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LINCOLN ELECTRIC HOLDINGS INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

February 21, 2014

(Dollars in thousands, except per share amounts) This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read together with "Selected Financial Data," the Company's consolidated financial statements and other financial information included elsewhere in this Annual Report on Form 10-K. This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated in the forward-looking statements. See "Item 1A. Risk Factors" for more information regarding forward-looking statements. General The Company is the world's largest designer and manufacturer of arc welding and cutting products, manufacturing a broad 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 welding, cutting and brazing products. Welding products include arc welding power sources, wire feeding systems, robotic welding packages, fume extraction equipment, consumable electrodes and fluxes. The Company's product offering also includes CNC plasma and oxy-fuel cutting systems, regulators and torches used in oxy-fuel welding, cutting and brazing. 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 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 continues to actively increase 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 coupled with its extensive distributor network provide a competitive advantage in the marketplace. The Company's 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 Company's various manufacturing sites to distributors and product users. The Company's major end-user markets include: general metal fabrication,



power generation and process industry,

structural steel construction (buildings and bridges),

heavy equipment fabrication (farming, mining and rail),

shipbuilding, automotive,



pipe mills and pipelines, and

offshore oil and gas exploration and extraction.

The Company has, through wholly-owned subsidiaries or joint ventures, manufacturing facilities located in the United States, Brazil, Canada, China, Colombia, France, Germany, India, Indonesia, Italy, Mexico, the Netherlands, Poland, Portugal, Russia, Turkey, the United Kingdom and Venezuela. The Company has aligned its business units into five operating segments to enhance the utilization of the Company's worldwide resources and global end user and sourcing initiatives. The operating segments consist of North America Welding, Europe Welding, Asia Pacific Welding, South America Welding and The Harris Products Group. The North America Welding segment includes welding operations in the United States, Canada and Mexico. The Europe Welding segment includes welding operations in Europe, Russia, Africa and the Middle East. The other two welding segments include welding operations in Asia Pacific and South America, respectively. The fifth segment, The Harris Products Group, includes the Company's global cutting, soldering and brazing businesses as well as the retail business in the United States. See Note 5 to the Company's consolidated financial statements for segment and geographic area information, which is incorporated herein by reference. The principal raw materials essential to the Company's business are steel, electronic components, engines, brass, copper, silver, aluminum alloys and various chemicals, all of which are normally available for purchase in the open market. 15 -------------------------------------------------------------------------------- The Company's facilities are subject to environmental regulations. To date, compliance with these environmental regulations has not had a material adverse effect on the Company's 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 North America and Europe and is progressing towards certification at its remaining facilities worldwide. 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 steel, farm machinery and equipment, construction and transportation, fabricated metals, electrical equipment, ship and boat building, defense, truck manufacturing, energy 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 Company's welding products. Key operating measures utilized by the operating units to manage the Company include orders, sales, inventory and fill-rates, all of 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 Company's 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; operating income; earnings before interest and taxes; earnings before interest, taxes and bonus; net income; adjusted operating income; adjusted net income; adjusted diluted earnings per share; operating cash flows; and capital expenditures, including applicable ratios such as return on invested capital 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 shows the Company's results of operations: Year Ended December 31, 2013 2012 2011 Amount % of Sales Amount % of Sales Amount % of Sales Net sales $ 2,852,671 100.0 % $ 2,853,367 100.0 % $ 2,694,609 100.0 % Cost of goods sold 1,910,017 67.0 % 1,986,711 69.6 % 1,957,872 72.7 % Gross profit 942,654 33.0 % 866,656 30.4 % 736,737 27.3 % Selling, general & administrative expenses 527,206 18.5 % 495,221 17.4 % 439,775 16.3 % Rationalization and asset impairment charges 8,463 0.3 % 9,354 0.3 % 282 - Operating income 406,985 14.3 % 362,081 12.7 % 296,680 11.0 % Interest income 3,320 0.1 % 3,988 0.1 % 3,121 0.1 % Equity earnings in affiliates 4,806 0.2 % 5,007 0.2 % 5,385 0.2 % Other income 4,194 0.1 % 2,685 0.1 % 2,849 0.1 % Interest expense (2,864 ) (0.1 %) (4,191 ) (0.1 %) (6,704 ) (0.2 %) Income before income taxes 416,441 14.6 % 369,570 13.0 % 301,331 11.2 % Income taxes 124,754 4.4 % 112,354 3.9 % 84,318 3.1 % Net income including non-controlling interests 291,687 10.2 % 257,216 9.0 % 217,013 8.1 % Non-controlling interests in subsidiaries' loss (2,093 ) (0.1 %) (195 ) - (173 ) - Net income $ 293,780 10.3 % $ 257,411 9.0 % $ 217,186 8.1 % 16

-------------------------------------------------------------------------------- 2013 Compared with 2012 Net Sales: Net sales for 2013 remained flat with 2012. The sales change reflects volume decreases of 2.7%, price increases of 0.1%, increases from acquisitions of 3.2% and unfavorable impacts from foreign exchange of 0.6%. Sales volumes decreased as a result of soft demand in both domestic and international markets. Product pricing increased from prior year levels reflecting the highly inflationary environment in Venezuela offset by pricing declines in The Harris Products Group segment due to significant decreases in the costs of silver and copper. Net sales for 2013 include $109,139 in sales from the Company's Venezuelan operations. Gross Profit: Gross profit increased 8.8% to $942,654 during 2013 compared with $866,656 in 2012. As a percentage of Net sales, Gross profit increased to 33.0% in 2013 compared with 30.4% in 2012. The increase was the result of geographic mix and pricing stability in the wake of lower year over year input costs. The current period includes incremental costs of $4,117 due to the devaluation of the Venezuelan currency and charges of $2,521 for inventory write-downs, partially offset by a gain of $1,672 from insurance proceeds associated with a fire at a manufacturing operation. In the prior year period, the Company recorded charges of $2,334 related to the initial accounting for recent acquisitions and charges of $1,039 due to a change in Venezuelan labor law, which provides for increased employee severance obligations. Foreign currency exchange rates had a $5,622 unfavorable translation impact in 2013. Selling, General & Administrative ("SG&A") Expenses: SG&A expenses increased 6.5% to $527,206 during 2013 compared with $495,221 in 2012. The increase was primarily due to incremental SG&A expenses from acquisitions of $18,620, general and administrative spending primarily related to additional employee compensation costs of $17,160 and higher foreign exchange transaction losses of $3,280, which include a charge of $8,081 due to the devaluation of the Venezuelan currency, partially offset by foreign currency translation of $3,264, lower bonus expense of $3,112 and lower U.S. retirement costs of $1,415. Rationalization and Asset Impairment Charges: In 2013, the Company recorded $8,463 in charges primarily related to asset impairments and rationalization actions. See "Rationalization and Asset Impairments" for additional information. Equity Earnings in Affiliates: Equity earnings in affiliates were $4,806 in 2013 compared with earnings of $5,007 in 2012. The decrease was due to decreased earnings in Chile of $161 and Turkey of $40. Interest Expense: Interest expense decreased to $2,864 in 2013 from $4,191 in 2012, primarily as a result of lower levels of debt in the current period. Income Taxes: The Company recorded $124,754 of tax expense on pre-tax income of $416,441, resulting in an effective tax rate of 30.0% for 2013. The effective income tax rate is lower than the Company's statutory rate primarily due to income earned in lower tax rate jurisdictions and the utilization of foreign tax loss carry-forwards for which valuation allowances had been previously provided. The effective income tax rate of 30.4% for 2012 was lower than the Company's statutory rate primarily due to income earned in lower tax rate jurisdictions and the utilization of foreign tax loss carry-forwards for which valuation allowances had been previously provided. Net Income: Net income for 2013 was $293,780 compared with $257,411 in the prior year. Diluted earnings per share for 2013 were $3.54 compared with diluted earnings of $3.06 per share in 2012. Net income for 2013 included $25,614, or $0.31 per diluted share, from the Company's Venezuelan operations. Foreign currency exchange rate movements had an unfavorable translation effect of $1,572 and $2,879 on Net income for 2013 and 2012, respectively. 17 -------------------------------------------------------------------------------- Segment Results Net Sales: The table below summarizes the impacts of volume, acquisitions, price and foreign currency exchange rates on Net sales for the twelve months ended December 31, 2013: Change in Net Sales due to: Net Sales Net Sales 2012 Volume Acquisitions Price Foreign Exchange 2013 Operating Segments North America Welding $ 1,580,818$ (22,962 )$ 91,442$ 7,785$ (4,314 )$ 1,652,769 Europe Welding 452,227 (18,518 ) - (5,696 ) 1,535 429,548 Asia Pacific Welding 324,482 (48,964 ) - (4,947 ) (4,289 ) 266,282 South America Welding 161,483 13,269 - 29,730 (8,587 ) 195,895 The Harris Products Group 334,357 1,276 - (24,748 ) (2,708 ) 308,177 Consolidated $ 2,853,367$ (75,899 )$ 91,442$ 2,124$ (18,363 )$ 2,852,671 % Change North America Welding (1.5 %) 5.8 % 0.5 % (0.3 %) 4.6 % Europe Welding (4.1 %) - (1.3 %) 0.3 % (5.0 %) Asia Pacific Welding (15.1 %) - (1.5 %) (1.3 %) (17.9 %) South America Welding 8.2 % - 18.4 % (5.3 %) 21.3 % The Harris Products Group 0.4 % - (7.4 %) (0.8 %) (7.8 %) Consolidated (2.7 %) 3.2 % 0.1 % (0.6 %) - Net sales volumes for 2013 decreased for all operating segments except for the South America Welding and The Harris Products Group segments, as a result of soft demand in both domestic and international markets. Net sales volumes in the South America Welding segment increased as a result of improved demand in the South American markets. Net sales volumes in The Harris Products Group segment increased as a result of improved sales volumes on equipment. Product pricing in the North America Welding segment increased slightly due to the realization of price increases and improved pricing management. Product pricing in the Europe Welding segment decreased due to declining raw material costs. Product pricing decreased for the Asia Pacific Welding segment due to lower raw material costs and competitive pricing conditions. Product pricing in the South America Welding segment reflects a highly inflationary environment, particularly in Venezuela. Product pricing decreased for The Harris Products Group segment because of significant decreases in the costs of silver and copper as compared to the prior year period. The increase in Net sales from acquisitions was due to the acquisitions of Robolution GmbH ("Robolution") in November 2013, Burlington Automation Corporation ("Burlington") in November 2013, Tennessee Rand, Inc. ("Tenn Rand") in December 2012, Kaliburn, Burny and Cleveland Motion Control businesses (collectively, "Kaliburn") in November 2012, Wayne Trail Technologies, Inc. ("Wayne Trail") in May 2012 and Weartech International, Inc. ("Weartech") in March 2012 (see the "Acquisitions" section below for additional information regarding the acquisitions). With respect to changes in Net sales due to foreign exchange, all segments, except for the Europe Welding segment, decreased due to a stronger U.S. dollar. 18 --------------------------------------------------------------------------------



Earnings Before Interest and Income Taxes ("EBIT"), as Adjusted: Segment performance is measured and resources are allocated based on a number of factors, the primary profit measure being EBIT, as adjusted. The following table presents EBIT, as adjusted for 2013 by segment compared with 2012:

Twelve Months Ended December 31, 2013 2012 $ Change % Change North America Welding: Net sales $ 1,652,769$ 1,580,818 71,951 4.6 % Inter-segment sales 127,254 131,062 (3,808 ) (2.9 %) Total Sales $ 1,780,023$ 1,711,880 68,143 4.0 % EBIT, as adjusted $ 318,507$ 293,070 25,437 8.7 % As a percent of total sales 17.9 % 17.1 % 0.8 % Europe Welding: Net sales $ 429,548$ 452,227 (22,679 ) (5.0 %) Inter-segment sales 19,911 16,048 3,863 24.1 % Total Sales $ 449,459$ 468,275 (18,816 ) (4.0 %) EBIT, as adjusted $ 36,247$ 37,299 (1,052 ) (2.8 %) As a percent of total sales 8.1 % 8.0 % 0.1 % Asia Pacific Welding: Net sales $ 266,282$ 324,482 (58,200 ) (17.9 %) Inter-segment sales 14,906 14,829 77 0.5 % Total Sales $ 281,188$ 339,311 (58,123 ) (17.1 %) EBIT, as adjusted $ 1,815$ 7,247 (5,432 ) (75.0 %) As a percent of total sales 0.6 % 2.1 % (1.5 %) South America Welding: Net sales $ 195,895$ 161,483 34,412 21.3 % Inter-segment sales 233 38 195 513.2 % Total Sales $ 196,128$ 161,521 34,607 21.4 % EBIT, as adjusted $ 57,306$ 18,301 39,005 213.1 % As a percent of total sales 29.2 % 11.3 % 17.9 % The Harris Products Group: Net sales $ 308,177$ 334,357 (26,180 ) (7.8 %) Inter-segment sales 9,605 8,549 1,056 12.4 % Total Sales $ 317,782$ 342,906 (25,124 ) (7.3 %) EBIT, as adjusted $ 27,826$ 29,477 (1,651 ) (5.6 %) As a percent of total sales 8.8 % 8.6 % 0.2 % EBIT, as adjusted as a percent of total sales increased for all segments, except for the Asia Pacific Welding segment, in 2013 as compared with 2012. The North America Welding segment increase is primarily due to improved pricing management and lower material costs. The increase at the Europe Welding segment is primarily due to cost control on volume decreases of 4.1%. The Asia Pacific Welding segment decrease is due to lower profitability in China and Australia due to weaker demand. The South America Welding segment increase is a result of improved pricing management and manufacturing costs in Brazil and Colombia, and pricing increases as a result of the highly inflationary economy in Venezuela. The Harris Products Group segment growth is primarily a result of improved product mix on equipment sales volume. 19 -------------------------------------------------------------------------------- In 2013, EBIT, as adjusted, for the North America Welding, Europe Welding and Asia Pacific Welding segments excluded special item charges of $1,052, $2,045 and $922, respectively, primarily related to employee severance and other costs associated with the consolidation of manufacturing operations. The Asia Pacific Welding segment EBIT, as adjusted, also excluded charges of $4,444 related to impairment of long-lived assets and a charge of $705 related to a loss on the sale of land. The South America Welding segment EBIT, as adjusted, excluded special item charges of $12,198, related to the devaluation of the Venezuelan currency. In 2012, EBIT, as adjusted, for the North America Welding, Europe Welding and Asia Pacific Welding segments excluded special item charges of $827, $3,534 and $4,993, respectively, primarily related to employee severance and other costs associated with the consolidation of manufacturing operations. The South America Welding segment EBIT, as adjusted, excluded a special item charge of $1,381, related to a change in Venezuelan labor law, which provides for increased employee severance obligations. 2012 Compared with 2011 Net Sales: Net sales for 2012 increased 5.9% from 2011. The sales increase reflects volume increases of 1.3%, price increases of 1.7%, increases from acquisitions of 4.9% and unfavorable impacts from foreign exchange of 2.0%. Sales volumes increased because of growth in the domestic markets offset by lower demand in the international markets. Product pricing increased from prior year levels due to the realization of price increases implemented in response to increases in raw material costs. Gross Profit: Gross profit increased 17.6% to $866,656 during 2012 compared with $736,737 in 2011. As a percentage of Net sales, Gross profit increased to 30.4% in 2012 compared with 27.3% in 2011. The increase was the result of pricing increases and operating leverage partially offset by lower margins from the acquisitions of Kaliburn, Wayne Trail, Weartech, Techalloy Company, Inc. and certain assets of its parent company, Central Wire Industries Ltd. (collectively, "Techalloy") and OOO Severstal-metiz: welding consumables ("Severstal"). In 2012, the Company recorded charges of $2,334 related to the initial accounting for recent acquisitions and charges of $1,039 due to a change in Venezuelan labor law, which provides for increased employee severance obligations. Foreign currency exchange rates had a $13,166 unfavorable translation impact in 2012. Selling, General & Administrative ("SG&A") Expenses: SG&A expenses increased 12.6% to $495,221 during 2012 compared with $439,775 in 2011. The increase was primarily due to higher bonus expense of $20,439, incremental SG&A expenses from acquisitions of $15,403, higher general and administrative spending primarily related to additional employee compensation costs of $12,692, higher U.S. retirement costs of $3,986 and higher legal expenses of $2,142 partially offset by foreign currency translation of $8,821. Rationalization and Asset Impairment Charges: In 2012, the Company recorded $9,354 in charges primarily related to rationalization actions initiated in 2012. See "Rationalization and Asset Impairments" for additional information. Equity Earnings in Affiliates: Equity earnings in affiliates were $5,007 in 2012 compared with earnings of $5,385 in 2011. The decrease was due to a decrease in earnings of $542 in Chile being partially offset by an increase in earnings of $164 in Turkey. Interest Expense: Interest expense decreased to $4,191 in 2012 from $6,704 in 2011, primarily as a result of lower levels of debt in the current period. Income Taxes: The Company recorded $112,354 of tax expense on pre-tax income of $369,570, resulting in an effective tax rate of 30.4% for 2012. The effective income tax rate is lower than the Company's statutory rate primarily due to income earned in lower tax rate jurisdictions and the utilization of foreign tax loss carry-forwards for which valuation allowances had been previously provided. The effective income tax rate of 28.0% for 2011 was lower than the Company's statutory rate primarily due to income earned in lower tax rate jurisdictions, the utilization of foreign tax loss carry-forwards for which valuation allowances had been previously provided and a tax benefit of $4,844 for tax audit settlements. Net Income: Net income for 2012 was $257,411 compared with $217,186 in the prior year. Diluted earnings per share for 2012 were $3.06 compared with diluted earnings of $2.56 per share in 2011. Foreign currency exchange rate movements had an unfavorable translation effect of $2,879 and a favorable translation effect of $2,948 on Net income for 2012 and 2011, respectively. 20 -------------------------------------------------------------------------------- Segment Results Net Sales: The table below summarizes the impacts of volume, acquisitions, price and foreign currency exchange rates on Net sales for the twelve months ended December 31, 2012: Change in Net Sales due to: Net Sales Foreign Net Sales 2011 Volume Acquisitions Price Exchange 2012 Operating Segments North America Welding $ 1,309,499$ 112,898$ 124,830$ 37,124$ (3,533 )$ 1,580,818 Europe Welding 508,692 (36,199 ) 8,322 4,874 (33,462 ) 452,227 Asia Pacific Welding 376,276 (54,289 ) - 1,646 849 324,482 South America Welding 156,684 (1,284 ) - 15,584 (9,501 ) 161,483 The Harris Products Group 343,458 13,683 - (13,427 ) (9,357 ) 334,357 Consolidated $ 2,694,609$ 34,809$ 133,152$ 45,801$ (55,004 )$ 2,853,367 % Change North America Welding 8.6 % 9.5 % 2.8 % (0.3 %) 20.7 % Europe Welding (7.1 %) 1.6 % 1.0 % (6.6 %) (11.1 %) Asia Pacific Welding (14.4 %) - 0.4 % 0.2 % (13.8 %) South America Welding (0.8 %) - 9.9 % (6.1 %) 3.1 % The Harris Products Group 4.0 % - (3.9 %) (2.7 %) (2.6 %) Consolidated 1.3 % 4.9 % 1.7 % (2.0 %) 5.9 % Net sales volumes for 2012 increased for the North America Welding and The Harris Products Group segments because of growth within the domestic markets. Volume decreases for the Europe Welding, Asia Pacific Welding and South America Welding segments are the result of softening demand in these international markets. Product pricing increased for all operating segments from prior year levels, except for The Harris Products Group segment, due to the realization of price increases implemented in response to increases in raw material costs. Product pricing in the South America Welding segment reflects a higher inflationary environment, particularly in Venezuela. Product pricing decreased for The Harris Products Group segment because of significant decreases in the costs of silver and copper as compared to the prior year period. The increase in Net sales from acquisitions was due to the acquisitions of Kaliburn in November 2012, Wayne Trail in May 2012, Weartech in March 2012, Techalloy in July 2011, Applied Robotics, Inc. (d/b/a Torchmate) ("Torchmate") in July 2011 and SSCO Manufacturing, Inc. (d/b/a Arc Products) ("Arc Products") in January 2011 in the North America Welding segment and the acquisition of Severstal in March 2011 in the Europe Welding segment (see the "Acquisitions" section below for additional information regarding the acquisitions). With respect to changes in Net sales due to foreign exchange, all segments, except for the Asia Pacific Welding segment, decreased due to a stronger U.S. dollar. 21 --------------------------------------------------------------------------------



Earnings Before Interest and Income Taxes ("EBIT"), as Adjusted: Segment performance is measured and resources are allocated based on a number of factors, the primary profit measure being EBIT, as adjusted. The following table presents EBIT, as adjusted for 2012 by segment compared with 2011:

Twelve Months Ended December 31, 2012 2011 $ Change % Change North America Welding: Net sales $ 1,580,818$ 1,309,499 271,319 20.7 % Inter-segment sales 131,062 136,314 (5,252 ) (3.9 %) Total Sales $ 1,711,880$ 1,445,813 266,067 18.4 % EBIT, as adjusted $ 293,070$ 227,924 65,146 28.6 % As a percent of total sales 17.1 % 15.8 % 1.3 % Europe Welding: Net sales $ 452,227$ 508,692 (56,465 ) (11.1 %) Inter-segment sales 16,048 17,422 (1,374 ) (7.9 %) Total Sales $ 468,275$ 526,114 (57,839 ) (11.0 %) EBIT, as adjusted $ 37,299$ 36,171 1,128 3.1 % As a percent of total sales 8.0 % 6.9 % 1.1 % Asia Pacific Welding: Net sales $ 324,482$ 376,276 (51,794 ) (13.8 %) Inter-segment sales 14,829 15,614 (785 ) (5.0 %) Total Sales $ 339,311$ 391,890 (52,579 ) (13.4 %) EBIT, as adjusted $ 7,247$ 2,629 4,618 175.7 % As a percent of total sales 2.1 % 0.7 % 1.4 % South America Welding: Net sales $ 161,483$ 156,684 4,799 3.1 % Inter-segment sales 38 494 (456 ) (92.3 %) Total Sales $ 161,521$ 157,178 4,343 2.8 % EBIT, as adjusted $ 18,301$ 12,895 5,406 41.9 % As a percent of total sales 11.3 % 8.2 % 3.1 % The Harris Products Group: Net sales $ 334,357$ 343,458 (9,101 ) (2.6 %) Inter-segment sales 8,549 8,496 53 0.6 % Total Sales $ 342,906$ 351,954 (9,048 ) (2.6 %) EBIT, as adjusted $ 29,477$ 25,151 4,326 17.2 % As a percent of total sales 8.6 % 7.1 % 1.5 % EBIT, as adjusted as a percent of total sales increased for all segments in 2012 as compared with 2011. The North America Welding segment growth was primarily due to improved leverage on an 8.6% increase in volumes and price increases of 2.8%. The increase at the Europe Welding segment was primarily due to improved product mix. The Asia Pacific Welding segment increase was due to improved profitability resulting from prior rationalization actions in Australia and improved product mix. The South America Welding segment increase was a result of product pricing increases of 9.9% exceeding inflationary cost. The Harris Products Group segment growth was primarily a result of improved product mix on equipment sales volume. 22 -------------------------------------------------------------------------------- In 2012, EBIT, as adjusted, for the North America Welding, Europe Welding and Asia Pacific Welding segments excluded special item charges of $827, $3,534 and $4,993, respectively, primarily related to employee severance and other costs associated with the consolidation of manufacturing operations. The South America Welding segment EBIT, as adjusted, excluded a special item charge of $1,381, related to a change in Venezuelan labor law, which provides for increased employee severance obligations. In 2011, EBIT, as adjusted, for the Europe Welding and Asia Pacific Welding segments excluded special item net charges of $188 and $93, respectively, primarily related to employee severance and other cost associated with the consolidation of manufacturing operations. The Europe Welding segment special items also include a loss of $204 on the sale of assets at a rationalized operation. The Asia Pacific Welding segment special items also include a gain of $203 on the sale of assets at a rationalized operation. Non-GAAP Financial Measures The Company reviews Adjusted operating income, Adjusted net income and Adjusted diluted earnings per share, all non-GAAP financial measures, in assessing and evaluating the Company's underlying operating performance. These non-GAAP financial measures exclude the impact of special items on the Company's reported financial results. Non-GAAP financial measures should be read in conjunction with the generally accepted accounting principles ("GAAP") financial measures, as non-GAAP measures are a supplement to, and not a replacement for, GAAP financial measures. The following table presents a reconciliation of Operating income as reported to Adjusted operating income: Year Ended December 31, 2013 2012 2011 Operating income as reported $ 406,985$ 362,081 $



296,680

Special items (pre-tax): Rationalization and asset impairment charges 8,463 9,354



282

Loss on the sale of land 705 -



-

Venezuela currency devaluation 12,198 -



-

Venezuela statutory severance obligation - 1,381 - Adjusted operating income $ 428,351$ 372,816$ 296,962 Special items included in Operating income during 2013 include net rationalization and asset impairment charges of $8,463 primarily related to employee severance and other costs associated with the consolidation of manufacturing operations and impairment of long-lived assets and a loss on the sale of land of $705. Special items for 2013 also include charges of $12,198 related to the devaluation of the Venezuelan currency. Special items included in Operating income during 2012 include net rationalization and asset impairment charges of $9,354 primarily related to employee severance and other costs associated with the consolidation of manufacturing operations initiated in 2012, partially offset by gains on the disposal of assets at rationalized operations and a charge of $1,381 related to the change in Venezuelan labor law, which provides for increased employee severance obligations. Special items included in Operating income during 2011 include net rationalization and asset impairment charges of $282 primarily related to employee severance and other costs associated with the consolidation of manufacturing operations resulting from actions initiated in 2009. 23 -------------------------------------------------------------------------------- The following table presents reconciliations of Net income and Diluted earnings per share as reported to Adjusted net income and Adjusted diluted earnings per share: Year Ended December 31, 2013 2012 2011 Net income as reported $ 293,780$ 257,411$ 217,186 Special items (after-tax): Rationalization and asset impairment charges 7,573 7,442 237 Loss on the sale of land 705 - - Venezuela currency devaluation 12,198 - - Venezuela statutory severance obligation - 906 - Adjustment for tax audit settlements - - (4,844 ) Non-controlling interests associated with special items (1,068 ) - - Adjusted net income $ 313,188$ 265,759$ 212,579 Diluted earnings per share as reported $ 3.54$ 3.06$ 2.56 Special items per share 0.23 0.10 (0.05 ) Adjusted diluted earnings per share $ 3.77$ 3.16



$ 2.51

Net income for 2013 includes net rationalization and asset impairment charges of $7,573 primarily related to employee severance and other costs associated with the consolidation of manufacturing operations and impairment of long-lived assets and a loss on the sale of land of $705. Associated with the impairment of long-lived assets and loss on the sale of land is an offsetting special item of $1,068 attributable to non-controlling interests. Special items for 2013 also include charges of $12,198 related to the devaluation of the Venezuelan currency. Adjusted net income for 2013 includes $37,812, or $0.46 per diluted share, from the Company's Venezuelan operations. Net income for 2012 includes net rationalization and asset impairment charges of $7,442 primarily related to employee severance and other costs associated with the consolidation of manufacturing operations initiated in 2012 partially offset by gains on the disposal of assets at rationalized operations and a charge of $906 related to the change in Venezuelan labor law, which provides for increased employee severance obligations. Net income for 2011 includes net rationalization and asset impairment charges of $237 primarily related to employee severance and other costs associated with the consolidation of manufacturing operations resulting from actions initiated in 2009. Special items for 2011 also include a gain of $4,844 related to a favorable adjustment for tax audit settlements. Liquidity and Capital Resources The Company's cash flow from operations can be cyclical. 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 for improvement. Management anticipates the Company will be able to satisfy cash requirements for its ongoing businesses for the foreseeable future primarily with cash generated by operations, existing cash balances and, if necessary, borrowings under its existing credit facilities. 24 --------------------------------------------------------------------------------



The following table reflects changes in key cash flow measures:

Year Ended December 31, $ Change 2013 2012 2011 2013 vs. 2012 2012 vs. 2011 Cash provided by operating activities $ 338,894$ 327,484$ 193,518$ 11,410$ 133,966 Cash used by investing activities: (129,500 ) (187,471 ) (130,796 ) 57,971 (56,675 ) Capital expenditures (76,015 ) (52,715 ) (65,813 ) (23,300 ) 13,098 Acquisition of businesses, net of cash acquired (53,161 ) (134,602 ) (66,229 ) 81,441 (68,373 ) Proceeds from the sale of property, plant and equipment 1,393 1,387 1,246 6 141 Other investing activities (1,717 ) (1,541 ) - (176 ) (1,541 ) Cash used by financing activities: (194,184 ) (216,838 ) (63,370 ) 22,654 (153,468 ) (Payments) proceeds on short-term borrowings, net (1,451 ) (4,533 ) 8,981 3,082 (13,514 ) Payments on long-term borrowings, net (389 ) (84,770 ) (1,032 ) 84,381 (83,738 ) Proceeds from exercise of stock options 20,297 18,776 11,351 1,521 7,425 Excess tax benefit from stock-based compensation 10,602 7,819 2,916 2,783 4,903



Purchase of shares for treasury (167,879 ) (81,018 ) (36,997 )

(86,861 ) (44,021 ) Cash dividends paid to shareholders (49,277 ) (73,112 ) (51,935 ) 23,835 (21,177 ) Transactions with non-controlling interests (6,087 ) - - (6,087 ) - Other financing activities - - 3,346 - (3,346 ) Increase (decrease) in Cash and cash equivalents 13,361 (74,637 ) (5,092 ) Cash and cash equivalents increased 4.7%, or $13,361, to $299,825 during the twelve months ended December 31, 2013, from $286,464 as of December 31, 2012. This increase was predominantly due to cash provided by operating activities offset by capital expenditures of $76,015, cash used in the acquisition of businesses, net of cash acquired of $53,161, purchases of common shares for treasury of $167,879 and cash dividends paid to shareholders of $49,277. Additionally, in the twelve months ended December 31, 2012 a deposit of $89,448 for tax and interest assessed by the Canada Revenue Agency ("CRA") was made, which did not recur in the current period. Cash provided by operating activities increased $11,410 for the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012. The increase was predominantly due to increased Net income for the twelve months ended December 31, 2013, compared with the twelve months ended December 31, 2012 and a deposit of $89,448 for tax and interest assessed by the CRA made in 2012, which did not recur in the current period, offset by a slight improvement in net operating working capital requirements in the twelve months ended December 31, 2013 as compared to a significant improvement in the twelve months ended December 31, 2012. Net operating working capital, defined as the sum of Accounts receivable and Total inventory less Trade accounts payable, decreased $8,667 in 2013 compared with a decrease of $102,155 in 2012. Net operating working capital to sales, defined as net operating working capital divided by annualized rolling three months of Net sales, decreased to 17.6% at December 31, 2013 compared with 18.8% at December 31, 2012. Days sales in inventory decreased to 93.2 days at December 31, 2013 from 94.3 days at December 31, 2012. Accounts receivable days decreased to 50.3 days at December 31, 2013 from 51.8 days at December 31, 2012. Average days in accounts payable increased to 45.5 days at December 31, 2013 from 43.9 days at December 31, 2012. Cash used by investing activities in the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012 decreased by $57,971. The decrease was predominantly due to a decrease in the acquisition of businesses of $81,441 offset by an increase in capital expenditures of $23,300. The Company anticipates capital expenditures of $60,000 to $80,000 in 2014. Anticipated capital expenditures reflect investments for capital maintenance, to improve operational effectiveness and the Company's continuing international expansion. Management critically evaluates all proposed capital expenditures and requires each project to increase efficiency, reduce costs, promote business growth, or to improve the overall safety and environmental conditions of the Company's facilities. Cash used by financing activities decreased $22,654 in the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012. The decrease was predominantly due to lower net payments of long-term borrowings of $84,381, lower cash dividends paid to shareholders of $23,835 offset by higher purchases of common shares for treasury of $86,861. 25 -------------------------------------------------------------------------------- The Company continues to expand globally and periodically looks at transactions that would involve significant investments. The Company can fund its global expansion plans with operational cash flow, but a significant acquisition may require access to capital markets, in particular, the long-term debt market, as well as the syndicated bank loan market. The Company's 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. The Company's debt levels decreased from $20,275 at December 31, 2012 to $19,087 at December 31, 2013. Debt to total invested capital decreased to 1.2% at December 31, 2013 from 1.5% at December 31, 2012. The Company paid $49,277 in cash dividends to its shareholders in the twelve months ended December 31, 2013. The Company has a share repurchase program for up to 45 million shares of the Company's common stock. At management's discretion, the Company repurchases its common stock from time to time in the open market, depending on market conditions, stock price and other factors. During the twelve months ended December 31, 2013, the Company purchased 2,671,614 shares at a cost of $164,755. As of December 31, 2013, 15,670,759 shares remained available for repurchase under the stock repurchase program. The Company made voluntary contributions to its U.S. defined benefit plans of $75,216, $60,277 and $30,000 in 2013, 2012 and 2011, respectively. The Company expects to voluntarily contribute approximately $20,000 to its U.S. plans in 2014. Based on current pension funding rules, the Company does not anticipate that contributions to the plans would be required in 2014. Canada - Notice of Reassessment As discussed in Note 12 to the consolidated financial statements, in July 2012, the Company received a Notice of Reassessment from the CRA for 2004 to 2011, which would disallow the deductibility of inter-company dividends. These adjustments would increase Canadian federal and provincial tax due by $58,824 plus approximately $16,022 of interest, net of tax. The Company disagrees with the position taken by the CRA and believes it is without merit. The Company will vigorously contest the assessment through the Tax Court of Canada. A trial date has not yet been scheduled. In connection with the litigation process, the Company is required to deposit no less than one half of the tax and interest assessed by the CRA. The Company has elected to deposit the entire amount of the dispute in order to suspend the continuing accrual of a 5% interest charge. Additionally, deposited amounts will earn interest of approximately 1% due upon a favorable outcome. A deposit was made in 2012 and is recorded as a non-current asset as of December 31, 2013. Although the Company believes it will prevail on the merits of the tax position, the ultimate outcome of the assessment remains uncertain. Rationalization and Asset Impairments In 2013, the Company recorded rationalization and asset impairment net charges of $8,463 resulting from rationalization activities primarily initiated in 2012 and the third quarter 2013. The 2013 net charges include $3,658 primarily related to employee severance and other related costs and $4,961 in asset impairment charges, partially offset by gains from sales of assets of $156. In 2012, the Company recorded rationalization and asset impairment net charges of $9,354 resulting from rationalization activities primarily initiated in 2012. The Company initiated a number of rationalization activities in 2012 to align its business to current market conditions. The 2012 net charges include $7,512 primarily related to employee severance and other related costs, partially offset by gains from sales of assets at rationalized operations and $1,842 in asset impairment charges. In 2011, the Company recorded rationalization and asset impairment net charges of $282 resulting from rationalization activities primarily initiated in the third and second quarters of 2009. The Company initiated a number of rationalization activities in 2009 to align its business to current market conditions. The 2011 net charges include $259 primarily related to employee severance and other related costs and $23 in asset impairment charges. Fair values of impaired assets were determined using projected discounted cash flows. Acquisitions During November 2013, the Company completed the acquisition of Robolution. Robolution, based outside of Frankfurt, Germany, is a leading European provider of robotic arc welding systems. The acquisition added to the Company's growing automation business and will enable the Company to seamlessly support automation customers across three continents. 26 -------------------------------------------------------------------------------- During November 2013, the Company acquired an ownership interest in Burlington. Burlington, based in Hamilton, Ontario, Canada, is a leader in the design and manufacture of 3D robotic plasma cutting systems whose products are sold under the brand name Python X. The acquisition broadens the Company's portfolio of automated cutting and welding process solutions. Combined revenues for Robolution and Burlington in 2013 were approximately $35,000. The Company acquired Robolution and Burlington for approximately $54,023 in cash, net of cash acquired, and assumed debt and a $17,225 liability to acquire the remaining financial interest in Burlington. The fair value of net assets acquired was $30,051, resulting in goodwill of $41,197. The purchase price allocations are preliminary and subject to final opening balance sheet adjustments. In addition, during 2013 the Company acquired a greater interest in its majority-owned joint venture, Lincoln Electric Heli (Zhengzhou) Welding Materials Company Ltd. On December 31, 2012, the Company completed the acquisition of the privately-held automated systems and tooling manufacturer, Tenn Rand. Tenn Rand, based in Chattanooga, Tennessee, is a leader in the design and manufacture of tooling and robotic systems for welding applications. The acquisition added tool design, system building and machining capabilities that will enable the Company to further expand its welding automation business. Annual sales for Tenn Rand at the date of acquisition were approximately $35,000. On November 13, 2012, the Company completed the acquisition of Kaliburn from ITT Corporation. Kaliburn, headquartered in Ladson, South Carolina, is a designer and manufacturer of shape cutting solutions, producer of shape cutting control systems and manufacturer of web tension transducers and engineered machine systems. The acquisition added to the Company's cutting business portfolio. Annual sales for Kaliburn as of the date of acquisition were approximately $36,000. On May 17, 2012, the Company completed the acquisition of Wayne Trail. Wayne Trail, based in Ft. Loramie, Ohio, is a manufacturer of automated systems and tooling, serving a wide range of applications in the metal processing market. The acquisition added to the Company's welding and automated solutions portfolio. Annual sales for Wayne Trail at the date of acquisition were approximately $50,000. On March 6, 2012, the Company completed the acquisition of Weartech. Weartech, based in Anaheim, California, is a producer of cobalt-based hard facing and wear-resistant welding consumables. The acquisition added to the Company's consumables portfolio. Sales for Weartech during 2011 were approximately $40,000. The Company acquired Tenn Rand, Kaliburn, Wayne Trail and Weartech for approximately $144,423 in cash, net of cash acquired, and assumed debt. The fair value of net assets acquired was $73,257, resulting in goodwill of $71,166. On July 29, 2011, the Company acquired substantially all of the assets of Techalloy. Techalloy, based in Baltimore, Maryland, is a manufacturer of nickel alloy and stainless steel welding consumables. The acquisition added to the Company's consumables portfolio. Annual sales for Techalloy at the date of acquisition were approximately $70,000. On July 29, 2011, the Company acquired substantially all of the assets of Torchmate. Torchmate, based in Reno, Nevada, provides a wide selection of computer numeric controlled plasma cutter and oxy-fuel cutting systems. The acquisition added to the Company's plasma and oxy-fuel cutting product offering. Annual sales for Torchmate at the date of acquisition were approximately $13,000. On March 11, 2011, the Company completed the acquisition of Severstal. Severstal is a leading manufacturer of welding consumables in Russia and was a subsidiary of OAO Severstal, one of the world's leading vertically integrated steel and mining companies. This acquisition expanded the Company's capacity and distribution channels in Russia and the Commonwealth of Independent States ("CIS"). Sales for Severstal during 2010 were approximately $40,000. On January 31, 2011, the Company acquired substantially all of the assets of Arc Products. Arc Products is a manufacturer of orbital welding systems and welding automation components based in Southern California. Orbital welding systems are designed to automatically weld pipe and tube in difficult to access locations and for mission-critical applications requiring high weld integrity and sophisticated quality monitoring capabilities. The acquisition will complement the Company's ability to serve global customers in the nuclear, power generation and process industries worldwide. Sales for Arc Products during 2010 were not significant. The Company acquired Techalloy, Torchmate, Severstal and Arc Products for approximately $65,321 in cash and assumed debt and a contingent consideration liability fair valued at $3,806. The contingent consideration is based upon estimated sales at the related acquisition for the five-year period ending December 31, 2015 and will be paid in 2016 based on actual sales during the five-year period. The fair value of net assets acquired was $46,837, resulting in goodwill of $22,290. Pro forma information related to these acquisitions has not been presented because the impact on the Company's Consolidated Statements of Income is not material. Acquired companies are included in the Company's consolidated financial statements as of the date of acquisition. 27 --------------------------------------------------------------------------------



Debt

At December 31, 2013 and 2012, the fair value of long-term debt, including the current portion, was approximately $4,212 and $1,919, respectively, which was determined using available market information and methodologies requiring judgment. Since considerable judgment is required in interpreting market information, the fair value of the debt is not necessarily the amount which could be realized in a current market exchange. Revolving Credit Agreement The Company has a line of credit totaling $300,000 through the Amended and Restated Credit Agreement (the "Credit Agreement"), which was entered into on July 26, 2012. The Credit Agreement contains customary affirmative, negative and financial covenants for credit facilities of this type, including limitations on the Company and its subsidiaries with respect to liens, investments, distributions, mergers and acquisitions, dispositions of assets, transactions with affiliates and a fixed charges coverage ratio and total leverage ratio. As of December 31, 2013, the Company was in compliance with all of its covenants and had no outstanding borrowings under the Credit Agreement. The Credit Agreement has a five-year term and may be increased, subject to certain conditions, by an additional amount up to $100,000. The interest rate on borrowings is based on either LIBOR or the prime rate, plus a spread based on the Company's leverage ratio, at the Company's election. Short-term Borrowings The Company's short-term borrowings included in Amounts due banks were $14,581 and $18,220 at December 31, 2013 and 2012, respectively, and represent the borrowings of foreign subsidiaries at weighted average interest rates of 11.3% and 11.3%, respectively. Contractual Obligations and Commercial Commitments The Company's contractual obligations and commercial commitments as of December 31, 2013 are as follows: Payments Due By Period 2015 to 2017 to 2019 and Total 2014 2016 2018 Beyond Long-term debt, including current portion $ 2,722$ 644$ 854$ 450$ 774 Interest on long-term debt 311 107 104 54 46 Capital lease obligations 236 72 127 37 - Short-term debt 14,581 14,581 - - - Interest on short-term debt 1,019 1,019 - - - Operating leases 48,170 13,263 18,631 9,708 6,568 Purchase commitments(1) 164,232 160,987 2,983 175 87 Total $ 231,271$ 190,673$ 22,699$ 10,424$ 7,475



_______________________________________________________________________________

(1) Purchase commitments include contractual obligations for raw materials and

services.

As of December 31, 2013, there was $25,907 of tax liabilities related to unrecognized tax benefits. Because of the high degree of uncertainty regarding the timing of future cash outflows associated with these liabilities, the Company is unable to estimate the years in which settlement will occur with the respective taxing authorities. See Note 12 to the Company's consolidated financial statements for further discussion. The Company expects to voluntarily contribute approximately $20,000 to the U.S. pension plans in 2014. Stock-Based Compensation On April 28, 2006, the shareholders of the Company approved the 2006 Equity and Performance Incentive Plan, as amended ("EPI Plan"), which replaced the 1998 Stock Plan, as amended and restated 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 additional 6,000,000 of the Company's common shares. In addition, on April 28, 2006, the shareholders of the Company approved the 2006 Stock Plan for Non-Employee Directors, as amended ("Director Plan"), which replaced the Stock Option Plan for Non-Employee Directors adopted in 2000. The Director Plan provides for the granting of options, restricted shares and restricted stock units up to an additional 600,000 of the Company's common shares. At December 31, 2013, there were 2,315,239 common shares available for future grant under all plans. 28 -------------------------------------------------------------------------------- Under these plans, options, restricted shares and restricted stock units granted were 357,494 in 2013, 567,023 in 2012 and 648,561 in 2011. The Company issued shares of common stock from treasury upon all exercises of stock options and the granting of restricted stock awards in 2013, 2012 and 2011. Expense is recognized for all awards of stock-based compensation by allocating the aggregate grant date fair value over the vesting period. No expense is recognized for any stock options, restricted or deferred shares or restricted stock units ultimately forfeited because recipients fail to meet vesting requirements. Total stock-based compensation expense recognized in the Consolidated Statements of Income for 2013, 2012 and 2011 was $9,734, $8,961 and $6,610, respectively. The related tax benefit for 2013, 2012 and 2011 was $3,727, $3,409 and $2,515, respectively. As of December 31, 2013, total unrecognized stock-based compensation expense related to non-vested stock options, restricted shares and restricted stock units was $21,633, which is expected to be recognized over a weighted average period of approximately 3.3 years. The aggregate intrinsic value of options outstanding and exercisable which would have been received by the optionees had all awards been exercised at December 31, 2013, was $85,404 and $76,076, respectively. The total intrinsic value of awards exercised during 2013, 2012 and 2011 was $20,297, $18,776 and $10,028 respectively. Product Liability Costs Product liability costs have historically been significant particularly with respect to asbestos claims. Costs incurred are volatile and are largely related to trial activity. The costs associated with these claims are predominantly defense costs which are recognized in the periods incurred. Product liability costs decreased $767 in 2013 compared with 2012 primarily due to reduced trial activity. The long-term impact of the asbestos loss contingency, in the aggregate, on operating results, operating cash flows and access to capital markets 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. Off-Balance Sheet Arrangements 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 Company's Credit Agreement. New Accounting Pronouncements New Accounting Standards to be Adopted: In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." ASU 2013-11 requires an entity to present an unrecognized tax benefit in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward, with limited exceptions. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption and retrospective application is permitted. The Company is currently evaluating the impact of the adoption of ASU 2013-11, but does not expect it will have a significant impact on the Company's financial statements. In March 2013, the FASB issued ASU No. 2013-05, "Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." ASU 2013-05 clarifies the applicable guidance for the release of the cumulative translation adjustment under current U.S. GAAP by emphasizing that the accounting for the release of the cumulative translation adjustment into net income for sales or transfers of a controlling financial interest within a foreign entity is the same irrespective of whether the sale or transfer is of a subsidiary or a group of assets that is a nonprofit activity or business. When a reporting entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity, the parent is required to apply the guidance in Subtopic 830-30 to release any related cumulative translation adjustment into net income. The amendments are effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. The Company is currently evaluating the impact of the adoption of ASU 2013-05 on the Company's financial statements. 29 -------------------------------------------------------------------------------- Critical Accounting Policies The Company's 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 Company's estimates have been determined to be reasonable. No material changes to the Company's accounting policies were made during 2013. The Company believes the following accounting policies are some of the more critical judgment areas affecting 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 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 differing procedural stages and information on the circumstances of each claimant, which forms the basis for judgments as to the validity or ultimate disposition of such actions, varies greatly. Therefore, in many situations a range of possible losses cannot be made. 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. 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 completion 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. See Note 12 to the Company's consolidated financial statements and the "Item 3. Legal Proceedings" section of this Annual Report on Form 10-K for further discussion of tax contingencies. Translation of Foreign Currencies Asset and liability accounts are translated into U.S. dollars using exchange rates in effect at the dates of the Consolidated Balance Sheets; revenue and expense accounts are translated at average monthly exchange rates. Translation adjustments are reflected as a component of Total equity. For subsidiaries operating in highly inflationary economies, both historical and current exchange rates are used in translating balance sheet accounts and translation adjustments are included in Net income. Foreign currency transaction losses are included in Selling, general & administrative expenses and were $7,759, $4,608 and $4,904 in 2013, 2012 and 2011, respectively. 30 -------------------------------------------------------------------------------- Venezuela - Highly Inflationary Economy Venezuela is a highly inflationary economy under U.S. GAAP. As a result, the financial statements of the Company's Venezuelan operation are reported under highly inflationary accounting rules as of January 1, 2010. Under highly inflationary accounting, the financial statements of the Company's Venezuelan operation have been remeasured into the Company's reporting currency and exchange gains and losses from the re-measurement of monetary assets and liabilities are reflected in current earnings. On February 8, 2013, the Venezuelan government announced the devaluation of its currency relative to the U.S. dollar. Effective February 13, 2013 the official rate moved from 4.3 to 6.3 bolivars to the U.S. dollar. The devaluation of the bolivar resulted in a foreign currency transaction loss of $8,081 in Selling, general & administrative expenses and higher Cost of goods sold of $4,117 due to the liquidation of inventory valued at the historical exchange rate. In January 2014, the Venezuelan government announced the formation of the National Center of Foreign Trade ("CENCOEX") to replace the Commission for the Administration of Currency Exchange ("CADIVI"). In addition, the government announced the CENCOEX would utilize the rate used in the SICAD auction-based exchange rate program (the "SICAD rate") for certain transactions as opposed to the official rate. Transactions executed at the SICAD rate most recently used a rate of 11.7 bolivars to the U.S. dollar. In February 2014, the government announced a new foreign exchange system, SICAD 2, which is expected to use a currency mechanism based on bond swaps. At this time, the Company expects to continue to use the official rate of 6.3 bolivars to the U.S. dollar to translate its Venezuelan subsidiary's financial results. The Company will continue to assess the information available relative to Venezuelan exchange rates, however, the future impact on the Company's financial statements is uncertain. Future impacts to earnings of applying highly inflationary accounting for Venezuela on the Company's consolidated financial statements will be dependent upon movements in the applicable exchange rates between the bolivar and the U.S. dollar and the amount of monetary assets and liabilities included in the Company's Venezuelan operation's balance sheet. The bolivar-denominated monetary net asset position was $38,633 at December 31, 2013, which includes $50,642 of cash and cash equivalents, and $31,545 at December 31, 2012, which includes $32,610 of cash and cash equivalents. The increased exposure was due to the limited opportunities to convert bolivars into U.S. dollars. The Company's ability to effectively manage sales and profit levels in Venezuela will be impacted by several factors. These include, but are not limited to, the Company's ability to mitigate the effect of any potential devaluation and Venezuelan government price exchange controls. If in the future the Company were to convert bolivars at a rate other than the official exchange rate or the official exchange rate is revised, the Company may realize a loss to earnings. For example, a future devaluation in the Venezuelan currency to a rate of 12.6 would result in the Company realizing additional charges of approximately $3,000 to Cost of goods sold based on current inventory levels and $20,000 to Selling, general and administrative expenses based upon the current bolivar-denominated monetary net asset position. Additionally, the various restrictions on the distribution of foreign currency by the Venezuelan government could affect the Company's ability to pay obligations and maintain normal production levels in Venezuela. 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 carry-forwards. 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. Deferred income taxes associated with earnings of $8,354 that are not expected to be permanently reinvested were not significant. At December 31, 2013, the Company had approximately $102,128 of gross deferred tax assets related to deductible temporary differences and tax loss and credit carry-forwards 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 December 31, 2013, a valuation allowance of $49,684 was 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 Company's assessment of future taxable income or tax planning strategies changes. 31 --------------------------------------------------------------------------------



Pensions

The Company maintains a number of defined benefit and defined contribution plans to provide retirement benefits for employees. 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. A substantial portion of the Company's pension amounts relates to its defined benefit plan in the United States. The fair value of plan assets is determined at December 31 of each year. A significant element in determining the Company's 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 plan's 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 7.4% and 7.7% at December 31, 2013 and 2012, respectively. 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 2013, investment returns were 12.4% compared with a return of 11.1% in 2012. A 25 basis point change in the expected return on plan assets would increase or decrease pension expense by approximately $1,900. Another significant element in determining the Company's pension expense is the discount rate for plan liabilities. To develop the discount rate assumption, the Company refers to 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 4.7% at December 31, 2013 and 3.8% at December 31, 2012. A 10 basis point change in the discount rate would increase or decrease pension expense by approximately $1,100. Pension expense relating to the Company's defined benefit plans was $29,908, $36,258 and $26,370 in 2013, 2012 and 2011, respectively. The Company expects 2014 defined benefit pension expense to decrease by a range of approximately $15,000 to $18,000. The Accumulated other comprehensive loss, excluding tax effects, recognized on the Consolidated Balance Sheet was $256,260 as of December 31, 2013 and $417,967 as of December 31, 2012. The decrease is primarily the result of actuarial gains recorded during the year. Actuarial gains arising during 2013 are primarily attributable to a higher discount rate. The Company made voluntary contributions to its U.S. defined benefit plans of $75,216, $60,277 and $30,000 in 2013, 2012 and 2011, respectively. The Company expects to voluntarily contribute $20,000 to its U.S. plans in 2014. Based on current pension funding rules, the Company does not anticipate that contributions to the plans would be required in 2014. Inventories Inventories are valued at the lower of cost or market. Fixed manufacturing overhead costs are allocated to inventory based on normal production capacity and abnormal manufacturing costs are recognized as period costs. 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. Accordingly, interim LIFO calculations are based on management's estimates of expected year-end inventory levels and costs. Actual year-end costs and inventory levels may differ from interim LIFO inventory valuations. The excess of current cost over LIFO cost was $70,882 at December 31, 2013 and $72,173 at December 31, 2012. The Company reviews the net realizable value of inventory 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 Company's estimates prove to be inaccurate, write-downs of inventory values and adjustments to Cost of goods sold may be required. Historically, the Company's reserves have approximated actual experience. Accounts Receivable 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 Company's reserves have approximated actual experience. 32



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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 impairment exists. If an asset is determined to be impaired, a loss is recognized to the extent that carrying value exceeds fair value. Fair value 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. Goodwill and Intangibles The Company performs an annual impairment test of goodwill and indefinite-lived intangible assets in the fourth quarter using the same dates each year or more frequently if changes in circumstances or the occurrence of events indicate potential impairment. The fair value of each indefinite-lived intangible asset is compared to its carrying value and an impairment charge is recorded if the carrying value exceeds the fair value. Goodwill is tested by comparing the fair value of each reporting unit with its carrying value. If the carrying value of the reporting unit exceeds its fair value, the implied value of goodwill is compared to its carrying value and impairment is recognized to the extent that the carrying value exceeds the implied fair value. Fair values are determined using established business valuation multiples and models developed by the Company that incorporate allocations of certain assets and cash flows among reporting units, estimates of market participant assumptions of future cash flows, future growth rates and the applicable discount rates to value estimated cash flows. Changes in economic and operating conditions impacting these assumptions could result in asset impairments in future periods. The fair value of goodwill for all of the Company's operating business units exceeded its carrying value by at least 20% as of the testing date during the fourth quarter of 2013. Key assumptions in estimating the reporting unit's fair value include assumed market participant assumptions of revenue growth, operating margins and the rate used to discount future cash flows. Actual revenue growth and operating margins below the assumed market participant assumptions or an increase in the discount rate would have a negative impact on the fair value of the reporting unit that could result in a goodwill impairment charge in a future period. Stock-Based Compensation The Company utilizes the Black-Scholes option pricing model for estimating fair values of options. The Black-Scholes model requires assumptions regarding the volatility of the Company's stock, the expected life of the stock award and the Company's dividend yield. The Company utilizes historical data in determining these assumptions. An increase or decrease in the assumptions or economic events outside of management's control could have a direct impact on the Black-Scholes model.


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Source: Edgar Glimpses


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