Timken Company - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

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

 

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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.

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,” 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-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. The adoption of SFAS No. 123(R) reduced operating income for the second quarter of 2006 by $1.5 million, reduced net income for the second quarter of 2006 by $0.9 million ($.01 per basic and diluted share), reduced operating income for the first six months 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 June 30, 2005:

The fair value for significant 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 model with the following assumptions:

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 six-month period ended June 30, 2006 is as follows:

The total intrinsic value of stock option awards exercised during the six months ended June 30, 2006 and 2005 was $9.1 million and $7.4 million, respectively. Net cash proceeds from the exercise of stock options were $14.0 million and $12.6 million for the six months ended June 30, 2006 and 2005, respectively. Income tax benefits of $3.7 million and $2.8 million were realized from stock option exercises during the six months ended June 30, 2006 and 2005, respectively.

A summary of nonvested share activity for the six-month period ended June 30, 2006 is as follows:

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

The company recognized compensation expense of $5.1 million and $3.0 million for the six-month periods ended June 30, 2006 and 2005, respectively, related to nonvested shares. As of June 30, 2006, the company had unrecognized compensation expense of $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.

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.

Short-term debt:

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 June 30, 2006, there were no outstanding borrowings under this facility. An outstanding balance related to the Asset Securitization would be reflected on the company’s Condensed Consolidated 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 June 30, 2006, there were letters of credit totaling $19.8 million, which reduced the availability under the Asset Securitization to $180.2 million.

The lines of credit of the company’s European and Asian subsidiaries provide for borrowings up to $165.6 million. At June 30, 2006, the company had borrowings outstanding of $36.1 million, which reduced the availability under these facilities to $129.5 million.

Long-term debt:

The company has a $500 million Amended and Restated Credit Agreement (Senior Credit Facility) that matures on June 30, 2010. At 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 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.

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 six months of 2006, the effective tax rate was less than the U.S. federal statutory tax rate due to tax benefits on foreign income, including the 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 reduction in the company’s tax reserves related primarily to the settlement of certain prior year tax 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 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 six months of 2005, the effective tax rate was less than the U.S. federal statutory tax rate due primarily to the earnings of certain foreign subsidiaries being taxed at a rate less than 35%, tax holidays in China and the Czech Republic, and other U.S. tax 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, 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 its Condensed Consolidated Financial Statements.

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.

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

For the three months ended June 30, 2006:

In 2005, the company announced the closure of manufacturing facilities in Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross, Georgia 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 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.

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 second quarter of 2006 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 six 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 $38 million as of June 30, 2006 for these restructuring plans.

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.

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.

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:

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.

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).

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

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

Amortization expense for intangible assets was approximately $2.7 million and $5.2 million, respectively, for the three months and six months ended June 30, 2006 and is estimated to be approximately $8.4 million annually for the next five years.

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 $20.8 million and $19.9 million at 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 six 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 $45.7 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.

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 June 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 six months ended 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.

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.

Net sales for the second quarter of 2006 were $1.39 billion compared to $1.32 billion in the second quarter of 2005, an increase of 4.8%. For the second quarter of 2006, earnings per diluted share were $0.79 compared to $0.73 per diluted share for the second 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 second 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 second quarter of 2006, the Industrial Group’s net sales, excluding intersegment sales, increased 6.3% from the second quarter of 2005 to $528.6 million. For the first six months of 2006, the Industrial Group’s net sales, excluding intersegment sales, increased 6.8% 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 and industrial

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

distribution. 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 six months of 2006 increased compared to the same periods in 2005 as a result of price increases and favorable sales mix as well as continued strong plant utilization and manufacturing productivity.

The Industrial Group’s net sales in the second quarter and first six months of 2006 increased from the second quarter and first six months of 2005 as a result of higher volume. Most industrial end markets showed continued strength, with the highest growth in aerospace and industrial distribution. The Automotive Group’s net sales in the second quarter and first six months of 2006 increased slightly compared to sales in the same periods of 2005. Higher pricing was offset by volume declines. The Steel Group’s net sales in the second quarter and first six months of 2006 increased from the same periods a year ago due to higher pricing and higher demand in the aerospace, service center and energy sectors, which more than offset lower automotive sales.

Gross profit increased in the second quarter and first six months of 2006 primarily due to favorable sales volume, price increases, increased productivity and lower pension and retiree medical expense, which offset higher manufacturing and energy costs.

Rationalization expenses recorded in the second quarter and first six 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, Connecticut. In the second quarter and first six 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.

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 six months of 2006 compared to the first six months of 2005 was primarily due 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 six months of 2006, the rationalization expenses primarily related to the rationalization of certain Automotive Group manufacturing facilities. In the second quarter and first six months of 2005, the rationalization expenses related to the rationalization of the Canton, Ohio Industrial Group bearing facilities.

In 2005, the company announced the closure of manufacturing facilities in Clinton, South Carolina and administrative facilities in Torrington, Connecticut and Norcross, Georgia 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 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.

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 $0.7 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.

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 second quarter of 2006 and 2005 is included in accounts payable and other liabilities in the Condensed Consolidated Balance Sheet.

Interest expense for the second quarter and first six months of 2006 decreased $1.2 million and $0.7 million, respectively, compared to the same periods a year ago due to lower average debt outstanding in 2006 compared to 2005. Interest income increased due to higher cash balances and higher interest rates.

In the second quarter and first six months of 2006, the gain on sale 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 converted 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 (FIN  46). In 2006, the company will wind down the joint venture. Refer to Note 10 — Equity Investments for additional discussion.

In the second quarter and first six months of 2005, the gain on sale of 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 $0.1 million and $4.4 million, respectively, in the second quarter and first six months of 2006.

For the second quarter and first six 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.

For the first six months of 2006, the effective tax rate was less than the U.S. federal statutory tax rate due to tax benefits on foreign income, including the 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 reduction in the company’s tax reserves related primarily to the settlement of certain prior year tax 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 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 six months of 2005, the effective tax rate was less than the U.S. federal statutory tax rate due primarily to the earnings of certain foreign subsidiaries being taxed at a rate less than 35%, tax holidays in China and the Czech Republic and other U.S. tax 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.

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 / 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.