LINCOLN ELECTRIC HOLDINGS, INC. 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934. |
For the quarterly period ended June 30, 2006
or
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934. |
For the transition period from to
Commission File Number 0-1402
LINCOLN ELECTRIC HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
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Ohio
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34-1860551 |
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(State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.) |
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22801 St. Clair Avenue, Cleveland, Ohio
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44117 |
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(Address of principal executive offices)
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(Zip Code) |
(216) 481-8100
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes 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 Securities Exchange Act of 1934.
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
The number of shares outstanding of the registrants common shares as of June 30, 2006 was
42,580,865.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
LINCOLN ELECTRIC HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands of dollars, except per share data)
(UNAUDITED)
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Three Months Ended June 30, |
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Six Months Ended June 30, |
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2006 |
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2005 |
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2006 |
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2005 |
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Net sales |
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$ |
502,510 |
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$ |
405,902 |
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$ |
970,904 |
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$ |
768,805 |
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Cost of goods sold |
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356,043 |
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291,951 |
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694,371 |
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556,576 |
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Gross profit |
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146,467 |
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113,951 |
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276,533 |
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212,229 |
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Selling, general & administrative
expenses |
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83,436 |
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71,919 |
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160,107 |
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138,821 |
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Rationalization charges |
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1,292 |
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2,341 |
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1,250 |
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Operating income |
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61,739 |
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42,032 |
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114,085 |
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72,158 |
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Other income (expense): |
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Interest income |
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1,400 |
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891 |
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2,594 |
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1,660 |
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Equity earnings in affiliates |
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2,160 |
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1,030 |
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2,524 |
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1,564 |
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Other income |
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176 |
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995 |
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549 |
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1,466 |
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Interest expense |
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(2,438 |
) |
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(2,186 |
) |
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(4,839 |
) |
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(3,868 |
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Total other income |
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1,298 |
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730 |
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828 |
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822 |
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Income before income taxes |
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63,037 |
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42,762 |
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114,913 |
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72,980 |
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Income taxes |
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20,418 |
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10,650 |
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35,545 |
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18,628 |
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Net income |
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$ |
42,619 |
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$ |
32,112 |
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$ |
79,368 |
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$ |
54,352 |
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Per share amounts: |
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Basic earnings per share |
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$ |
1.00 |
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$ |
0.77 |
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$ |
1.87 |
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$ |
1.31 |
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Diluted earnings per share |
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$ |
0.99 |
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$ |
0.77 |
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$ |
1.85 |
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$ |
1.30 |
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Cash dividends declared per share |
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$ |
0.19 |
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$ |
0.18 |
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$ |
0.38 |
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$ |
0.36 |
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See notes to these consolidated financial statements.
3
LINCOLN ELECTRIC HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands of dollars)
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June 30, |
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December 31, |
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2006 |
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2005 |
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(UNAUDITED) |
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(NOTE A) |
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ASSETS |
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CURRENT ASSETS |
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Cash and cash equivalents |
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$ |
125,427 |
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$ |
108,007 |
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Accounts receivable (less allowance for doubtful accounts of $8,002 in 2006;
$7,583 in 2005) |
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304,161 |
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242,093 |
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Inventories |
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Raw materials |
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90,149 |
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80,047 |
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In-process |
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51,123 |
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33,707 |
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Finished goods |
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189,771 |
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161,991 |
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331,043 |
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275,745 |
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Deferred income taxes |
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9,623 |
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9,069 |
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Other current assets |
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50,864 |
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41,720 |
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TOTAL CURRENT ASSETS |
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821,118 |
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676,634 |
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PROPERTY, PLANT AND EQUIPMENT |
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Land |
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25,183 |
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23,034 |
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Buildings |
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205,290 |
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196,639 |
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Machinery and equipment |
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552,183 |
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536,834 |
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782,656 |
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756,507 |
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Less: accumulated depreciation and amortization |
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428,271 |
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415,974 |
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354,385 |
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340,533 |
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OTHER ASSETS |
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Prepaid pension costs |
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1,913 |
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1,956 |
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Equity investments in affiliates |
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43,175 |
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39,673 |
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Intangibles, net |
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41,122 |
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39,232 |
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Goodwill |
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25,910 |
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25,596 |
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Long-term investments |
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28,194 |
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27,905 |
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Other |
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7,991 |
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9,632 |
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148,305 |
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143,994 |
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TOTAL ASSETS |
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$ |
1,323,808 |
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$ |
1,161,161 |
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See notes to these consolidated financial statements.
4
LINCOLN ELECTRIC HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands of dollars, except share data)
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June 30, |
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December 31, |
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2006 |
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2005 |
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(UNAUDITED) |
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(NOTE A) |
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LIABILITIES AND SHAREHOLDERS EQUITY |
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CURRENT LIABILITIES |
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Amounts due banks |
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$ |
3,662 |
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$ |
7,143 |
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Trade accounts payable |
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152,754 |
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121,917 |
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Accrued employee compensation and benefits |
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75,541 |
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40,658 |
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Accrued expenses |
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20,235 |
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17,597 |
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Accrued taxes, including income taxes |
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47,794 |
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38,342 |
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Accrued pensions, current |
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21,279 |
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28,662 |
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Dividends payable |
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8,084 |
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8,014 |
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Other current liabilities |
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33,907 |
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30,289 |
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Current portion of long-term debt |
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41,453 |
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1,020 |
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TOTAL CURRENT LIABILITIES |
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404,709 |
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293,642 |
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Long-term debt, less current portion |
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111,940 |
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157,853 |
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Accrued pensions |
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15,005 |
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14,786 |
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Deferred income taxes |
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18,162 |
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17,752 |
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Other long-term liabilities |
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30,170 |
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24,834 |
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SHAREHOLDERS EQUITY |
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Preferred Shares, without par value at stated capital amount: |
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Authorized - 5,000,000 shares as of June 30, 2006 and December 31,
2005; Issued and Outstanding none |
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Common shares, without par value at stated capital amount: |
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Authorized - 120,000,000 shares as of June 30, 2006 and December 31,
2005; Issued - 49,282,306 shares as of June 30, 2006 and December 31,
2005; Outstanding - 42,580,865 shares as of June 30,2006 and 42,181,021
shares as of December 31, 2005 |
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4,928 |
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4,928 |
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Additional paid-in capital |
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132,111 |
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125,925 |
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Retained earnings |
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827,954 |
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764,748 |
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Accumulated other comprehensive loss |
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(76,862 |
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(91,276 |
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Treasury shares, at cost - 6,701,441 as of June 30, 2006 and 7,101,285
shares as of December 31, 2005 |
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(144,309 |
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(152,031 |
) |
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TOTAL SHAREHOLDERS EQUITY |
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743,822 |
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652,294 |
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TOTAL LIABILITIES AND SHAREHOLDERS EQUITY |
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$ |
1,323,808 |
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$ |
1,161,161 |
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See notes to these consolidated financial statements.
5
LINCOLN ELECTRIC HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands of dollars)
UNAUDITED
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Six Months Ended June 30, |
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2006 |
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2005 |
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OPERATING ACTIVITIES |
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Net income |
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$ |
79,368 |
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$ |
54,352 |
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Adjustments to reconcile net income to net cash provided by
operating activities: |
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Rationalization charges |
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2,341 |
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1,250 |
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Depreciation and amortization |
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22,985 |
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20,866 |
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Equity earnings of affiliates, net |
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(1,591 |
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(1,564 |
) |
Deferred income taxes |
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(34 |
) |
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1,600 |
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Stock-based compensation |
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1,938 |
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1,897 |
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Amortization of terminated interest rate swaps |
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(1,050 |
) |
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(1,050 |
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Other non-cash items, net |
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1,624 |
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216 |
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Changes in operating assets and liabilities: |
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Increase in accounts receivable |
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(55,800 |
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(22,539 |
) |
Increase in inventories |
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(49,428 |
) |
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(25,055 |
) |
(Increase) decrease in other current assets |
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(8,072 |
) |
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1,204 |
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Increase in accounts payable |
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27,824 |
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15,575 |
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Increase in other current liabilities |
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46,812 |
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31,402 |
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Contributions to pension plans |
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(16,397 |
) |
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(21,466 |
) |
Increase in accrued pensions |
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8,637 |
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7,319 |
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Net change in other long-term assets and liabilities |
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(1,827 |
) |
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(2,166 |
) |
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NET CASH PROVIDED BY OPERATING ACTIVITIES |
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57,330 |
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|
61,841 |
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INVESTING ACTIVITIES |
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Capital expenditures |
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(32,261 |
) |
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(21,435 |
) |
Acquisitions of businesses, net of cash acquired |
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(95 |
) |
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(70,704 |
) |
Proceeds from sale of fixed assets |
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641 |
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|
846 |
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Sales of marketable securities |
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65,500 |
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Purchases of marketable securities |
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(15,000 |
) |
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NET CASH USED BY INVESTING ACTIVITIES |
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(31,715 |
) |
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(40,793 |
) |
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FINANCING ACTIVITIES |
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Proceeds from short-term borrowings |
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2,035 |
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Payments on short-term borrowings |
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(925 |
) |
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|
(130 |
) |
Amounts due banks, net |
|
|
(7,138 |
) |
|
|
4,114 |
|
Payments on long-term borrowings |
|
|
(1,449 |
) |
|
|
(14,993 |
) |
Proceeds from exercise of stock options |
|
|
8,952 |
|
|
|
7,592 |
|
Tax benefit from the exercise of stock options |
|
|
3,051 |
|
|
|
|
|
Purchase of shares for treasury |
|
|
|
|
|
|
(12,804 |
) |
Cash dividends paid to shareholders |
|
|
(16,077 |
) |
|
|
(14,985 |
) |
|
|
|
|
|
|
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NET CASH USED BY FINANCING ACTIVITIES |
|
|
(11,551 |
) |
|
|
(31,206 |
) |
Effect of exchange rate changes on cash and cash equivalents |
|
|
3,356 |
|
|
|
(2,277 |
) |
|
|
|
|
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|
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INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |
|
|
17,420 |
|
|
|
(12,435 |
) |
Cash and cash equivalents at beginning of year |
|
|
108,007 |
|
|
|
92,819 |
|
|
|
|
|
|
|
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CASH AND CASH EQUIVALENTS AT END OF PERIOD |
|
$ |
125,427 |
|
|
$ |
80,384 |
|
|
|
|
|
|
|
|
See notes to these consolidated financial statements.
6
LINCOLN ELECTRIC HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands of dollars except share and per share data)
June 30, 2006
NOTE A BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Lincoln Electric Holdings, Inc.
(the Company) have been prepared in accordance with accounting principles generally accepted in
the United States for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, these consolidated financial statements do not include
all of the information and notes required by accounting principles generally accepted in the United
States for complete financial statements. However, in the opinion of management, these consolidated
financial statements contain all the adjustments (consisting of normal recurring accruals)
considered necessary to present fairly the financial position, results of operations and changes in
cash flows for the interim periods. Operating results for the six months ended June 30, 2006 are
not necessarily indicative of the results to be expected for the year ending December 31, 2006.
The balance sheet at December 31, 2005 has been derived from the audited financial statements at
that date, but does not include all of the information and notes required by accounting principles
generally accepted in the United States for complete financial statements. For further information,
refer to the consolidated financial statements and notes thereto included in the Companys Annual
Report on Form 10-K for the year ended December 31, 2005.
Certain reclassifications have been made to the prior year financial statements to conform to
current year classifications.
NOTE B STOCK-BASED COMPENSATION
On April 28, 2006, the shareholders of the Company approved the 2006 Equity and Performance
Incentive Plan (EPI Plan) which replaces the 1998 Stock Plan, as amended in May 2003. The EPI
Plan provides for the granting of options, appreciation rights, restricted shares, restricted stock
units and performance-based awards up to an aggregate of 3,000,000 of the Companys common shares.
There were 230 and 500 options granted during the six months ended June 30, 2006 and 2005,
respectively. There were no TARs, restricted shares or deferred shares granted during the six
months ended June 30, 2006 and 2005.
In addition, on April 28, 2006, the shareholders of the Company approved the 2006 Stock Plan for
Non-Employee Directors (Director Plan). The Director Plan provides for the granting of options,
restricted shares and restricted stock units up to an aggregate of 300,000 of the Companys common
shares.
The Company issued 365,867 and 365,656 shares of common stock from treasury upon exercise of
employee stock options during the six months ended June 30, 2006 and 2005, respectively.
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share-Based Payment, which is a
revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees. Generally, the approach in SFAS No.
123(R) is similar to the approach described in SFAS 123. SFAS No. 123(R) requires all share-based
payments to employees, including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an alternative. The Company
adopted SFAS No. 123(R) on January 1, 2006 using the modified-prospective method. The adoption of
the standard did not have a material impact on the Companys financial statements as the Company
previously adopted fair value accounting under SFAS No. 123 on January 1, 2003.
Prior to 2003, the Company applied the intrinsic value method permitted under SFAS No. 123, as
defined in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees and related interpretations, in accounting for the Companys stock option plans.
Accordingly, no compensation cost was recognized in years prior to adoption.
Total stock-based compensation expense recognized in the consolidated statement of earnings for the
six months ended June 30, 2006 and 2005 was $1,938 and $1,897, respectively. The related tax
benefit for the six months ended June 30, 2006 and 2005 was $741 and $725, respectively.
The following table sets forth the pro forma disclosure of net income and earnings per share as if
compensation expense had been recognized for the fair value of options granted prior to January 1,
2003 (date of adoption of SFAS No. 123). All stock options granted prior to January 1, 2003 were
fully vested as of December 31, 2005. Therefore, no pro-forma disclosure is
7
necessary for periods ending after December 31, 2005. For purposes of this pro forma disclosure,
the estimated fair value of the options granted prior to January 1, 2003 was determined using the
Black-Scholes option pricing model and is amortized ratably over the vesting periods.
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2005 |
|
|
2005 |
|
Net income, as reported |
|
$ |
32,112 |
|
|
$ |
54,352 |
|
Add: Stock-based employee compensation expense included
in reported net income, net of related tax effects |
|
|
385 |
|
|
|
1,169 |
|
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards
granted, net of related tax effects |
|
|
(488 |
) |
|
|
(1,853 |
) |
|
|
|
|
|
|
|
Pro forma net income |
|
$ |
32,009 |
|
|
$ |
53,668 |
|
|
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
Basic, as reported |
|
$ |
0.77 |
|
|
$ |
1.31 |
|
Basic, pro forma |
|
$ |
0.77 |
|
|
$ |
1.29 |
|
Diluted, as reported |
|
$ |
0.77 |
|
|
$ |
1.30 |
|
Diluted, pro forma |
|
$ |
0.76 |
|
|
$ |
1.28 |
|
Weighted-average number of shares outstanding
(in thousands): |
|
|
|
|
|
|
|
|
Basic |
|
|
41,477 |
|
|
|
41,577 |
|
Diluted |
|
|
41,845 |
|
|
|
41,966 |
|
As of June 30, 2006, total unrecognized stock-based compensation expense related to nonvested
stock options, restricted shares and deferred shares was $4,947, which is expected to be recognized
over a weighted average period of approximately 27 months.
The following table summarizes nonvested stock options, TARs, restricted and deferred shares for
the six months ended June 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, 2006 |
|
|
|
Number of Options, |
|
|
Weighted-Average |
|
|
|
TARs, Restricted |
|
|
Grant Date Fair |
|
|
|
and Deferred Shares |
|
|
Value |
|
Balance at beginning of year |
|
|
746,549 |
|
|
$ |
10.59 |
|
Granted |
|
|
230 |
|
|
$ |
11.11 |
|
Vested |
|
|
10,300 |
|
|
$ |
7.47 |
|
Forfeited |
|
|
900 |
|
|
$ |
9.57 |
|
|
|
|
|
|
|
|
|
Balance at end of period |
|
|
735,579 |
|
|
$ |
10.64 |
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value of options outstanding at June 30, 2006, based on the Companys
closing stock price of $62.65 as of the last business day of the period ended June 30, 2006, which
would have been received by the optionees had all options been exercised on that date was $55,342.
The aggregate intrinsic value of options exercisable at June 30, 2006, based on the Companys
closing stock price of $62.65 as of the last business day of the period ended June 30, 2006, which
would have been received by the optionees had all options exercisable been exercised on that date was $36,267. The
total intrinsic value of stock options exercised during the six months ended June 30, 2006 and 2005
was $9,073 and $3,939, respectively. Intrinsic value is the amount by which the fair value of the
underlying stock exceeds the exercise price of the options.
Prior to the adoption of SFAS 123(R) the Company presented all tax benefits resulting from the
exercise of stock options as operating cash inflows in the consolidated statements of cash flows,
in accordance with the provisions of the Emerging Issues Task Force (EITF) Issue No. 00-15,
Classification in the Statement of Cash Flows of the Income Tax Benefit Received by
8
a Company upon Exercise of a Nonqualified Employee Stock Option. SFAS 123(R) requires the benefits of tax
deductions in excess of the compensation cost recognized for those options to be classified as
financing cash inflows rather than operating cash inflows, on a prospective basis. This amount was
$3,051 for the six months ended June 30, 2006 and is shown as Tax benefit from the exercise of
stock options in the consolidated statement of cash flows.
NOTE C GOODWILL AND INTANGIBLE ASSETS
There were no impairments of goodwill during the first half of 2006. Goodwill totaled $25,910 and
$25,596 at June 30, 2006 and December 31, 2005, respectively. Goodwill by segment at June 30, 2006
was $9,382 for North America, $4,848 for Europe and $11,680 for Other countries.
Gross intangible assets other than goodwill as of June 30, 2006 and December 31, 2005 were $56,336
and $52,814, respectively, and included accumulated amortization of $15,214 and $13,582,
respectively. Aggregate amortization expense was $299 and $74 for the six months ended June 30,
2006 and 2005, respectively. Included in the previously mentioned total are intangible assets other
than goodwill with indefinite lives totaling $9,977 at June 30, 2006 and December 31, 2005,
respectively.
NOTE D EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share (dollars and
shares in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
42,619 |
|
|
$ |
32,112 |
|
|
$ |
79,368 |
|
|
$ |
54,352 |
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share
Weighted-average shares outstanding |
|
|
42,514 |
|
|
|
41,477 |
|
|
|
42,397 |
|
|
|
41,577 |
|
Effect of dilutive securities Employee stock options |
|
|
494 |
|
|
|
368 |
|
|
|
477 |
|
|
|
389 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per share Adjusted
weighted-average shares outstanding |
|
|
43,008 |
|
|
|
41,845 |
|
|
|
42,874 |
|
|
|
41,966 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share |
|
$ |
1.00 |
|
|
$ |
0.77 |
|
|
$ |
1.87 |
|
|
$ |
1.31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share |
|
$ |
0.99 |
|
|
$ |
0.77 |
|
|
$ |
1.85 |
|
|
$ |
1.30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE E COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net income |
|
$ |
42,619 |
|
|
$ |
32,112 |
|
|
$ |
79,368 |
|
|
$ |
54,352 |
|
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gain (loss) on derivatives designated and
qualified as cash flow hedges, net of tax |
|
|
1,519 |
|
|
|
(135 |
) |
|
|
653 |
|
|
|
(596 |
) |
Currency translation adjustment |
|
|
10,199 |
|
|
|
(9,820 |
) |
|
|
13,761 |
|
|
|
(18,450 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
$ |
54,337 |
|
|
$ |
22,157 |
|
|
$ |
93,782 |
|
|
$ |
35,306 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE F INVENTORY VALUATION
Inventories are valued at the lower of cost or market. For most domestic inventories, cost is
determined principally by the last-in, first-out (LIFO) method, and for non-U.S. inventories, cost
is determined by the first-in, first-out (FIFO) method. The valuation of inventory under the LIFO
method is made at the end of each year based on inventory levels. Accordingly, interim LIFO
calculations, by necessity, are based on estimates of expected year-end inventory levels and costs
and are subject to final year-end LIFO inventory calculations. The excess of current cost over LIFO
cost amounted to $67,424 at June 30, 2006 and $62,900 at December 31, 2005.
9
NOTE G ACCRUED EMPLOYEE COMPENSATION AND BENEFITS
Accrued employee compensation and benefits at June 30, 2006 and June 30, 2005 include accruals for
year-end bonuses and related payroll taxes of $45,774 and $33,453, respectively, related to Lincoln
employees worldwide. The payment of bonuses is discretionary and is subject to approval by the
Board of Directors. A majority of annual bonuses are paid in December resulting in an increasing
bonus accrual during the Companys fiscal year. The increase in the accrual from June 30, 2005 to
June 30, 2006 is due to the increase in profitability of the Company.
NOTE H SEGMENT INFORMATION
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
America |
|
|
Europe |
|
|
Countries |
|
|
Eliminations |
|
|
Consolidated |
|
Three months ended June 30, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales to unaffiliated customers |
|
$ |
335,717 |
|
|
$ |
92,355 |
|
|
$ |
74,438 |
|
|
$ |
|
|
|
$ |
502,510 |
|
Inter-segment sales |
|
|
25,669 |
|
|
|
6,596 |
|
|
|
3,815 |
|
|
|
(36,080 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
361,386 |
|
|
$ |
98,951 |
|
|
$ |
78,253 |
|
|
$ |
(36,080 |
) |
|
$ |
502,510 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before interest and income taxes |
|
$ |
47,428 |
|
|
$ |
8,735 |
|
|
$ |
7,928 |
|
|
$ |
(16 |
) |
|
$ |
64,075 |
|
Interest income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,400 |
|
Interest expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,438 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
63,037 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales to unaffiliated customers |
|
$ |
265,359 |
|
|
$ |
78,735 |
|
|
$ |
61,808 |
|
|
$ |
|
|
|
$ |
405,902 |
|
Inter-segment sales |
|
|
16,748 |
|
|
|
6,045 |
|
|
|
3,467 |
|
|
|
(26,260 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
282,107 |
|
|
$ |
84,780 |
|
|
$ |
65,275 |
|
|
$ |
(26,260 |
) |
|
$ |
405,902 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before interest and income taxes |
|
$ |
30,946 |
|
|
$ |
7,346 |
|
|
$ |
5,582 |
|
|
$ |
183 |
|
|
$ |
44,057 |
|
Interest income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
891 |
|
Interest expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,186 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
42,762 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales to unaffiliated customers |
|
$ |
655,912 |
|
|
$ |
174,668 |
|
|
$ |
140,324 |
|
|
$ |
|
|
|
$ |
970,904 |
|
Inter-segment sales |
|
|
46,198 |
|
|
|
12,984 |
|
|
|
7,700 |
|
|
|
(66,882 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
702,110 |
|
|
$ |
187,652 |
|
|
$ |
148,024 |
|
|
$ |
(66,882 |
) |
|
$ |
970,904 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before interest and income taxes |
|
$ |
86,445 |
|
|
$ |
17,808 |
|
|
$ |
12,656 |
|
|
$ |
249 |
|
|
$ |
117,158 |
|
Interest income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,594 |
|
Interest expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,839 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
114,913 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
899,927 |
|
|
$ |
318,200 |
|
|
$ |
249,643 |
|
|
$ |
(143,962 |
) |
|
$ |
1,323,808 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales to unaffiliated customers |
|
$ |
496,877 |
|
|
$ |
158,656 |
|
|
$ |
113,272 |
|
|
$ |
|
|
|
$ |
768,805 |
|
Inter-segment sales |
|
|
28,365 |
|
|
|
12,108 |
|
|
|
5,727 |
|
|
|
(46,200 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
525,242 |
|
|
$ |
170,764 |
|
|
$ |
118,999 |
|
|
$ |
(46,200 |
) |
|
$ |
768,805 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before interest and income taxes |
|
$ |
53,097 |
|
|
$ |
13,575 |
|
|
$ |
8,203 |
|
|
$ |
313 |
|
|
$ |
75,188 |
|
Interest income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,660 |
|
Interest expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,868 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
72,980 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
738,911 |
|
|
$ |
262,829 |
|
|
$ |
211,047 |
|
|
$ |
(104,778 |
) |
|
$ |
1,108,009 |
|
The Europe
segment includes rationalization charges of $1,292 for the three
months ended June 30, 2006 and $2,341 and $1,250 for the six months
ended June 30, 2006 and 2005, respectively.
10
NOTE I RATIONALIZATION CHARGES
In 2005, the Company committed to a plan to rationalize manufacturing operations (the Ireland
Rationalization) at Harris Calorific Limited (Harris Ireland). In connection with the Ireland
Rationalization, the Company intends to transfer all manufacturing currently taking place at Harris
Ireland to a lower cost facility in Eastern Europe and sell the facility in Ireland.
The Company expects to incur a charge of approximately $5,000 (pre-tax) associated with employee
severance costs, equipment relocation, employee retention and professional services. This charge
does not reflect the impact of anticipated proceeds from the planned sale of the facility in
Ireland. A total of 66 employees will be impacted by the Ireland Rationalization.
The Company has incurred a total of $2,852 (pre-tax) in charges related to this plan of which
$2,341 (pre-tax) was incurred in the first half of 2006. Cash expenditures are expected to be paid
throughout 2006 with the expected completion of the Ireland Rationalization occurring in the fourth
quarter of 2006. As of June 30, 2006, the Company has recorded a liability of $2,948 for charges
related to these efforts.
In 2004, the Company committed to a plan to rationalize machine manufacturing (the French
Rationalization) at Lincoln Electric France, S.A.S. (LE France). In connection with the French
Rationalization, the Company transferred machine manufacturing performed at LE France to other
facilities. The Company committed to the French Rationalization as a result of the regions
decreased demand for locally-manufactured machines. In connection with the French Rationalization,
the Company incurred a charge of $2,292 (pre-tax), of which $1,188 (pre-tax) was incurred in the
first half of 2005. Employee severance costs associated with the termination of approximately 40 of
LE Frances 179 employees were $2,123 (pre-tax). Costs not relating to employee severance primarily
included warehouse relocation costs and professional fees.
NOTE J ACQUISITIONS
On April 29, 2005, the Company acquired all of the outstanding stock of J.W. Harris Co., Inc.
(J.W. Harris), a privately held brazing and soldering alloys manufacturer headquartered in Mason,
Ohio for approximately $71,000 in cash and $15,000 of assumed debt. The Company began consolidating
the results of J.W. Harris operations in the Companys consolidated financial statements in May
2005.
The purchase price allocation for this investment resulted in goodwill of $9,103. Included in the
aggregate purchase price is $4,160 deposited in escrow accounts. Distribution of amounts in escrow
is dependent on resolution of pre-closing contingencies. Amounts remaining in escrow as of the
second anniversary of the closing date will be distributed to the former shareholders and will
result in adjustments to the purchase price allocation.
This acquisition has provided the Company with a strong complementary metals-joining technology and
a leading position in the brazing and soldering alloys market. J.W. Harris has manufacturing plants
in Ohio and Rhode Island and an international distribution center located in Spain.
NOTE K CONTINGENCIES AND GUARANTEE
The Company, like other manufacturers, is subject from time to time to a variety of civil and
administrative proceedings arising in the ordinary course of business. Such claims and litigation
include, without limitation, product liability claims and health, safety and environmental claims,
some of which relate to cases alleging asbestos and manganese induced illnesses. The Company
believes it has meritorious defenses to these claims and intends to contest such suits vigorously.
Although defense costs have been increasing, all other costs associated with these claims,
including indemnity charges and settlements, have been immaterial to the Companys consolidated
financial statements. Based on the Companys historical experience in litigating these claims,
including a significant number of dismissals, summary judgments and defense verdicts in many cases
and immaterial settlement amounts, as well as the Companys current assessment of the underlying
merits of the claims and applicable insurance, the Company believes resolution of these claims and
proceedings, individually or in the aggregate (exclusive of defense costs), will not have a
material adverse impact upon the Companys consolidated financial statements.
The Company has provided a guarantee on loans for an unconsolidated joint venture of approximately
$6,250 at June 30, 2006. The guarantee is provided on three separate loan agreements. Two loans are
for $2,000 each, one which expires in October 2006 and the other expiring in May 2007. The other
loan is for approximately $2,250 and expires in October 2010. The loans were undertaken to fund the
joint ventures working capital and capital improvement needs. The Company would
11
become liable for
any unpaid principal and accrued interest if the joint venture were to default on payment at the
respective maturity dates. The Company believes the likelihood is remote that material payment will
be required under these arrangements because of the current financial condition of the joint
venture.
NOTE L PRODUCT WARRANTY COSTS
The Company accrues for product warranty claims based on historical experience and the expected
material and labor costs to provide warranty service. The accrual for product warranty claims is
included in Other current liabilities. Warranty accruals have increased as a result of the effect
of higher sales levels. The changes in the carrying amount of product warranty accruals for the six
months ended June 30, 2006 and 2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
|
2006 |
|
|
2005 |
|
Balance at beginning of year |
|
$ |
7,728 |
|
|
$ |
6,800 |
|
Charged to costs and expenses |
|
|
4,991 |
|
|
|
4,526 |
|
Deductions |
|
|
(4,092 |
) |
|
|
(3,848 |
) |
|
|
|
|
|
|
|
Balance at end of period |
|
$ |
8,627 |
|
|
$ |
7,478 |
|
|
|
|
|
|
|
|
Warranty expense was 0.5% and 0.6% of sales for the six months ended June 30, 2006 and 2005,
respectively.
NOTE M DEBT
During March 2002, the Company issued Senior Unsecured Notes (the Notes) totaling $150,000
through a private placement. The Notes have original maturities ranging from five to ten years with
a weighted-average interest rate of 6.1% and an average tenure of eight years. Interest is payable
semi-annually in March and September. The proceeds are being used for general corporate purposes,
including acquisitions. The proceeds are generally invested in short-term, highly liquid
investments. The Notes contain certain affirmative and negative covenants, including restrictions
on asset dispositions and financial covenants (interest coverage and funded debt-to-EBITDA
ratios). As of June 30, 2006, the Company was in compliance with all of its debt covenants.
The maturity and interest rates of the Notes follow (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount Due |
|
Matures |
|
Interest Rate |
Series A
|
|
$ |
40,000 |
|
|
March 2007
|
|
|
5.58 |
% |
Series B
|
|
$ |
30,000 |
|
|
March 2009
|
|
|
5.89 |
% |
Series C
|
|
$ |
80,000 |
|
|
March 2012
|
|
|
6.36 |
% |
During March 2002, the Company entered into floating rate interest rate swap agreements
totaling $80,000, to convert a portion of the outstanding Notes from fixed to floating rates. These
swaps were designated as fair value hedges, and as such, the gain or loss on the derivative
instrument, as well as the offsetting gain or loss on the hedged item attributable to the hedged
risk were recognized in earnings. Net payments or receipts under these agreements were recognized
as adjustments to interest expense. In May 2003, these swap agreements were terminated. The gain on
the termination of these swaps was $10,613, and has been deferred and is being amortized as an
offset to interest expense over the remaining life of the instrument. The amortization of this gain
reduced interest expense by $1,050 in the first half of 2006 and 2005 and is expected to reduce
annual interest expense by $2,117 in 2006 and $1,121 in 2007. At June 30, 2006, $3,901 remains to
be amortized of which $3,150 is included in the balance sheet caption Long-term debt, less current
portion and $751 is included in the balance sheet caption Current portion of long-term debt. The
financing costs related to the $150,000 private placement are further reduced by the interest
income earned on the cash balances. These short-term, highly liquid investments earned
approximately $1,335 during the first half of 2006.
During July 2003 and April 2004, the Company entered into various floating rate interest rate swap
agreements totaling $110,000, to convert a portion of the outstanding Notes from fixed to floating
rates based on the London Inter-Bank Offered Rate (LIBOR), plus a spread of between 179.75 and
226.50 basis points. The variable rates are reset every six months, at which time payment or
receipt of interest will be settled. These swaps are designated as fair value hedges, and as such,
the gain or loss on the derivative instrument, as well as the offsetting gain or loss on the hedged
item attributable to the hedged risk are recognized in earnings. Net payments or receipts under
these agreements are recognized as adjustments to interest expense. The fair value of these swaps
is included in the balance sheet caption Other long-term liabilities with a corresponding
decrease in Long-term debt. The fair value of these swaps at June 30, 2006 was $6,202.
12
Terminated swaps have increased the value of the Series A Notes from $40,000 to $40,751 as of June
30, 2006. Active and terminated swaps have increased the value of the Series B Notes from $30,000
to $30,533 and decreased the value of the Series C Notes from $80,000 to $76,415 as of June 30,
2006. The weighted-average effective rate on the Notes, net of the impact of active and terminated
swaps, was 5.11% for the first half of 2006.
NOTE N NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes an interpretation of FASB Statement No. 109. FIN 48 clarifies the recognition threshold
and measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company will adopt this
interpretation as required. The Company is currently evaluating the impact of this Interpretation
on its financial statements.
In June 2005, the Financial Accounting Standards Board (FASB) issued Staff Position No. 143-1
Accounting for Electronic Equipment Waste Obligations (FSP 143-1), which provides guidance on
the accounting for obligations associated with the Directive on Waste Electrical and Electronic
Equipment (the WEEE Directive), which was adopted by the European Union. FSP 143-1 provides
guidance on accounting for the effects of the WEEE Directive with respect to historical waste and
waste associated with products on the market on or before August 13, 2005. FSP 143-1 requires
commercial users to account for their WEEE obligation as an asset retirement liability in
accordance with FASB Statement No. 143, Accounting for Asset Retirement Obligations. FSP 143-1
was required to be applied to the later of the first reporting period ending after June 8, 2005 or
the date of the adoption of the WEEE Directive into law by the applicable European Union member
country. The WEEE Directive has been adopted into law by the majority of European Union member
countries in which the Company has significant operations. The Company adopted the provisions of
FSP 143-1 as it relates to these countries with no material impact to its financial statements. The
Company will apply the guidance of FSP 143-1 as it relates to the remaining European Union member
countries in which it operates when those countries have adopted the WEEE Directive into law.
In March 2005, the FASB issued FASB Interpretation No. 47 (FIN 47) Accounting for Conditional
Asset Retirement Obligations an interpretation of FASB Statement No. 143. This interpretation
defines the term conditional asset retirement obligation as used in FASB Statement No. 143,
Accounting for Asset Retirement Obligations, as a legal obligation to perform an asset retirement
activity, in which the timing, and/or method of settlement are conditional on a future event that
may or may not be within the control of the entity. FIN 47 requires that an obligation to perform
an asset retirement activity is unconditional even though uncertainty exists about the timing
and/or method of settlement. FIN 47 also clarifies when an entity would have sufficient information
to reasonably estimate the fair value of an asset retirement. The Company adopted the provisions of
FIN 47 as of December 31, 2005 with no material impact to its financial statements.
In November 2004, the FASB issued SFAS No. 151 Inventory Costs an amendment of ARB No. 43,
Chapter 4. This Statement amends the guidance in Accounting Research Bulletin No. 43 to require
idle facility expense, freight, handling costs, and wasted material (spoilage) be recognized as
current-period charges. In addition, SFAS No. 151 requires the allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of production facilities. SFAS
No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15,
2005. The Company adopted SFAS No. 151 on January 1, 2006 with no material impact to its financial
statements.
NOTE O RETIREMENT ANNUITY PLANS
A summary of the components of net periodic benefit costs is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Service cost benefits earned during the period |
|
$ |
4,813 |
|
|
$ |
4,354 |
|
|
$ |
9,680 |
|
|
$ |
8,857 |
|
Interest cost on projected benefit obligation |
|
|
9,457 |
|
|
|
8,891 |
|
|
|
18,997 |
|
|
|
18,053 |
|
Expected return on plan assets |
|
|
(12,545 |
) |
|
|
(11,729 |
) |
|
|
(25,151 |
) |
|
|
(23,603 |
) |
Amortization of prior service cost |
|
|
282 |
|
|
|
743 |
|
|
|
563 |
|
|
|
1,349 |
|
Amortization of net loss |
|
|
2,726 |
|
|
|
2,020 |
|
|
|
5,260 |
|
|
|
3,893 |
|
Termination benefits |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
177 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net pension cost of defined benefit plans |
|
$ |
4,733 |
|
|
$ |
4,279 |
|
|
$ |
9,349 |
|
|
$ |
8,726 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13
The Company previously disclosed in its financial statements for the year ended December 31,
2005, that it expected to voluntarily contribute $30,000 to its U.S. pension plans during 2006. As
of June 30, 2006, $15,000 has been contributed.
In the first quarter of 2006, the Company modified its retirement benefit programs whereby
employees of its U.S. company hired on or after January 1, 2006 will be covered under a newly
enhanced 401(k) defined contribution plan. In the second quarter of 2006, current employees of the
U.S. company made an election to either remain in the companys existing retirement programs or
switch to new programs offering enhanced defined contribution benefits, improved vacation and a
reduced defined benefit. The Company does not expect a significant change in retirement costs
immediately after the change, however, the Company does expect cost savings in future years as a
result of reduced benefits to be accrued for employees hired on or after January 1, 2006.
NOTE P INCOME TAXES
The effective income tax rates of 30.9% and 25.5% for the six months ended June 30, 2006 and 2005,
respectively, are lower than the Companys statutory rate primarily because of the utilization of
foreign tax credits, lower taxes on non-U.S. earnings and the utilization of foreign tax loss
carryforwards, for which valuation allowances have been previously
provided. The effective income tax rate for the three months ended
June 30, 2006 reflects an adjustment to bring the effective rate
for the six months ended June 30, 2006 to the expected full year
effective rate. The 2006 quarter also includes a charge for recording
a valuation allowance of $1,071 at a non-U.S. subsidiary. The effective income
tax rate for the six months ended June 30, 2005 included an adjustment to state deferred
income taxes totaling $1,807. The deferred tax adjustment reflected the impact of a one-time state
income tax benefit related to changes in Ohio tax laws, including the effect of lower tax rates.
The anticipated effective rate for 2006 depends on the amount of earnings in various tax
jurisdictions and the level of related tax deductions achieved during the year.
14
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(in thousands of dollars, except share and per share data)
The following discussion and analysis of the Companys results of operations and financial position
should be read in conjunction with the audited consolidated financial statements and related notes
included in the Companys Annual Report on Form 10-K for the year ended December 31, 2005 and the
unaudited consolidated financial statements and related notes included in this Quarterly Report on
Form 10-Q.
This report contains forward-looking statements that involve risks and uncertainties. The Companys
actual results may differ materially from those indicated in the forward-looking statements. See
Risk Factors in Item 1A for more information regarding forward-looking statements.
GENERAL
The Company is the worlds largest designer and manufacturer of arc welding and cutting products,
manufacturing a full line of arc welding equipment, consumable welding products and other welding
and cutting products.
The Company is one of only a few worldwide broad line manufacturers of both arc welding equipment
and consumable products. Welding products include arc welding power sources, wire feeding systems,
robotic welding packages, fume extraction equipment, consumable electrodes and fluxes. The
Companys welding product offering also includes regulators and torches used in oxy-fuel welding
and cutting. In addition, the Company has a leading global position in the brazing and soldering
alloys market.
The Company invests in the research and development of arc welding equipment and consumable
products in order to continue its market leading product offering. The Company continues to invest
in technologies that improve the quality and productivity of welding products. In addition, the
Company has been actively increasing its patent application process in order to secure its
technology advantage in the United States and other major international jurisdictions. The Company
believes its significant investment in research and development and its highly trained technical
sales force provides a competitive advantage in the marketplace.
The Companys products are sold in both domestic and international markets. In North America,
products are sold principally through industrial distributors, retailers and also directly to users
of welding products. Outside of North America, the Company has an international sales organization
comprised of Company employees and agents who sell products from the Companys various
manufacturing sites to distributors, agents, dealers and product users.
The Companys major end user markets include:
|
|
general metal fabrication, |
|
|
|
infrastructure including oil and gas pipelines and platforms, buildings, bridges and power generation, |
|
|
|
transportation and defense industries (automotive/trucks, rail, ships and aerospace), |
|
|
|
equipment manufacturers in construction, farming and mining, |
|
|
|
retail resellers, and |
|
|
|
rental market. |
The Company has, through wholly-owned subsidiaries or joint ventures, manufacturing facilities
located in the United States, Australia, Brazil, Canada, Colombia, England, France, Germany,
Indonesia, Ireland, Italy, Mexico, the Netherlands, Peoples Republic of China, Poland, Spain,
Taiwan, Turkey and Venezuela.
The Companys sales and distribution network, coupled with its manufacturing facilities are
reported as three separate reportable segments: North America, Europe and Other Countries.
The principal raw materials essential to the Companys business are various chemicals, electronics,
steel, engines, brass, copper and aluminum alloys, all of which are normally available for purchase
in the open market.
15
The Companys facilities are subject to environmental regulations. To date, compliance with these
environmental regulations has not had a material effect on the Companys earnings. The Company is
ISO 9001 certified at nearly all facilities worldwide. In addition, the Company is ISO 14001
certified at most significant manufacturing facilities in the United States and is
working to gain certification at its remaining United States facilities, as well as its major
facilities in Canada, Mexico and Europe.
Key indicators
Key economic measures relevant to the Company include industrial production trends, steel
consumption, purchasing manager indices, capacity utilization within durable goods manufacturers,
and consumer confidence indicators. Key industries which provide a relative indication of demand
drivers to the Company include farm machinery and equipment, construction and transportation,
fabricated metals, electrical equipment, ship and boat building, defense, truck manufacturing and
railroad equipment. Although these measures provide key information on trends relevant to the
Company, the Company does not have available a more direct correlation of leading indicators which
can provide a forward-looking view of demand levels in the markets which ultimately use the
Companys welding products.
Key operating measures utilized by the operating units to manage the Company include orders, sales,
inventory and fill-rates, which provide key indicators of business trends. These measures are
reported on various cycles including daily, weekly, and monthly depending on the needs established
by operating management.
Key financial measures utilized by the Companys executive management and operating units in order
to evaluate the results of its business and in understanding key variables impacting the current
and future results of the Company include: sales, gross profit, selling, general and administrative
expenses, earnings before interest, taxes and bonus, operating cash flows and capital expenditures,
including applicable ratios such as return on investment and average operating working capital to
sales. These measures are reviewed at monthly, quarterly and annual intervals and compared with
historical periods as well as objectives established by the Board of Directors of the Company.
RESULTS OF OPERATIONS
The following table presents the Companys results of operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
Change |
|
(Dollars in thousands) |
|
Amount |
|
|
% of Sales |
|
|
Amount |
|
|
% of Sales |
|
|
Amount |
|
|
% |
|
Net sales |
|
$ |
502,510 |
|
|
|
100.0 |
% |
|
$ |
405,902 |
|
|
|
100.0 |
% |
|
$ |
96,608 |
|
|
|
23.8 |
% |
Costs of goods sold |
|
|
356,043 |
|
|
|
70.9 |
% |
|
|
291,951 |
|
|
|
71.9 |
% |
|
|
64,092 |
|
|
|
22.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
146,467 |
|
|
|
29.1 |
% |
|
|
113,951 |
|
|
|
28.1 |
% |
|
|
32,516 |
|
|
|
28.5 |
% |
Selling, general and administrative
expenses |
|
|
83,436 |
|
|
|
16.6 |
% |
|
|
71,919 |
|
|
|
17.7 |
% |
|
|
11,517 |
|
|
|
16.0 |
% |
Rationalization charges |
|
|
1,292 |
|
|
|
0.2 |
% |
|
|
|
|
|
|
|
|
|
|
1,292 |
|
|
|
N/A |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
61,739 |
|
|
|
12.3 |
% |
|
|
42,032 |
|
|
|
10.4 |
% |
|
|
19,707 |
|
|
|
46.9 |
% |
Interest income |
|
|
1,400 |
|
|
|
0.3 |
% |
|
|
891 |
|
|
|
0.2 |
% |
|
|
509 |
|
|
|
57.1 |
% |
Equity earnings in affiliates |
|
|
2,160 |
|
|
|
0.4 |
% |
|
|
1,030 |
|
|
|
0.2 |
% |
|
|
1,130 |
|
|
|
109.7 |
% |
Other income |
|
|
176 |
|
|
|
0.0 |
% |
|
|
995 |
|
|
|
0.2 |
% |
|
|
(819 |
) |
|
|
(82.3 |
%) |
Interest expense |
|
|
(2,438 |
) |
|
|
(0.5 |
%) |
|
|
(2,186 |
) |
|
|
(0.5 |
%) |
|
|
(252 |
) |
|
|
11.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
63,037 |
|
|
|
12.5 |
% |
|
|
42,762 |
|
|
|
10.5 |
% |
|
|
20,275 |
|
|
|
47.4 |
% |
Income taxes |
|
|
20,418 |
|
|
|
4.0 |
% |
|
|
10,650 |
|
|
|
2.6 |
% |
|
|
9,768 |
|
|
|
91.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
42,619 |
|
|
|
8.5 |
% |
|
$ |
32,112 |
|
|
|
7.9 |
% |
|
$ |
10,507 |
|
|
|
32.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
Change |
|
(Dollars in thousands) |
|
Amount |
|
|
% of Sales |
|
|
Amount |
|
|
% of Sales |
|
|
Amount |
|
|
% |
|
Net sales |
|
$ |
970,904 |
|
|
|
100.0 |
% |
|
$ |
768,805 |
|
|
|
100.0 |
% |
|
$ |
202,099 |
|
|
|
26.3 |
% |
Costs of goods sold |
|
|
694,371 |
|
|
|
71.5 |
% |
|
|
556,576 |
|
|
|
72.4 |
% |
|
|
137,795 |
|
|
|
24.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
276,533 |
|
|
|
28.5 |
% |
|
|
212,229 |
|
|
|
27.6 |
% |
|
|
64,304 |
|
|
|
30.3 |
% |
Selling, general and administrative
expenses |
|
|
160,107 |
|
|
|
16.5 |
% |
|
|
138,821 |
|
|
|
18.0 |
% |
|
|
21,286 |
|
|
|
15.3 |
% |
Rationalization charges |
|
|
2,341 |
|
|
|
0.2 |
% |
|
|
1,250 |
|
|
|
0.2 |
% |
|
|
1,091 |
|
|
|
87.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
114,085 |
|
|
|
11.8 |
% |
|
|
72,158 |
|
|
|
9.4 |
% |
|
|
41,927 |
|
|
|
58.1 |
% |
Interest income |
|
|
2,594 |
|
|
|
0.2 |
% |
|
|
1,660 |
|
|
|
0.2 |
% |
|
|
934 |
|
|
|
56.3 |
% |
Equity earnings in affiliates |
|
|
2,524 |
|
|
|
0.2 |
% |
|
|
1,564 |
|
|
|
0.2 |
% |
|
|
960 |
|
|
|
61.4 |
% |
Other income |
|
|
549 |
|
|
|
0.1 |
% |
|
|
1,466 |
|
|
|
0.2 |
% |
|
|
(917 |
) |
|
|
(62.6 |
%) |
Interest expense |
|
|
(4,839 |
) |
|
|
(0.5 |
%) |
|
|
(3,868 |
) |
|
|
(0.5 |
%) |
|
|
(971 |
) |
|
|
25.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
114,913 |
|
|
|
11.8 |
% |
|
|
72,980 |
|
|
|
9.5 |
% |
|
|
41,933 |
|
|
|
57.5 |
% |
Income taxes |
|
|
35,545 |
|
|
|
3.6 |
% |
|
|
18,628 |
|
|
|
2.4 |
% |
|
|
16,917 |
|
|
|
90.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
79,368 |
|
|
|
8.2 |
% |
|
$ |
54,352 |
|
|
|
7.1 |
% |
|
$ |
25,016 |
|
|
|
46.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005
Net Sales. Net sales for the second quarter of 2006 increased 23.8% to $502,510 from $405,902 in
the prior year quarter. The increase in net sales reflects a 16.5%, or $66,871 increase due to
volume, a 3.5%, or $14,085 increase due to the acquisition of J.W. Harris, an increase of 2.2%, or
$9,137 due to price increases, and a 1.6%, or $6,515 favorable impact of foreign currency exchange
rates. Net sales for North American operations increased 26.5% to $335,717 for 2006 compared to
$265,359 in 2005. This increase reflects an increase of 17.2% or $45,575 due to volume, an increase
of 4.9%, or $13,134 due to the acquisition of J.W. Harris, an increase of $8,117, or 3.1% due to
price increases and a 1.3%, or $3,532 favorable impact of foreign currency exchange rates. European
sales have increased 17.3% to $92,355 in 2006 from $78,735 in the prior year. This increase is due
to a 12.9%, or $10,139 increase due to volume, an increase of 1.2%, or $943 due to the acquisition
of J.W. Harris, and a 3.4% or $2,709 favorable impact of foreign currency exchange rates. Other
Countries sales increased 20.4% to $74,438 in 2006 from $61,808 in the prior year. This increase
reflects an increase of $11,157 or 18.1% due to volume and an increase of 1.9%, or $1,191 due to
price increases.
Gross Profit. Gross profit increased 28.5% to $146,467 during the second quarter of 2006 compared
to $113,951 in 2005. As a percentage of net sales, Gross profit increased to 29.1% in the second
quarter of 2006 from 28.1% in 2005. This increase was principally driven by increased leverage on
improved volume, partially offset by an increase in product liability
defense costs of $2,339. In
addition, foreign currency exchange rates had a favorable impact of $1,624 in the second quarter of
2006.
Selling, General & Administrative (SG&A) Expenses. SG&A expenses increased $11,517, or 16.0%, in
the second quarter of 2006, compared with 2005. The increase was primarily due to higher bonus
expense of $5,005, incremental selling, general and administrative expenses from the acquisition of
J.W. Harris totaling $817, and higher selling expenses of $2,709 resulting from increased sales
levels and related selling activity.
Rationalization Charges. In the second quarter of 2006, the Company recorded rationalization
charges of $1,292 ($1,292 after-tax) primarily related to severance costs covering 66 employees at
the Companys facility in Ireland.
Equity Earnings in Affiliates. Equity earnings in affiliates increased to $2,160 in the second
quarter of 2006 from $1,030 in the second quarter of 2005 primarily due to increased earnings at
the Companys joint venture investment in Taiwan.
Income Taxes. Income taxes for the second quarter of 2006 were $20,418 on income before income
taxes of $63,037, an effective rate of 32.4%, as compared with income taxes of $10,650 on income
before income taxes of $42,762, or an effective rate of 24.9% for the same period in 2005. The
effective rate for 2006 was lower than the Companys statutory rate primarily because of the
utilization of foreign tax credits, lower taxes on non-U.S. earnings and the utilization of foreign
tax loss carryforwards, for which valuation allowances have been previously provided. The increase
in the effective tax rate from 2005 to 2006 is primarily because of an increase in earnings in
higher tax rate jurisdictions. The effective income tax rate for the
three months ended June 30, 2006 reflects an adjustment to bring
the effective rate for the six months ended June 30, 2006 to the
expected full year effective rate. The current quarter also includes a charge for recording a valuation
allowance of $1,071 at a non-U.S. subsidiary. The second quarter of 2005 included an adjustment to
state deferred income taxes totaling $1,807. The deferred tax adjustment reflected the impact of a
one-time state income tax benefit related to changes in Ohio tax laws, including the effect of
lower tax rates.
17
Net Income. Net income for the second quarter of 2006 was $42,619 compared to $32,112 last year.
Diluted earnings per share for the second quarter of 2006 was $0.99 compared to $0.77 per share in
2005. Foreign currency exchange rate movements had a $511 and $740 favorable effect on 2006 and
2005 second quarter net income, respectively.
Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005
Net Sales. Net sales for the first half of 2006 increased 26.3% to $970,904 from $768,805 in the
prior year period. The increase in net sales reflects a 16.8%, or $128,900 increase due to volume,
a 6.4%, or $49,549 increase due to the acquisition of J.W. Harris, an increase of 2.8%, or $21,418
due to price increases, and a 0.3%, or $2,232 favorable impact of foreign currency exchange rates.
Net sales for North American operations increased 32% to $655,912 for 2006 compared to $496,877 in
2005. This increase reflects an increase of 18.2% or $90,526 due to volume, an increase of 9.4%, or
$46,784 due to the acquisition of J.W. Harris, an increase of $16,281, or 3.3% due to price
increases and a 1.1%, or $5,444 favorable impact of foreign currency exchange rates. European sales
have increased 10.1% to $174,668 in 2006 from $158,656 in the prior year. This increase is due to a
10.7%, or $16,966 increase due to volume, an increase of 1.7%, or $2,743 due to the acquisition of
J.W. Harris, and a 2.2% or $3,440 unfavorable impact of foreign currency exchange rates. Other
Countries sales increased 23.9% to $140,324 in 2006 from $113,272 in the prior year. This increase
reflects an increase of $21,408 or 18.9% due to volume, and an increase of 4.8%, or $5,394 due to
price increases.
Gross Profit. Gross profit increased 30.3% to $276,533 during the first half of 2006 compared to
$212,229 in 2005. As a percentage of net sales, Gross profit increased to 28.5% in the first half
of 2006 from 27.6% in 2005. This increase was primarily due to favorable leverage on increased
volumes. This increase was partially offset by a shift in sales mix to traditionally lower margin
geographies and businesses, including the effects of acquisitions, as well as an increase in
product liability defense costs of $4,078. Foreign currency exchange rates did not have a material
impact in the first half of 2006.
Selling, General & Administrative (SG&A) Expenses. SG&A expenses increased $21,286, or 15.3%, in
the first half of 2006, compared with 2005. The increase was primarily due to higher bonus expense
of $11,081, incremental selling, general and administrative expenses from the acquisition of J.W.
Harris totaling $3,352, and higher selling expenses of $3,497 resulting from increased sales levels
and related selling activity.
Rationalization Charges. In the first half of 2006, the Company recorded rationalization charges of
$2,341 ($2,341 after-tax) primarily related to severance costs covering 66 employees at the
Companys facility in Ireland. During the first half of 2005, the Company recorded rationalization
charges of $1,250 ($848 after-tax) primarily due to employee severance costs related to
rationalization efforts in France.
Equity Earnings in Affiliates. Equity earnings in affiliates increased to $2,524 in the first half
of 2006 from $1,564 in the first half of 2005 primarily due to increased earnings at the Companys
joint venture investment in Taiwan.
Interest Expense: Interest expense increased to $4,839 in the first half of 2006 from $3,868 in the
comparable 2005 period as a result of higher interest rates.
Income Taxes. Income taxes for the first half of 2006 were $35,545 on income before income taxes of
$114,913, an effective rate of 30.9%, as compared with income taxes of $18,628 on income before
income taxes of $72,980, or an effective rate of 25.5% for the same period in 2005. The effective
rate for 2006 was lower than the Companys statutory rate primarily because of the utilization of
foreign tax credits, lower taxes on non-U.S. earnings and the utilization of foreign tax loss
carryforwards, for which valuation allowances have been previously provided. The increase in the
effective tax rate from 2005 to 2006 is primarily because of an increase in earnings in higher tax
rate jurisdictions and the level of related tax deductions. The first half also includes a charge
for recording a valuation allowance of $1,071 at a non-U.S. subsidiary. The first half of 2005
included an adjustment to state deferred income taxes totaling $1,807. The deferred tax adjustment
reflected the impact of a one-time state income tax benefit related to changes in Ohio tax laws,
including the effect of lower tax rates.
Net Income. Net income for the first half of 2006 was $79,368 compared to $54,352 last year.
Diluted earnings per share for the first half of 2006 was $1.85 compared to $1.30 per share in
2005. Foreign currency exchange rate movements did not have a material effect on net income for
2006, and had a $1,381 favorable effect on net income in 2005.
LIQUIDITY AND CAPITAL RESOURCES
The Companys cash flow from operations, while cyclical, has been reliable and consistent. The
Company has relatively unrestricted access to capital markets. Operational cash flow is a key
driver of liquidity, providing cash and access to capital markets. In assessing liquidity, the
Company reviews working capital measurements to define areas of improvement. Management anticipates
the Company will be able to satisfy cash requirements for its ongoing businesses for the
foreseeable
18
future primarily with cash generated by operations, existing cash balances and, if necessary,
borrowings under its existing credit facilities.
The following table reflects changes in key cash flow measures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
(Dollars in thousands) |
|
2006 |
|
2005 |
|
Change |
Cash provided by operating activities: |
|
$ |
57,330 |
|
|
$ |
61,841 |
|
|
$ |
(4,511 |
) |
Cash used by investing activities: |
|
|
(31,715 |
) |
|
|
(40,793 |
) |
|
|
9,078 |
|
Capital expenditures |
|
|
(32,261 |
) |
|
|
(21,435 |
) |
|
|
(10,826 |
) |
Sales of marketable securities, net |
|
|
|
|
|
|
50,500 |
|
|
|
(50,500 |
) |
Acquisitions, net of cash acquired |
|
|
(95 |
) |
|
|
(70,704 |
) |
|
|
70,609 |
|
Cash used by financing activities: |
|
|
(11,551 |
) |
|
|
(31,206 |
) |
|
|
19,655 |
|
Amounts due banks, net |
|
|
(7,138 |
) |
|
|
4,114 |
|
|
|
(11,252 |
) |
Payments on long-term borrowings |
|
|
(1,449 |
) |
|
|
(14,993 |
) |
|
|
13,544 |
|
Tax benefit from the exercise of stock options |
|
|
3,051 |
|
|
|
|
|
|
|
3,051 |
|
Purchase of shares for treasury |
|
|
|
|
|
|
(12,804 |
) |
|
|
12,804 |
|
Cash dividends paid to shareholders |
|
|
(16,077 |
) |
|
|
(14,985 |
) |
|
|
(1,092 |
) |
Increase (decrease) in Cash and cash equivalents |
|
|
17,420 |
|
|
|
(12,435 |
) |
|
|
29,855 |
|
Cash and cash equivalents increased 16.1%, or $17,420, to $125,427 as of June 30, 2006, from
$108,007 as of December 31, 2005. This compares to a $12,435 decrease in cash and cash equivalents
during the same period in 2005.
Cash provided by operating activities decreased by $4,511 for the first half in 2006 compared to
2005. The decrease was primarily related to an increase in working capital levels when compared to
the same period in 2005. Average working capital to sales was 31.3% at June 30, 2006 and December
31, 2005. Average days in accounts payable increased to 44.0 days at June 30, 2006 from 40.2 days
at December 31, 2005. Days sales in inventory increased from 114.8 days at December 31, 2005 to
117.8 days at June 30, 2006. Accounts receivable days increased from 56.1 days at December 31, 2005
to 58.0 days at June 30, 2006.
Cash used by investing activities for the first half of 2006 compared to 2005 reflects a decrease
in cash used in the acquisition of businesses and a net decrease in the proceeds from the sale of
marketable securities of $50,500. In addition, capital expenditures during the first half of 2006
were $32,261, a $10,826 increase from 2005. The Company anticipates capital expenditures in 2006 of
approximately $60,000 $70,000. Anticipated capital expenditures reflect the acceleration of plans
to expand the Companys manufacturing capacity due to an increase in customer demand and the
Companys continuing international expansion. Management critically evaluates all proposed capital
expenditures and requires each project to either increase efficiency, reduce costs, promote
business growth, or to improve the overall safety and environmental conditions of the Companys
facilities. Management does not currently anticipate any unusual future cash outlays relating to
capital expenditures.
Cash used by financing activities decreased $19,655 in the first half of 2006 compared to 2005. The
decrease was primarily due to a decrease in treasury share purchases of $12,804, an increase in the
tax benefit from the exercise of stock options of $3,051, and less of a reduction in debt in 2006
of $3,532.
The Companys debt levels decreased from $166,016 at December 31, 2005, to $157,055 at June 30,
2006. Debt to total capitalization decreased to 17.4% at June 30, 2006, from 20.3% at December 31,
2005.
The Companys Board of Directors authorized share repurchase programs for up to 15 million shares
of the Companys common stock. Total shares purchased through the share repurchase programs were
10,241,673 shares at a cost of $216,266 through June 30, 2006.
In April 2006, the Company paid a quarterly cash dividend of 19 cents per share, or $8,062 to
shareholders of record on March 31, 2006.
19
Rationalization
In 2005, the Company committed to a plan to rationalize manufacturing operations (the Ireland
Rationalization) at Harris Calorific Limited (Harris Ireland). In connection with the Ireland
Rationalization, the Company intends to transfer all manufacturing currently taking place at Harris
Ireland to a lower cost facility in Eastern Europe and sell the facility in Ireland.
The Company expects to incur a charge of approximately $5,000 (pre-tax) associated with employee
severance costs, equipment relocation, employee retention and professional services. This charge
does not reflect the impact of anticipated proceeds from the planned sale of the facility in
Ireland. A total of 66 employees will be impacted by the Ireland Rationalization.
The Company has incurred a total of $2,852 (pre-tax) in charges related to this plan of which
$2,341 (pre-tax) was incurred in the first half of 2006. Cash expenditures are expected to be paid
throughout 2006 with the expected completion of the Ireland Rationalization occurring in the fourth
quarter of 2006. As of June 30, 2006, the Company has recorded a liability of $2,948 for charges
related to these efforts.
In 2004, the Company committed to a plan to rationalize machine manufacturing (the French
Rationalization) at Lincoln Electric France, S.A.S. (LE France). In connection with the French
Rationalization, the Company transferred machine manufacturing performed at LE France to other
facilities. The Company committed to the French Rationalization as a result of the regions
decreased demand for locally-manufactured machines. In connection with the French Rationalization,
the Company incurred a charge of $2,292 (pre-tax), of which $1,188 (pre-tax) was incurred in the
first half of 2005. Employee severance costs associated with the termination of approximately 40 of
LE Frances 179 employees were $2,123 (pre-tax). Costs not relating to employee severance primarily
included warehouse relocation costs and professional fees.
Acquisitions
On April 29, 2005, the Company acquired all of the outstanding stock of J.W. Harris Co., Inc.
(J.W. Harris), a privately held brazing and soldering alloys manufacturer headquartered in Mason,
Ohio for approximately $71,000 in cash and $15,000 of assumed debt. The Company began consolidating
the results of J.W. Harris operations in the Companys consolidated financial statements in May
2005.
The purchase price allocation for this investment resulted in goodwill of $9,103. Included in the
aggregate purchase price is $4,160 deposited in escrow accounts. Distribution of amounts in escrow
is dependent on resolution of pre-closing contingencies. Amounts remaining in escrow as of the
second anniversary of the closing date will be distributed to the former shareholders and will
result in adjustments to the purchase price allocation.
This acquisition has provided the Company with a strong complementary metals-joining technology and
a leading position in the brazing and soldering alloys market. J.W. Harris has manufacturing plants
in Ohio and Rhode Island and an international distribution center located in Spain.
The Company continues to expand globally and periodically looks at transactions that would involve
significant investments. The Companys operational cash flow can fund the global expansion plans,
but a significant acquisition may require access to the capital markets, in particular, the public
and/or private bond market, as well as the syndicated bank loan market. The Companys financing
strategy is to fund itself at the lowest after-tax cost of funding. Where possible, the Company
utilizes operational cash flows and raises capital in the most efficient market, usually the U.S.,
and then lends funds to the specific subsidiary that requires funding. If additional acquisitions
providing appropriate financial benefits become available, additional expenditures may be made.
Debt
During March 2002, the Company issued Senior Unsecured Notes (the Notes) totaling $150,000
through a private placement. The Notes have original maturities ranging from five to ten years with
a weighted-average interest rate of 6.1% and an average tenure of eight years. Interest is payable
semi-annually in March and September. The proceeds are being used for general corporate purposes,
including acquisitions. The proceeds are generally invested in short-term, highly liquid
investments. The Notes contain certain affirmative and negative covenants, including restrictions
on asset dispositions and financial covenants (interest coverage and funded debt-to-EBITDA
ratios). As of June 30, 2006, the Company was in compliance with all of its debt covenants.
20
The maturity and interest rates of the Notes follow (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount Due |
|
Matures |
|
Interest Rate |
Series A
|
|
$ |
40,000 |
|
|
March 2007
|
|
|
5.58 |
% |
Series B
|
|
$ |
30,000 |
|
|
March 2009
|
|
|
5.89 |
% |
Series C
|
|
$ |
80,000 |
|
|
March 2012
|
|
|
6.36 |
% |
During March 2002, the Company entered into floating rate interest rate swap agreements
totaling $80,000, to convert a portion of the outstanding Notes from fixed to floating rates. These
swaps were designated as fair value hedges, and as such, the gain or loss on the derivative
instrument, as well as the offsetting gain or loss on the hedged item attributable to the hedged
risk were recognized in earnings. Net payments or receipts under these agreements were recognized
as adjustments to interest expense. In May 2003, these swap agreements were terminated. The gain on
the termination of these swaps was $10,613, and has been deferred and is being amortized as an
offset to interest expense over the remaining life of the instrument. The amortization of this gain
reduced interest expense by $1,050 in the first half of 2006 and 2005 and is expected to reduce
annual interest expense by $2,117 in 2006 and $1,121 in 2007. At June 30, 2006, $3,901 remains to
be amortized of which $3,150 is included in the balance sheet caption Long-term debt, less current
portion and $751 is included in the balance sheet caption Current portion of long-term debt. The
financing costs related to the $150,000 private placement are further reduced by the interest
income earned on the cash balances. These short-term, highly liquid investments earned
approximately $1,335 during the first half of 2006.
During July 2003 and April 2004, the Company entered into various floating rate interest rate swap
agreements totaling $110,000, to convert a portion of the outstanding Notes from fixed to floating
rates based on the London Inter-Bank Offered Rate (LIBOR), plus a spread of between 179.75 and
226.50 basis points. The variable rates are reset every six months, at which time payment or
receipt of interest will be settled. These swaps are designated as fair value hedges, and as such,
the gain or loss on the derivative instrument, as well as the offsetting gain or loss on the hedged
item attributable to the hedged risk are recognized in earnings. Net payments or receipts under
these agreements are recognized as adjustments to interest expense. The fair value of these swaps
is included in the balance sheet caption Other long-term liabilities with a corresponding
decrease in Long-term debt. The fair value of these swaps at June 30, 2006 was $6,202.
Terminated swaps have increased the value of the Series A Notes from $40,000 to $40,751 as of June
30, 2006. Active and terminated swaps have increased the value of the Series B Notes from $30,000
to $30,533 and decreased the value of the Series C Notes from $80,000 to $76,415 as of June 30,
2006. The weighted-average effective rate on the Notes, net of the impact of active and terminated
swaps, was 5.11% for the first half of 2006.
Stock-based compensation
On April 28, 2006, the shareholders of the Company approved the 2006 Equity and Performance
Incentive Plan (EPI Plan) which replaces the 1998 Stock Plan, as amended in May 2003. The EPI
Plan provides for the granting of options, appreciation rights, restricted shares, restricted stock
units and performance-based awards up to an aggregate of 3,000,000 of the Companys common shares.
There were 230 and 500 options granted during the six months ended June 30, 2006 and 2005,
respectively. There were no TARs, restricted shares or deferred shares granted during the six
months ended June 30, 2006 and 2005.
In addition, on April 28, 2006, the shareholders of the Company approved the 2006 Stock Plan for
Non-Employee Directors (Director Plan). The Director Plan provides for the granting of options,
restricted shares and restricted stock units up to an aggregate of 300,000 of the Companys common
shares.
The Company issued 365,867 and 365,656 shares of common stock from treasury upon exercise of
employee stock options during the six months ended June 30, 2006 and 2005, respectively.
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share-Based Payment, which is a
revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees. Generally, the approach in SFAS No.
123(R) is similar to the approach described in SFAS 123. SFAS No. 123(R) requires all share-based
payments to employees, including grants of employee stock options, to be
recognized in the income statement based on their fair values. Pro forma disclosure is no longer an
alternative. The Company adopted SFAS No. 123(R) on January 1, 2006 using the modified-prospective
method. The adoption of the standard did not have a material impact on the Companys financial
statements as the Company previously adopted fair value accounting under SFAS No. 123 on January 1,
2003.
21
Prior to 2003, the Company applied the intrinsic value method permitted under SFAS No. 123, as
defined in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees and related interpretations, in accounting for the Companys stock option plans.
Accordingly, no compensation cost was recognized in years prior to adoption.
Total stock-based compensation expense recognized in the consolidated statement of earnings for the
six months ended June 30, 2006 and 2005 was $1,938 and $1,897, respectively. The related tax
benefit for the six months ended June 30, 2006 and 2005 was $741 and $725, respectively.
As of June 30, 2006, total unrecognized stock-based compensation expense related to nonvested stock
options, restricted shares and deferred shares was $4,947, which is expected to be recognized over
a weighted average period of approximately 27 months.
The aggregate intrinsic value of options outstanding at June 30, 2006, based on the Companys
closing stock price of $62.65 as of the last business day of the period ended June 30, 2006, which
would have been received by the optionees had all options been exercised on that date was $55,342.
The aggregate intrinsic value of options exercisable at June 30, 2006, based on the Companys
closing stock price of $62.65 as of the last business day of the period ended June 30, 2006, which
would have been received by the optionees had all options exercisable been exercised on that date
was $36,267. The total intrinsic value of stock options exercised during the six months ended June
30, 2006 and 2005 was $9,073 and $3,939, respectively. Intrinsic value is the amount by which the
fair value of the underlying stock exceeds the exercise price of the options.
Product liability expense
Product liability expenses have been increasing, particularly with respect to the increased number
of welding fume claims. The costs associated with these claims are predominantly defense costs,
which are recognized in the periods incurred. These net expenditures increased $4,078 in the first
half of 2006 compared to the same period in 2005. See Note K. The long-term impact of the welding
fume loss contingency, in the aggregate, on operating cash flows and capital markets access is
difficult to assess, particularly since claims are in many different stages of development and the
Company benefits significantly from cost sharing with co-defendants and insurance carriers.
Moreover, the Company has been largely successful to date in its defense of these claims and
indemnity payments have been immaterial. If cost sharing dissipates for some currently unforeseen
reason, or the Companys trial experience changes overall, it is possible on a longer term basis
that the cost of resolving this loss contingency could materially reduce the Companys operating
results and cash flow and restrict capital market access.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The Company utilizes letters of credit to back certain payment and performance obligations. Letters
of credit are subject to limits based on amounts outstanding under the Companys Credit Agreement.
The Company has also provided a guarantee on loans for an unconsolidated joint venture of
approximately $6,250 at June 30, 2006. The Company believes the likelihood is remote that material
payment will be required under this arrangement because of the current financial condition of the
joint venture.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in
Income Taxesan interpretation of FASB Statement No. 109, which clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements in accordance with
FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes a
recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. This Interpretation
also provides guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. The provisions of FIN 48 are effective for fiscal
years beginning after December 16, 2006. The Company is currently evaluating the impact of this
Interpretation on its financial statements.
In June 2005, the Financial Accounting Standards Board (FASB) issued Staff Position No. 143-1
Accounting for Electronic Equipment Waste Obligations (FSP 143-1), which provides guidance on
the accounting for obligations associated with the Directive on Waste Electrical and Electronic
Equipment (the WEEE Directive), which was adopted by the European Union. FSP 143-1 provides
guidance on accounting for the effects of the WEEE Directive with respect to historical waste and
waste associated with products on the market on or before August 13, 2005. FSP 143-1 requires
commercial users to account for their WEEE obligation as an asset retirement liability in
accordance with FASB Statement No. 143, Accounting for Asset Retirement Obligations. FSP 143-1
was required to be applied to the later of the first reporting period ending after June 8, 2005 or
the date of the adoption of the WEEE Directive into law by the applicable European Union member
country. The
22
WEEE Directive has been adopted into law by the majority of European Union member countries in
which the Company has significant operations. The Company adopted the provisions of FSP 143-1 as it
relates to these countries with no material impact to its financial statements. The Company will
apply the guidance of FSP 143-1 as it relates to the remaining European Union member countries in
which it operates when those countries have adopted the WEEE Directive into law.
In March 2005, the FASB issued FASB Interpretation No. 47 (FIN 47) Accounting for Conditional
Asset Retirement Obligations an interpretation of FASB Statement No. 143. This interpretation
defines the term conditional asset retirement obligation as used in FASB Statement No. 143,
Accounting for Asset Retirement Obligations, as a legal obligation to perform an asset retirement
activity, in which the timing, and/or method of settlement are conditional on a future event that
may or may not be within the control of the entity. FIN 47 requires that an obligation to perform
an asset retirement activity is unconditional even though uncertainty exists about the timing
and/or method of settlement. FIN 47 also clarifies when an entity would have sufficient information
to reasonably estimate the fair value of an asset retirement. The Company adopted the provisions of
FIN 47 as of December 31, 2005 with no material impact to its financial statements.
In November 2004, the FASB issued SFAS No. 151 Inventory Costs an amendment of ARB No. 43,
Chapter 4. This Statement amends the guidance in Accounting Research Bulletin No. 43 to require
idle facility expense, freight, handling costs, and wasted material (spoilage) be recognized as
current-period charges. In addition, SFAS No. 151 requires the allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of production facilities. SFAS
No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15,
2005. The Company adopted SFAS No. 151 on January 1, 2006 with no material impact to its financial
statements.
CRITICAL ACCOUNTING POLICIES
The Companys consolidated financial statements are based on the selection and application of
significant accounting policies, which require management to make estimates and assumptions. These
estimates and assumptions are reviewed periodically by management and compared to historical trends
to determine the accuracy of estimates and assumptions used. If warranted, these estimates and
assumptions may be changed as current trends are assessed and updated. Historically, the Companys
estimates have been determined to be reasonable. No material changes to the Companys accounting
policies were made during the six months ended June 30, 2006. The Company believes the following
are some of the more critical judgment areas in the application of its accounting policies that
affect its financial condition and results of operations.
Legal And Tax Contingencies
The Company, like other manufacturers, is subject from time to time to a variety of civil and
administrative proceedings arising in the ordinary course of business. Such claims and litigation
include, without limitation, product liability claims and health, safety and environmental claims,
some of which relate to cases alleging asbestos and manganese-induced illnesses. The costs
associated with these claims are predominantly defense costs, which are recognized in the periods
incurred. Insurance reimbursements mitigate these costs and, where
reimbursements are probable,
they are recognized in the applicable period. With respect to costs other than defense costs (i.e., for liability and/or settlement or other
resolution), reserves are recorded when it is probable that the contingencies will have an
unfavorable outcome. The Company accrues its best estimate of the probable costs, after a review of
the facts with management and counsel and taking into account past experience. If an unfavorable
outcome is determined to be reasonably possible but not probable, or if the amount of loss cannot
be reasonably estimated, disclosure is provided for material claims or litigation. Many of the
current cases are in preliminary procedural stages and insufficient information exists upon which
judgments can be made as to the validity or ultimate disposition of such actions. Therefore, in
many situations a range of possible losses cannot be made at this time. Reserves are adjusted as
facts and circumstances change and related management assessments of the underlying merits and the
likelihood of outcomes change. Moreover, reserves only cover identified and/or asserted claims.
Future claims could, therefore, give rise to increases to such reserves. See Note K to the
Consolidated Financial Statements and the Legal Proceedings section of this Quarterly Report on
Form 10-Q for further discussion of legal contingencies.
The Company is subject to taxation from U.S. federal, state, municipal and international
jurisdictions. The calculation of current income tax expense is based on the best information
available and involves significant management judgment. The actual income tax liability for each
jurisdiction in any year can in some instances be ultimately determined several years after the
financial statements are published.
The Company maintains reserves for estimated income tax exposures for many jurisdictions. Exposures
are settled primarily through the settlement of audits within each individual tax jurisdiction or
the closing of a statute of limitation. Exposures can also be affected by changes in applicable tax
law or other factors, which may cause management to believe a revision of past estimates is
appropriate. Management believes that an appropriate liability has been established for income tax
exposures; however, actual results may materially differ from these estimates.
23
Deferred Income Taxes
Deferred income taxes are recognized at currently enacted tax rates for temporary differences
between the financial reporting and income tax bases of assets and liabilities and operating loss
and tax credit carryforwards. The Company does not provide deferred income taxes on unremitted
earnings of certain non-U.S. subsidiaries which are deemed permanently reinvested. It is not
practicable to calculate the deferred taxes associated with the remittance of these earnings. At
June 30, 2006, the Company had approximately $65,815 of gross deferred tax assets related to
deductible temporary differences and tax loss and credit carryforwards which may reduce taxable
income in future years.
In assessing the realizability of deferred tax assets, the Company assesses whether it is more
likely than not that a portion or all of the deferred tax assets will not be realized. The Company
considers the scheduled reversal of deferred tax liabilities, tax planning strategies, and
projected future taxable income in making this assessment. At June 30, 2006, a valuation allowance
of $18,349 had been recorded against these deferred tax assets based on this assessment. The
Company believes it is more likely than not that the tax benefit of the remaining net deferred tax
assets will be realized. The amount of net deferred tax assets considered realizable could be
increased or reduced in the future if the Companys assessment of future taxable income or tax
planning strategies changes.
Pensions
The Company and its subsidiaries maintain a number of defined benefit and defined contribution
plans to provide retirement benefits for employees in the U.S., as well as employees outside the
U.S. These plans are maintained and contributions are made in accordance with the Employee
Retirement Income Security Act of 1974 (ERISA), local statutory law or as determined by the Board
of Directors. The plans generally provide benefits based upon years of service and compensation.
Pension plans are funded except for a domestic non-qualified pension plan for certain key employees
and certain foreign plans.
The Company accounts for its defined benefit plans in accordance with SFAS No. 87, Employers
Accounting for Pensions, which requires amounts recognized in financial statements be determined
on an actuarial basis. A substantial portion of the Companys pension amounts relate to its defined
benefit plan in the United States. Upon adoption of SFAS No. 87, the market-related value of plan
assets could be determined by either fair value or a calculated value recognizing changes in fair
value in a systematic and rational manner over not more than five years. The method chosen must be
applied consistently year to year. The Company used fair values at December 31 for the
market-related value of plan assets.
A significant element in determining the Companys pension expense is the expected return on plan
assets. At the end of each year, the expected return on plan assets is determined based on the
weighted-average expected return of the various asset classes in the plans portfolio and the
targeted allocation of plan assets. The asset class return is developed using historical asset
return performance, as well as, current market conditions such as inflation, interest rates and
equity market performance. The Company determined this rate to be 8.5% for its U.S. plans at
December 31, 2005. The assumed long-term rate of return on assets is applied to the market value of
plan assets. This produces the expected return on plan assets included in pension expense. The
difference between this expected return and the actual return on plan assets is deferred and
amortized over the average remaining service period of active employees expected to receive
benefits under the plan. The amortization of the net deferral of past losses will increase future
pension expense. During 2005, investment returns in the Companys U.S. pension plans were
approximately 7.7%. A 25 basis point change in the expected return on plan assets would increase or
decrease pension expense by approximately $1,300.
Another significant element in determining the Companys pension expense is the discount rate for
plan liabilities. At the end of each year, the Company determines the discount rate to be used for
plan liabilities by referring to investment yields available on long-term bonds rated Aa- or
better. The Company also considers the yield derived from matching projected pension payments with
maturities of a portfolio of available non-callable bonds rated Aa-or better. The Company
determined this rate to be 5.7% for its U.S. plans at December 31, 2005. A 25 basis point change in
the discount rate would increase or decrease pension expense by approximately $2,000.
The Company made voluntary contributions to its U.S. defined benefit plans of $31,500 in 2005.
Based on current pension funding rules, the Company does not anticipate that contributions to the
plans will be required in 2006. The Company has voluntarily contributed $15,000 for the six months
ended June 30, 2006 and expects to contribute a total of $30,000 in 2006.
Pension expense relating to the Companys defined benefit plans was $21,328 in 2005. The Company
expects 2006 pension expense to decline by approximately $2,000.
24
In the first quarter of 2006, the Company modified its retirement benefit programs whereby
employees of its U.S. company hired on or after January 1, 2006 will be covered under a newly
enhanced 401(k) defined contribution plan. In the second quarter of 2006, current employees of the
U.S. company made an election to either remain in the companys existing retirement programs or
switch to new programs offering enhanced defined contribution benefits, improved vacation and a
reduced defined benefit. The Company does not expect a significant change in retirement costs
immediately after the change, however, the Company does expect cost savings in future years as a
result of reduced benefits to be accrued for employees hired on or after January 1, 2006.
Inventories and Reserves
Inventories are valued at the lower of cost or market. For most domestic inventories, cost is
determined principally by the last-in, first-out (LIFO) method, and for non-U.S. inventories, cost
is determined by the first-in, first-out (FIFO) method. The valuation of LIFO inventories is made
at the end of each year based on inventory levels and costs at that time. The excess of current
cost over LIFO cost amounted to $67,424 at June 30, 2006. The Company reviews the net realizable
value of inventory in detail on an on-going basis, with consideration given to deterioration,
obsolescence and other factors. If actual market conditions differ from those projected by
management, and the Companys estimates prove to be inaccurate, write-downs of inventory values and
adjustments to cost of sales may be required. Historically, the Companys reserves have
approximated actual experience.
Accounts Receivable and Allowances
The Company maintains an allowance for doubtful accounts for estimated losses from the failure of
its customers to make required payments for products delivered. The Company estimates this
allowance based on the age of the related receivable, knowledge of the financial condition of
customers, review of historical receivables and reserve trends and other pertinent information. If
the financial condition of customers deteriorates or an unfavorable trend in receivable collections
is experienced in the future, additional allowances may be required. Historically, the Companys
reserves have approximated actual experience.
Impairment of Long-Lived Assets
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
the Company periodically evaluates whether current facts or circumstances indicate that the
carrying value of its depreciable long-lived assets to be held and used may not be recoverable. If
such circumstances are determined to exist, an estimate of undiscounted future cash flows produced
by the long-lived asset, or the appropriate grouping of assets, is compared to the carrying value
to determine whether an impairment exists. If an asset is determined to be impaired, the loss is
measured based on quoted market prices in active markets, if available. If quoted market prices are
not available, the estimate of fair value is based on various valuation techniques, including the
discounted value of estimated future cash flows and established business valuation multiples.
The estimates of future cash flows, based on reasonable and supportable assumptions and
projections, require managements judgment. Any changes in key assumptions about the Companys
businesses and their prospects, or changes in market conditions, could result in an impairment
charge.
Impairment of Goodwill and Intangibles
The Company evaluates the recoverability of goodwill and intangible assets not subject to
amortization as required under SFAS No. 142 Goodwill and Other Intangible Assets by comparing the
fair value of each reporting unit with its carrying value. The fair values of reporting units is
determined using models developed by the Company which incorporate estimates of future cash flows,
allocations of certain assets and cash flows among reporting units, future growth rates,
established business valuation multiples, and management judgments regarding the applicable
discount rates to value those estimated cash flows.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in the Companys exposure to market risk since December 31,
2005. See Item 7A in the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
Item 4. Controls and Procedures
The Company carried out an evaluation, under the supervision and with the participation of the
Companys management, including the Companys Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation
25
of the Companys disclosure controls and procedures as of the end of the period covered by this
Form 10-Q. Based on that evaluation, the Companys management, including the Chief Executive
Officer and Chief Financial Officer, concluded that the Companys disclosure controls and
procedures are operating effectively as designed. There have been no changes in the Companys
internal controls or in other factors that occurred during the period covered by this Form 10-Q
that materially affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject, from time to time, to a variety of civil and administrative proceedings
arising out of its normal operations, including, without limitation, product liability claims and
health, safety and environmental claims. Among such proceedings are the cases described below.
At June 30, 2006, the Company was a co-defendant in cases alleging asbestos induced illness
involving claims by approximately 33,604 plaintiffs, which is a net decrease of 383 claims from
those previously reported. In each instance, the Company is one of a large number of defendants.
The asbestos claimants seek compensatory and punitive damages, in most cases for unspecified sums.
Since January 1, 1995, the Company has been a co-defendant in other similar cases that have been
resolved as follows: 20,851 of those claims were dismissed, 9 were tried to defense verdicts, 4
were tried to plaintiff verdicts (2 of which were satisfied and 2 of which are subject to appeal)
and 325 were decided in favor of the Company following summary judgment motions.
At June 30, 2006, the Company was a co-defendant in cases alleging manganese induced illness
involving claims by approximately 7,189 plaintiffs, which is a net decrease of 1,581 claims from
those previously reported. In each instance, the Company is one of a large number of defendants.
The claimants in cases alleging manganese induced illness seek compensatory and punitive damages,
in most cases for unspecified sums. The claimants allege that exposure to manganese contained in
welding consumables caused the plaintiffs to develop adverse neurological conditions, including a
condition known as manganism. At June 30, 2006, cases involving 3,820 claimants were filed in or
transferred to federal court where the Judicial Panel on MultiDistrict Litigation has consolidated
these cases for pretrial proceedings in the Northern District of Ohio (the MDL Court). Plaintiffs
have also filed class actions seeking medical monitoring in eight state courts, seven of which have
been removed to the MDL Court. Since January 1, 1995, the Company has been a co-defendant in
similar cases that have been resolved as follows: 7,590 of those claims were dismissed, 9 were
tried to defense verdicts in favor of the Company, 2 were tried to hung juries, 1 of which resulted
in a plaintiffs verdict upon retrial and 1 of which resulted in
a defense verdict upon retrial (subsequently,
however, a motion for a new trial has been granted), and 12 were settled for immaterial amounts.
Item 1A. Risk Factors
From time to time, information we provide, statements by our employees or information included in
our filings with the Securities and Exchange Commission may contain forward-looking statements that
are not historical facts. Those statements are forward-looking within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements, and our future performance,
operating results, financial position and liquidity, are subject to a variety of factors that could
materially affect results, including those described below. Any forward-looking statements made in
this report or otherwise speak only as of the date of the statement, and, except as required by
law, we undertake no obligation to update those statements. Comparisons of results for current and
any prior periods are not intended to express any future trends or indications of future
performance, unless expressed as such, and should only be viewed as historical data.
The risks and uncertainties described below and all of the other information in this report should
be carefully considered. These risks and uncertainties are not the only ones we face. Additional
risks and uncertainties of which we are currently unaware or that we currently believe to be
immaterial may also adversely affect our business.
If energy costs or the prices of our raw materials increase, our operating expenses could increase
significantly.
In the normal course of business, we are exposed to market risk and price fluctuations related to
the purchase of energy and commodities used in the manufacture of our products (primarily steel,
brass, copper and aluminum alloys). The availability and prices for raw materials are subject to
volatility and are influenced by worldwide economic conditions, speculative action, world supply
and demand balances, inventory levels, availability of substitute materials, currency exchange
rates, our competitors production costs, anticipated or perceived shortages and other factors.
Since 2003, the price of the type of steel used to manufacture our products has increased
significantly and has been subject to periodic shortages due to global economic factors, including
increased demand for construction materials in developing nations such as China and India. Since
2003, and accelerating through the first half of 2006, we have also experienced substantial
inflation in prices for other raw
26
materials, including metals, chemicals and energy costs. Energy costs could continue to rise, which
would result in higher transportation, freight and other operating costs. Our future operating
expenses and margins will be dependent on our ability to manage the impact of cost increases. Our
results of operations may be harmed by shortages of supply and by increases in prices to the extent
those increases can not be passed on to customers.
We are a co-defendant in litigation alleging manganese induced illness and litigation alleging
asbestos induced illness. Liabilities relating to such litigation could reduce our profitability
and impair our financial condition.
At June 30, 2006, we were a co-defendant in cases alleging manganese induced illness involving
claims by approximately 7,189 plaintiffs and a co-defendant in cases alleging asbestos induced
illness involving claims by approximately 33,604 plaintiffs. In each instance, we are one of a
large number of defendants. In the manganese cases, the claimants allege that exposure to manganese
contained in welding consumables caused the plaintiff to develop adverse neurological conditions,
including a condition known as manganism. In the asbestos cases, the claimants allege that exposure
to asbestos contained in welding consumables caused the plaintiffs to develop adverse pulmonary
diseases, including mesothelioma and other lung cancers.
Since January 1, 1995, we have been a co-defendant in manganese cases that have been resolved as
follows: 7,590 of those claims were dismissed, 9 were tried to defense verdicts in favor of us, 2
were tried to hung juries, 1 of which resulted in a plaintiffs verdict upon retrial and 1 of
which resulted in a defense verdict upon retrial, and 12 were settled for immaterial amounts. Since January 1,
1995, we have been a co-defendant in asbestos cases that have been resolved as follows: 20,851 of
those claims were dismissed, 9 were tried to defense verdicts, 4 were tried to plaintiff verdicts
and 325 were decided in favor of us following summary judgment motions.
Defense costs have been increasing. The long-term impact of the manganese and asbestos loss
contingencies, in each case in the aggregate, on operating cash flows and capital markets is
difficult to access, particularly since claims are in many different stages of development and we
benefit significantly from cost-sharing with co-defendants and insurance carriers. While we intend
to contest these lawsuits vigorously, and have applicable insurance relating to these claims, there
are several risks and uncertainties that may affect our liability for personal claims relating to
exposure to manganese and asbestos, including the possibility that cost sharing dissipates for some
currently unforeseen reason or that our trial experience changes overall.
Manganese is an essential element of steel and cannot be eliminated from welding consumables.
Asbestos use in welding consumables in the U.S. ceased in 1981.
We may incur material losses and costs as a result of product liability claims that may be brought
against us.
Our products are used in a variety of applications, including infrastructure projects such as oil
and gas pipelines and platforms, buildings, bridges and power generation facilities, the
manufacture of transportation and heavy equipment or machinery, and various other construction
projects. We face risk of exposure to product liability claims in the event that accidents or
failures on these projects result, or are alleged to result, in bodily injury or property damage.
Further, our welding products are designed for use in specific applications, and if a product is
used inappropriately, personal injury or property damage may result. For example, in the period
between 1994 and 2000, we were a defendant or co-defendant in 21 lawsuits filed by building owners
or insurers in Los Angeles County, California. The plaintiffs in those cases alleged that certain
buildings affected by the 1994 Northridge earthquake sustained property damage in part because a
particular electrode used in the construction of those buildings was unsuitable for that use. In
the Northridge cases, one case was tried to a defense verdict in favor of us, 12 were voluntarily
dismissed, 7 were settled and we received summary judgment in our favor in another.
The occurrence of defects in or failures of our products, or the misuse of our products in specific
applications, could cause termination of customer contracts, increased costs and losses to us, our
customers and other end users. We cannot be assured that we will not experience any material
product liability losses in the future or that we will not incur significant costs to defend those
claims. Further, we cannot be assured that our product liability insurance coverage will be
adequate for any liabilities that we may ultimately incur or that it will continue to be available
on terms acceptable to us.
The cyclicality and maturity of the United States arc welding and cutting industry may adversely
affect our performance.
The United States arc welding and cutting industry is a mature industry that is cyclical in nature.
The growth of the domestic arc welding and cutting industry has been and continues to be
constrained by factors such as the increased cost of steel and increased offshore production of
fabricated steel structures. Overall demand for arc welding and cutting products is largely
determined by the level of capital spending in manufacturing and other industrial sectors, and the
welding industry has historically experienced contraction during periods of slowing industrial
activity. If economic, business and industry
27
conditions deteriorate, capital spending in those sectors may be substantially decreased, which
could reduce demand for our products, our revenues and our results of operations.
We may not be able to complete our acquisition strategy or successfully integrate acquired
businesses.
Part of our business strategy is to pursue targeted business acquisition opportunities, including
foreign investment opportunities. We cannot be certain that we will be successful in pursuing
potential acquisition candidates or that the consequences of any acquisition would be beneficial to
us. Future acquisitions may involve the expenditure of significant funds and management time.
Depending on the nature, size and timing of future acquisitions, we may be required to raise
additional financing, which may not be available to us on acceptable terms. Our current operational
cash flow is sufficient to fund our current acquisition plans, but a significant acquisition would
require access to the capital markets. Further, we may not be able to successfully integrate any
acquired business with our existing businesses or recognize expected benefits from any completed
acquisition.
If we cannot continue to develop, manufacture and market products that meet customer demands, our
revenues and gross margins may suffer.
Our continued success depends, in part, on our ability to continue to meet our customers needs for
welding products through the introduction of innovative new products and the enhancement of
existing product design and performance characteristics. We must remain committed to product
research and development and customer service in order to remain competitive. Accordingly, we may
spend a proportionately greater amount on research and development than some of our competitors. We
cannot be assured that new products or product improvements, once developed, will meet with
customer acceptance and contribute positively to our operating results, or that we will be able to
continue our product development efforts at a pace to sustain future growth. Further, we may lose
customers to our competitors if they demonstrate product design, development or manufacturing
capabilities superior to ours.
The competitive pressures we face could harm our revenue, gross margins and prospects.
We operate in a highly competitive global environment and compete in each of our businesses with
other broad line manufacturers and numerous smaller competitors specializing in particular
products. We compete primarily on the basis of brand, product quality, price and performance,
warranty, delivery, service and technical support. If our products, services, support and cost
structure do not enable us to compete successfully based on any of those criteria, our operations,
results and prospects could suffer.
Further, in the past decade, the United States arc welding industry has been subject to increased
levels of foreign competition as low cost imports have become more readily available. This foreign
competition intensifies as the value of the U.S. dollar falls in relation to other currencies.
Our competitive position could also be harmed if new or emerging competitors become more active in
the arc welding business. For example, while steel manufacturers traditionally have not been
significant competitors in the domestic arc welding industry, some foreign integrated steel
producers have begun to manufacture selected consumable arc welding products. Our sales and results
of operations, as well as our plans to expand in some foreign countries, could be harmed by this
practice as well.
We conduct our sales and distribution operations on a worldwide basis and are subject to the risks
associated with doing business outside the United States.
Our long-term strategy is to increase our share in growing international markets, particularly Asia
(with emphasis in China), Latin America, Eastern Europe and other developing markets. In recent
years, we have expanded our operations abroad by gaining a manufacturing presence in Poland,
Venezuela, Colombia and China. There are a number of risks in doing business abroad, which may
impede our ability to achieve our strategic objectives relating to our foreign operations. Many
developing countries, like Venezuela, have a significant degree of political and economic
uncertainty that may impede our ability to implement and achieve our foreign growth objectives. In
addition, compliance with multiple and potentially conflicting foreign laws and regulations, import
and export limitations and exchange controls is burdensome and expensive.
Moreover, social unrest, the absence of trained labor pools and the uncertainties associated with
entering into joint ventures or similar arrangements in foreign countries have slowed our business
expansion into some developing economies. Our presence in China has been facilitated largely
through joint venture agreements with local organizations. While this strategy has allowed us to
gain a footprint in China while leveraging the experience of local organizations, it also presents
corporate governance and management challenges.
28
Our foreign operations also subject us to the risks of international terrorism and hostilities and
to foreign currency risks, including exchange rate fluctuations and limits on the repatriation of
funds.
Our operations depend on maintaining a skilled workforce, and any interruption in our workforce
could negatively impact our results of operations and financial condition.
We are dependent on our highly trained technical sales force and the support of our welding
research and development staff.
Any interruption of our workforce, including interruptions due to unionization efforts, changes in
labor relations or shortages of appropriately skilled individuals for our research, production and
sales forces could impact our results of operations and financial condition.
Our revenues and results of operations may suffer if we cannot continue to enforce the intellectual
property rights on which our business depends or if third parties assert that we violate their
intellectual property rights.
We rely upon patent, trademark, copyright and trade secret laws in the United States and similar
laws in foreign countries, as well as agreements with our employees, customers, suppliers and other
third parties, to establish and maintain our intellectual property rights. However, any of our
intellectual property rights could be challenged, invalidated or circumvented, or our intellectual
property rights may not be sufficient to provide a competitive advantage. Further, the laws of
certain foreign countries do not protect our proprietary rights to the same extent as U.S. laws.
Accordingly, in certain countries, we may be unable to protect our proprietary rights against
unauthorized third-party copying or use, which could impact our competitive position.
Further, third parties may claim that we or our customers are infringing upon their intellectual
property rights. Even if we believe that those claims are without merit, defending those claims can
be time-consuming and costly. Claims of intellectual property infringement also might require us to
redesign affected products, enter into costly settlement or license agreements or pay costly damage
awards, or face a temporary or permanent injunction prohibiting us from manufacturing, marketing or
selling certain of our products.
Our global operations are subject to increasingly complex environmental regulatory requirements.
We are subject to increasingly complex environmental regulations affecting international
manufacturers, including those related to air and water emissions and waste management. Further, it
is our policy to apply strict standards for environmental protection to sites inside and outside
the United States, even when we are not subject to local government regulations. We may incur
substantial costs, including cleanup costs, fines and civil or criminal sanctions, liabilities
resulting from third-party property damage or personal injury claims, or our products could be
enjoined from entering certain jurisdictions, if we were to violate or become liable under
environmental laws or if our products become non-compliant with environmental laws.
We also face increasing complexity in our products design and procurement operations as we adjust
to new and future requirements relating to the design, production and labeling of our electrical
equipment products that are sold in the European Union. The ultimate costs under environmental laws
and the timing of these costs are difficult to predict, and liability under some environmental laws
relating to contaminated sites can be imposed retroactively and on a joint and several basis.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None.
Item 3. Defaults Upon Senior Securities None.
Item 4. Submission of Matters to a Vote of Security Holders
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(a) |
|
The Annual Meeting of Lincoln Electric Holdings, Inc. (Lincoln) was held on April 28,
2006. |
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(b) |
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No response is required. |
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(c) |
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The following matters were voted upon by security holders: |
|
(i) |
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Election of Directors. The shareholders voted in favor of electing the following
persons as Directors of the Company: |
|
|
|
|
|
|
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|
|
|
|
|
|
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|
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Abstentions/ |
|
Broker |
For term ending in 2009 |
|
Votes For |
|
Votes Against |
|
Non-Votes |
Harold L. Adams |
|
|
37,389,619 |
|
|
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211,807 |
|
|
|
|
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Robert J. Knoll |
|
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37,480,117 |
|
|
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121,309 |
|
|
|
|
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John M. Stropki, Jr. |
|
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37,308,562 |
|
|
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292,864 |
|
|
|
|
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29
|
(ii) |
|
Approval of the 2006 Equity and Performance Incentive Plan: |
|
|
|
|
|
Votes For |
|
|
30,914,894 |
|
Votes Against |
|
|
2,079,989 |
|
Abstentions |
|
|
391,877 |
|
Broker Non-Votes |
|
|
|
|
|
(iii) |
|
Approval of the 2006 Stock Plan for Non-Employee Directors: |
|
|
|
|
|
Votes For |
|
|
31,759,360 |
|
Votes Against |
|
|
1,360,287 |
|
Abstentions |
|
|
267,110 |
|
Broker Non-Votes |
|
|
|
|
|
(iv) |
|
Appointment of Independent Auditors. The shareholders ratified the appointment of the
firm of Ernst & Young, LLP as independent auditors to examine the books of account and
other records of the Company for the fiscal year ending December 31, 2006. |
|
|
|
|
|
Votes For |
|
|
37,433,593 |
|
Votes Against |
|
|
65,080 |
|
Abstentions |
|
|
102,751 |
|
Broker Non-Votes |
|
|
|
|
Item 5. Other Information
(a) |
|
On July 20, 2006 the Board of Directors elected Stephen G. Hanks as a director of
Lincoln to serve with a term expiring at the 2007 annual meeting of shareholders. Mr.
Hanks is the President and Chief Executive Officer of Washington Group International Inc.,
a Nasdaq-traded company that provides integrated engineering, construction and management
solutions for businesses and governments worldwide. Mr. Hanks will serve on Lincolns
Compensation and Executive Development and Finance Committees of the Board. |
|
|
|
A copy of the press release announcing the election of Mr. Hanks as a director of Lincoln
is furnished as Exhibit 99.1 to this report and incorporated herein by reference. |
|
(b) |
|
None. |
Item 6. Exhibits
(a) Exhibits
10.1 |
|
2006 Equity and Performance Incentive Plan (filed as Appendix B to the Companys Proxy
Statement filed with the Commission on March 28, 2006 and incorporated herein by reference). |
|
10.2 |
|
2006 Stock Plan for Non-Employee Directors (filed as Appendix C to the Companys Proxy
Statement filed with the Commission on March 28, 2006 and
incorporated herein by reference). |
|
10.3 |
|
Agreement with Ranko Cucuz effective June 30, 2006 (see
Item 1.01 of the Companys Form 8-K
filed with the Commission on July 3, 2006 and incorporated herein by reference). |
|
31.1 |
|
Certification by the Chairman, President and Chief Executive Officer pursuant to Rules 13a-14(a)/15d-14(a) of the
Securities Exchange Act of 1934.
|
|
31.2 |
|
Certification by the Senior Vice President, Chief Financial Officer and Treasurer pursuant to Rules
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934. |
|
32.1 |
|
Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
99.1 |
|
Press release dated July 21, 2006 announcing the
election of Stephen G. Hanks to Lincolns Board of Directors. |
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
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LINCOLN ELECTRIC HOLDINGS, INC.
|
|
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/s/ Vincent K. Petrella
|
|
|
Vincent K. Petrella, Senior Vice President, |
|
|
Chief Financial Officer and Treasurer
(principal financial and accounting officer)
July 25, 2006 |
|
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30