expenses, primarily related to the rationalization of Automotive Group manufacturing facilities. In the third quarter and first nine months of 2005, the rationalization expenses related to the rationalization of the Canton, Ohio Industrial Group bearing facilities.

Impairment and Restructuring Charges:

		3Q 2006				3Q 2005				$ Change
(Dollars in millions)
Impairment charges		$	1.1			$	—			$	1.1
Severance and related benefit costs			1.6				21.7				(20.1	)
Exit costs			—				2.8				(2.8	)
Loss on divestiture			—				—				—
Total		$	2.7			$	24.5			$	(21.8	)

		YTD 2006				YTD 2005				$ Change
(Dollars in millions)
Impairment charges		$	1.8			$	—			$	1.8
Severance and related benefit costs			8.2				21.6				(13.4	)
Exit costs			1.2				2.8				(1.6	)
Loss on divestiture			10.0				—				10.0
Total		$	21.2			$	24.4			$	(3.2	)

Industrial

In May 2004, the company announced plans to rationalize 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 million through streamlining

Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

operations and workforce reductions, with pretax costs of approximately $35 to $40 million over the next four years.

Impairment charges of $0.6 million recorded in the third quarter are associated with the Industrial Group’s rationalization plans. Exit costs of $0.4 million recorded in the first nine months of 2006 are associated with 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 $20 million as of September 30, 2006 for these restructuring plans.

Automotive

In 2005, the company disclosed detailed plans for its Automotive Group to restructure its business. The company had determined that restructuring actions were necessary to improve the Automotive Group’s performance. These plans included the closure of manufacturing facilities in Clinton, South Carolina and engineering facilities in Torrington, Connecticut and Norcross, Georgia. In February 2006, the company announced additional plans to rationalize production capacity at its Vierzon, France bearing manufacturing facility in response to changes in customer demand for 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 million to $90 million.

In September 2006, the company announced further reductions in workforce of approximately 700 associates. The company will announce further details of these plans once they have been finalized. These additional plans are targeted to deliver annual pretax savings of approximately $35 million, with expected pretax costs of approximately $25 million.

Severance and related benefit costs of $1.6 million recorded in the third quarter of 2006 are associated with the Automotive Group’s restructuring plans. Impairment charges of $0.7 million, severance and related benefit costs of $8.2 million and exit costs of $0.8 million recorded in the first nine months of 2006 are associated with the Automotive Group’s restructuring plans.

During the third quarter of 2005, $21.7 million of severance and related benefits and $2.8 million of exit costs were recorded as a result of the Automotive Group’s restructuring plans. This included $7.8 million related to curtailment of pension and postretirement benefit 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 $43 million as of September 30, 2006 for these restructuring plans.

Steel

Impairment charges of $0.5 million, related to the write-down of property, plant and equipment at one of the Steel Group’s facilities, were recorded in the third quarter of 2006.

The loss on divestiture of $10.0 million recorded in the first nine months of 2006 was due to the sale of Timken Precision Components – Europe business in June 2006.

The consolidated restructuring accrual at September 30, 2006 and December 31, 2005 is included in accounts payable and other liabilities in the Condensed Consolidated Balance Sheet.

Rollforward of Restructuring Accruals:

		9/30/2006				12/31/2005
(Dollars in millions)
Beginning balance, January 1		$	18.1			$	4.1
Expense			9.4				17.5
Payments			(8.2	)			(3.5	)
Ending balance		$	19.3			$	18.1

Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Interest Expense and Income:

		3Q 2006				3Q 2005				$ Change				% Change
(Dollars in millions)
Interest expense		$	11.7			$	12.8			$	(1.1	)			(8.6	)%
Interest income		$	0.9			$	0.9			$	—				0.0	%

		YTD 2006				YTD 2005				$ Change				% Change
(Dollars in millions)
Interest expense		$	37.5			$	39.4			$	(1.9	)			(4.8	)%
Interest income		$	3.3			$	2.2			$	1.1				50.0	%

Interest expense for the third quarter and nine months of 2006 decreased $1.1 million and $1.9 million, respectively, compared to the same periods a year ago due to lower average debt outstanding in 2006 compared to 2005. Interest income increased for the first nine months of 2006 due to higher invested cash balances and higher interest rates.

Other Income and Expense:

		3Q 2006				3Q 2005				$ Change				% Change
(Dollars in millions)
Other expense – net		$	1.9			$	4.3			$	(2.4	)			(55.8	)%

		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			11.3				12.4				(1.1	)			(8.9	)%
Other expense – net		$	8.9			$	9.4			$	(0.5	)			(5.3	)%