LECO-2013.09.30-10Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
or
¨ 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)
Ohio
 
34-1860551
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
22801 St. Clair Avenue, Cleveland, Ohio
 
44117
(Address of principal executive offices)
 
(Zip Code)
(216) 481-8100
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
 
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 x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer   o (Do not check if a smaller reporting company)
 
Smaller reporting company 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 x
 
The number of shares outstanding of the registrant’s common shares as of September 30, 2013 was 81,614,694.

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TABLE OF CONTENTS
 
 
 
EX-31.1
Certification of the President and Chief Executive Officer (Principal Executive Officer) pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
 
EX-31.2
Certification of the Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
 
EX-32.1
Certification of the President and Chief Executive Officer (Principal Executive Officer) and Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
EX-101
Instance Document
 
EX-101
Schema Document
 
EX-101
Calculation Linkbase Document
 
EX-101
Label Linkbase Document
 
EX-101
Presentation Linkbase Document
 
EX-101
Definition Linkbase Document
 

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PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
LINCOLN ELECTRIC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Net sales
$
691,875

 
$
697,552

 
$
2,137,880

 
$
2,168,719

Cost of goods sold
459,178

 
484,190

 
1,438,273

 
1,515,095

Gross profit
232,697

 
213,362

 
699,607

 
653,624

Selling, general & administrative expenses
131,217

 
121,602

 
403,323

 
372,931

Rationalization and asset impairment charges
6,302

 
3,059

 
8,204

 
4,317

Operating income
95,178

 
88,701

 
288,080

 
276,376

 
 
 
 
 
 
 
 
Other income (expense):
 

 
 

 
 

 
 

Interest income
536

 
916

 
2,452

 
2,648

Equity earnings in affiliates
1,170

 
1,566

 
3,687

 
4,264

Other income
1,514

 
746

 
3,141

 
2,015

Interest expense
(558
)
 
(1,040
)
 
(2,307
)
 
(3,338
)
Total other income
2,662

 
2,188

 
6,973

 
5,589

Income before income taxes
97,840

 
90,889

 
295,053

 
281,965

Income taxes
33,588

 
26,153

 
91,431

 
86,715

Net income including non-controlling interests
64,252

 
64,736

 
203,622

 
195,250

Non-controlling interests in subsidiaries’ loss
(1,792
)
 
(29
)
 
(1,834
)
 
(77
)
Net income
$
66,044

 
$
64,765

 
$
205,456

 
$
195,327

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.81

 
$
0.78

 
$
2.50

 
$
2.35

Diluted earnings per share
$
0.80

 
$
0.77

 
$
2.47

 
$
2.32

Cash dividends declared per share
$
0.20

 
$
0.17

 
$
0.60

 
$
0.51

 
See notes to these consolidated financial statements.

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Table of Contents

LINCOLN ELECTRIC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(In thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Net income including non-controlling interests
$
64,252

 
$
64,736

 
$
203,622

 
$
195,250

Other comprehensive income (loss), net of tax:
 
 
 

 
 

 
 

Unrealized loss on derivatives designated and qualifying as cash flow hedges, net of tax of $276 and $(55) in the three and nine months ended September 30, 2013; $147 and $148 in the three and nine months ended September 30, 2012
(734
)
 
(5
)
 
(147
)
 
(564
)
Defined benefit pension plan activity, net of tax of $2,050 and $8,232 in the three and nine months ended September 30, 2013; $2,755 and $8,593 in the three and nine months ended September 30, 2012
4,314

 
4,794

 
14,391

 
14,009

Currency translation adjustment
19,891

 
16,928

 
(15,209
)
 
11,958

Other comprehensive income (loss):
23,471

 
21,717

 
(965
)
 
25,403

Comprehensive income
87,723

 
86,453

 
202,657

 
220,653

Comprehensive (loss) income attributable to non-controlling interests
(1,678
)
 
179

 
(1,769
)
 
(389
)
Comprehensive income attributable to shareholders
$
89,401

 
$
86,274

 
$
204,426

 
$
221,042

 
See notes to these consolidated financial statements.

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LINCOLN ELECTRIC HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
September 30, 2013
 
December 31, 2012
 
(UNAUDITED)
 
(NOTE 1)
ASSETS
 

 
 

Current Assets
 

 
 

Cash and cash equivalents
$
330,309

 
$
286,464

Accounts receivable (less allowance for doubtful accounts of $8,445 in 2013; $8,654 in 2012)
375,224

 
360,662

Inventories:
 

 
 

Raw materials
108,698

 
119,963

Work-in-process
45,794

 
41,805

Finished goods
215,371

 
203,122

Total inventory
369,863

 
364,890

Other current assets
107,253

 
120,800

Total Current Assets
1,182,649

 
1,132,816

 
 
 
 
Property, Plant and Equipment
 

 
 

Land
45,539

 
44,510

Buildings
367,090

 
343,867

Machinery and equipment
720,913

 
732,461

 
1,133,542

 
1,120,838

Less accumulated depreciation
654,869

 
634,602

Property, Plant and Equipment, Net
478,673

 
486,236

Non-current assets
458,319

 
470,811

TOTAL ASSETS
$
2,119,641

 
$
2,089,863

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

Current Liabilities
 

 
 

Amounts due banks
$
14,469

 
$
18,220

Trade accounts payable
177,006

 
209,647

Other current liabilities
289,297

 
211,944

Current portion of long-term debt
423

 
456

Total Current Liabilities
481,195

 
440,267

 
 
 
 
Long-Term Liabilities
 

 
 

Long-term debt, less current portion
1,251

 
1,599

Accrued pensions
127,085

 
216,189

Other long-term liabilities
81,291

 
73,487

Total Long-Term Liabilities
209,627

 
291,275

 
 
 
 
Shareholders’ Equity
 

 
 

Common shares
9,858

 
9,858

Additional paid-in capital
230,086

 
205,124

Retained earnings
1,838,770

 
1,682,668

Accumulated other comprehensive loss
(236,430
)
 
(235,400
)
Treasury shares
(427,644
)
 
(319,877
)
Total Shareholders’ Equity
1,414,640

 
1,342,373

Non-controlling interests
14,179

 
15,948

Total Equity
1,428,819

 
1,358,321

 
 
 
 
TOTAL LIABILITIES AND EQUITY
$
2,119,641

 
$
2,089,863


See notes to these consolidated financial statements.

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LINCOLN ELECTRIC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
 
Nine Months Ended September 30,
 
2013
 
2012
CASH FLOWS FROM OPERATING ACTIVITIES
 

 
 

Net income
$
205,456

 
$
195,327

Non-controlling interests in subsidiaries’ loss
(1,834
)
 
(77
)
Net income including non-controlling interests
203,622

 
195,250

Adjustments to reconcile Net income including non-controlling interests to Net cash
   provided by operating activities:
 

 
 

Rationalization and asset impairment charges
5,049

 
357

Depreciation and amortization
51,881

 
48,220

Equity earnings in affiliates, net
(1,313
)
 
(1,449
)
Deferred income taxes
21,023

 
(288
)
Stock-based compensation
7,511

 
6,711

Pension expense
22,261

 
26,590

Pension contributions and payments
(84,417
)
 
(57,814
)
Other, net
1,223

 
(512
)
Changes in operating assets and liabilities, net of effects from acquisitions:
 

 
 

(Increase) decrease in accounts receivable
(17,982
)
 
13,750

Increase in inventories
(9,889
)
 
(6,832
)
Decrease (increase) in other current assets
10,860

 
(12,180
)
Decrease in trade accounts payable
(32,703
)
 
(1,182
)
Increase in other current liabilities
64,767

 
85,593

Net change in other long-term assets and liabilities
198

 
(52,873
)
NET CASH PROVIDED BY OPERATING ACTIVITIES
242,091

 
243,341

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 

 
 

Capital expenditures
(59,691
)
 
(39,307
)
Acquisition of businesses, net of cash acquired
(4,936
)
 
(52,851
)
Proceeds from sale of property, plant and equipment
796

 
538

Other investing activities
(4,217
)
 
(1,541
)
NET CASH USED BY INVESTING ACTIVITIES
(68,048
)
 
(93,161
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 

 
 

Proceeds from short-term borrowings
788

 
2,291

Payments on short-term borrowings
(1,732
)
 
(3,813
)
Amounts due banks, net
(1,110
)
 
(1,858
)
Proceeds from long-term borrowings

 
914

Payments on long-term borrowings
(297
)
 
(85,535
)
Proceeds from exercise of stock options
16,077

 
12,695

Excess tax benefits from stock-based compensation
6,973

 
5,594

Purchase of shares for treasury
(113,641
)
 
(60,155
)
Cash dividends paid to shareholders
(32,987
)
 
(42,510
)
Other financing activities
(2,809
)
 

NET CASH USED BY FINANCING ACTIVITIES
(128,738
)
 
(172,377
)
 
 
 
 
Effect of exchange rate changes on Cash and cash equivalents
(1,460
)
 
1,771

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
43,845

 
(20,426
)
 
 
 
 
Cash and cash equivalents at beginning of period
286,464

 
361,101

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
330,309

 
$
340,675


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LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Dollars in thousands, except per share amounts


NOTE 1 — BASIS OF PRESENTATION
As used in this report, the term “Company,” except as otherwise indicated by the context, means Lincoln Electric Holdings, Inc. and its wholly-owned and majority-owned subsidiaries for which it has a controlling interest.  The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, these unaudited consolidated financial statements do not include all of the information and notes required by GAAP for complete financial statements.  However, in the opinion of management, these unaudited consolidated financial statements contain all the adjustments (consisting of normal recurring accruals) considered necessary to present fairly the financial position, results of operations and cash flows for the interim periods.  Operating results for the nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the year ending December 31, 2013.
The accompanying Consolidated Balance Sheet at December 31, 2012 has been derived from the audited financial statements at that date, but does not include all of the information and notes required by GAAP for complete financial statements.  For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.
Certain reclassifications have been made to the prior year financial statements to conform to current year classifications.
Venezuela — Highly Inflationary Economy
Venezuela is a highly inflationary economy under 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 remeasurement 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 non-essential 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.
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 $19,104 at September 30, 2013 and $31,545 at December 31, 2012
 
NOTE 2 — EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Numerator:
 

 
 

 
 

 
 

Net income
$
66,044

 
$
64,765

 
$
205,456

 
$
195,327

Denominator:
 

 
 

 
 

 
 

Basic weighted average shares outstanding
81,644

 
82,918

 
82,260

 
83,233

Effect of dilutive securities - Stock options and awards
1,063

 
998

 
1,054

 
1,093

Diluted weighted average shares outstanding
82,707

 
83,916

 
83,314

 
84,326

Basic earnings per share
$
0.81

 
$
0.78

 
$
2.50

 
$
2.35

Diluted earnings per share
$
0.80

 
$
0.77

 
$
2.47

 
$
2.32

For the three months ended September 30, 2013 and 2012, common shares subject to equity-based awards of 44,026 and 461,093, respectively, were excluded from the computation of diluted earnings per share because the effect of their exercise would be anti-dilutive. For the nine months ended September 30, 2013 and 2012, common shares subject to equity-based awards of 420,584 and 46,678, respectively, were excluded from the computation of diluted earnings per share because the effect of their exercise would be anti-dilutive.

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Table of Contents
LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

NOTE 3 — 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.

NOTE 4 — ACQUISITIONS
On December 31, 2012, the Company completed the acquisition of the privately-held automated systems and tooling manufacturer, Tennessee Rand, Inc. ("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 in 2012 were approximately $35,000.
On November 13, 2012, the Company completed the acquisition of the Kaliburn, Burny and Cleveland Motion Control businesses (collectively, "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 acquisitions added to the Company's cutting business portfolio. Annual sales for Kaliburn at the date of acquisition were approximately $36,000.
On May 17, 2012, the Company completed the acquisition of Wayne Trail Technologies, Inc. (“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 International, Inc. (“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 $143,456 in cash, net of cash acquired and assumed debt. The fair value of net assets acquired was $71,727, resulting in goodwill of $71,729. The purchase price allocations for some of the acquisitions are preliminary and subject to final opening balance sheet adjustments.
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.


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Table of Contents
LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

NOTE 5 — SEGMENT INFORMATION
The Company’s primary business is the design and manufacture 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 also has a leading global position in the brazing and soldering alloys market.  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.
Segment performance is measured and resources are allocated based on a number of factors, the primary profit measure being earnings before interest and income taxes (“EBIT”), as adjusted.  Segment EBIT is adjusted for special items as determined by management such as the impact of rationalization activities, certain asset impairment charges and gains or losses on disposals of assets.

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LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

Financial information for the reportable segments follows:
 
North
America
Welding
 
Europe
Welding
 
Asia
Pacific
Welding
 
South
America
Welding
 
The Harris
Products
Group
 
Corporate /
Eliminations
 
Consolidated
Three Months Ended September 30, 2013
 

 
 

 
 

 
 

 
 

 
 

 
 

Net sales
$
404,113

 
$
98,522

 
$
63,834

 
$
51,715

 
$
73,691

 
$

 
$
691,875

Inter-segment sales
35,355

 
5,256

 
3,821

 
151

 
2,311

 
(46,894
)
 

Total
$
439,468

 
$
103,778

 
$
67,655

 
$
51,866

 
$
76,002

 
$
(46,894
)
 
$
691,875

 
 
 
 
 
 
 
 
 
 
 
 
 
 
EBIT, as adjusted
$
75,225

 
$
7,881

 
$
(979
)
 
$
15,942

 
$
6,917

 
$
(822
)
 
$
104,164

Special items charge
(17
)
 
1,595

 
4,724

 

 

 

 
6,302

EBIT
$
75,242

 
$
6,286

 
$
(5,703
)
 
$
15,942

 
$
6,917

 
$
(822
)
 
$
97,862

Interest income
 

 
 

 
 

 
 

 
 

 
 

 
536

Interest expense
 

 
 

 
 

 
 

 
 

 
 

 
(558
)
Income before income taxes
 

 
 

 
 

 
 

 
 

 
 

 
$
97,840

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2012
 

 
 

 
 

 
 

 
 

 
 

 
 

Net sales
$
390,327

 
$
104,480

 
$
76,263

 
$
44,545

 
$
81,937

 
$

 
$
697,552

Inter-segment sales
28,186

 
3,261

 
2,748

 
27

 
1,869

 
(36,091
)
 

Total
$
418,513

 
$
107,741

 
$
79,011

 
$
44,572

 
$
83,806

 
$
(36,091
)
 
$
697,552

 
 
 
 
 
 
 
 
 
 
 
 
 
 
EBIT, as adjusted
$
70,797

 
$
8,515

 
$
2,054

 
$
7,587

 
$
7,739

 
$
(2,620
)
 
$
94,072

Special items charge
477

 
1,874

 
708

 

 

 

 
3,059

EBIT
$
70,320

 
$
6,641

 
$
1,346

 
$
7,587

 
$
7,739

 
$
(2,620
)
 
$
91,013

Interest income
 

 
 

 
 

 
 

 
 

 
 

 
916

Interest expense
 

 
 

 
 

 
 

 
 

 
 

 
(1,040
)
Income before income taxes
 

 
 

 
 

 
 

 
 

 
 

 
$
90,889

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2013
 

 
 

 
 

 
 

 
 

 
 

 
 

Net sales
$
1,242,736

 
$
317,674

 
$
203,112

 
$
132,592

 
$
241,766

 
$

 
$
2,137,880

Inter-segment sales
99,869

 
13,865

 
12,579

 
222

 
7,209

 
(133,744
)
 

Total
$
1,342,605

 
$
331,539

 
$
215,691

 
$
132,814

 
$
248,975

 
$
(133,744
)
 
$
2,137,880

 
 
 
 
 
 
 
 
 
 
 
 
 
 
EBIT, as adjusted
$
234,662

 
$
28,114

 
$
1,967

 
$
32,119

 
$
21,411

 
$
(2,963
)
 
$
315,310

Special items charge
1,109

 
1,664

 
5,431

 
12,198

 

 

 
20,402

EBIT
$
233,553

 
$
26,450

 
$
(3,464
)
 
$
19,921

 
$
21,411

 
$
(2,963
)
 
$
294,908

Interest income
 

 
 

 
 

 
 

 
 

 
 

 
2,452

Interest expense
 

 
 

 
 

 
 

 
 

 
 
 
(2,307
)
Income before income taxes
 

 
 

 
 

 
 

 
 

 
 

 
$
295,053

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
979,043

 
$
415,387

 
$
329,117

 
$
145,672

 
$
186,474

 
$
63,948

 
$
2,119,641

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2012
 

 
 

 
 

 
 

 
 

 
 

 
 

Net sales
$
1,187,879

 
$
344,720

 
$
254,259

 
$
121,552

 
$
260,309

 
$

 
$
2,168,719

Inter-segment sales
101,386

 
12,178

 
11,641

 
38

 
6,605

 
(131,848
)
 

Total
$
1,289,265

 
$
356,898

 
$
265,900

 
$
121,590

 
$
266,914

 
$
(131,848
)
 
$
2,168,719

 
 
 
 
 
 
 
 
 
 
 
 
 
 
EBIT, as adjusted
$
216,872

 
$
32,317

 
$
8,641

 
$
13,472

 
$
23,933

 
$
(6,882
)
 
$
288,353

Special items charge
554

 
2,466

 
1,297

 
1,381

 

 

 
5,698

EBIT
$
216,318

 
$
29,851

 
$
7,344

 
$
12,091

 
$
23,933

 
$
(6,882
)
 
$
282,655

Interest income
 

 
 

 
 

 
 

 
 

 
 

 
2,648

Interest expense
 

 
 

 
 

 
 

 
 

 
 

 
(3,338
)
Income before income taxes
 

 
 

 
 

 
 

 
 

 
 

 
$
281,965

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
909,827

 
$
460,586

 
$
358,626

 
$
128,658

 
$
203,536

 
$
30,289

 
$
2,091,522


10

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LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

In the third quarter 2013, special items include net charges of $1,595 and $49 for rationalization actions in the Europe Welding and Asia Pacific Welding segments, respectively, and a net gain of $17 in the North America Welding segment primarily related to employee severance and other costs associated with the consolidation of manufacturing operations. The Asia Pacific Welding segment special items also include charges of $4,675 related to impairment of long-lived assets.
In the third quarter 2012, special items include charges of $477, $1,914 and $311 for rationalization actions in the North America Welding, Europe Welding and Asia Pacific Welding segments, respectively, primarily related to employee severance and other costs associated with the consolidation of manufacturing operations. The Asia Pacific Welding segment special items also include a charge of $397 related to asset impairments.
In the nine months ended September 30, 2013, special items include net charges of $1,109, $1,664 and $756 in the North America Welding, Europe Welding and Asia Pacific Welding segments, respectively, primarily related to employee severance and other costs associated with the consolidation of manufacturing operations.  The Asia Pacific Welding segment special items also include charges of $4,675 related to impairment of long-lived assets. The South America Welding segment special items represent charges of $12,198 related to the devaluation of the Venezuelan currency.
In the nine months ended September 30, 2012, special items include charges of $554, $2,506 and $900 for rationalization actions in the North America Welding, Europe Welding and Asia Pacific Welding segments, respectively, primarily related to employee severance and other costs associated with the consolidation of manufacturing operations. The Asia Pacific Welding segment special items also include a charge of $397 related to asset impairments. The South America Welding segment special item represents a charge of $1,381 related to a change in Venezuelan labor law, which provides for increased employee severance obligations.

NOTE 6 — RATIONALIZATION AND ASSET IMPAIRMENTS
The Company recorded net rationalization charges of $8,204 for the nine months ended September 30, 2013. The charges include $3,479 primarily related to employee severance and $4,881 in asset impairment charges, partially offset by gains of $156 related to sale of assets.  A description of each restructuring plan and the related costs follows:
North America Welding Plans:
During 2012, the Company initiated various rationalization plans within the North America Welding segment. Plans for the segment include consolidating its Oceanside, California operations and its Reno, Nevada operations to another facility in Reno, Nevada and consolidating its Baltimore, Maryland manufacturing operations into its current manufacturing operations in Cleveland, Ohio.  These actions impacted 72 employees within the North America Welding segment.  During the nine months ended September 30, 2013, the Company recorded charges of $1,109, which represent employee severance and other related costs. At September 30, 2013, a liability relating to these actions of $614 was recognized in Other current liabilities, which will be substantially paid in 2013. Additional charges related to the completion of this plan are expected to be immaterial.
Europe Welding Plans:
The Company initiated a rationalization plan within the Europe Welding segment to consolidate certain consumable manufacturing operations. These actions are expected to impact 56 employees within the Europe Welding segment. During the nine months ended September 30, 2013, the Company recorded charges of $1,518 related to these activities which represents employee severance and other related costs. At September 30, 2013, a liability relating to these actions of $1,518 was recognized in Other current liabilities. The Company expects to incur additional charges in the range of $600 to $1,500 related to the completion of this plan.
During 2012, the Company initiated various rationalization plans within the Europe Welding segment. Plans for the segment include the consolidation of manufacturing facilities in Russia, relocation of its Italian machine manufacturing operations to current facilities in Poland and headcount restructuring at various other manufacturing operations within the segment to better align the cost structure and capacity requirements with current economic needs and conditions. These actions impacted 285 employees within the Europe Welding segment. During the nine months ended September 30, 2013, the Company recorded net charges of $146 related to these activities.  The amount represents employee severance and other related costs partially offset by a gain on sale of assets.  At September 30, 2013, a liability relating to these actions of $1,315 was recognized in Other current liabilities, which will be substantially paid in 2013.  Additional charges related to the completion of this plan are expected to be immaterial.

11

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LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

Asia Pacific Welding Plans:
During 2012, the Company initiated various rationalization plans within the Asia Pacific Welding segment. Plans for the segment include the rationalization of its Australian manufacturing operations and headcount restructuring at various other manufacturing operations within the segment to better align the cost structure and capacity requirements with current economic needs and conditions. These actions impacted 268 employees within the Asia Pacific Welding segment. During the nine months ended September 30, 2013, the Company recorded net charges of $756, which represent employee severance and other related costs of $704 and asset impairment charges of $206, partially offset by gains of $154 from the sale of assets.  At September 30, 2013, a liability relating to these actions of $461 was recognized in Other current liabilities, which will be substantially paid in 2013.  Additional charges related to the completion of this plan are expected to be immaterial.
The Company continues evaluating its cost structure and additional rationalization actions may result in charges in future periods.
In the third quarter 2013, the Company recorded long-lived asset impairment charges of $4,675 in Rationalization and asset impairment charges. The charge is the result of the Company removing capacity to align itself with current market conditions and improve operating efficiency.
The following tables summarize the activity related to the rationalization liabilities by segment for the nine months ended September 30, 2013:
 
North
America
Welding
 
Europe
Welding
 
Asia Pacific
Welding
 
Consolidated
Balance, December 31, 2012
$

 
$
2,013

 
$
1,044

 
$
3,057

Payments and other adjustments
(495
)
 
(846
)
 
(1,287
)
 
(2,628
)
Charged to expense
1,109

 
1,666

 
704

 
3,479

Balance, September 30, 2013
$
614

 
$
2,833

 
$
461

 
$
3,908

 

NOTE 7 — COMMON SHARE REPURCHASE PROGRAM
As of September 30, 2013, the Company had a share repurchase program for up to 45 million of the Company’s common shares.  At management’s discretion, the Company repurchases its common shares from time to time in the open market, depending on market conditions, stock price and other factors.  During the three and nine month periods ended September 30, 2013, the Company purchased an aggregate of 710,726 and 1,923,142 common shares, respectively, in the open market under this program.  As of September 30, 2013, there remained 16,419,231 common shares available for repurchase under this program.  The repurchased common shares remain in treasury and have not been retired.
 

12

Table of Contents
LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

NOTE 8 — ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME ("AOCI")
The following tables set forth the total changes in AOCI by component, net of taxes, for the three months ended September 30, 2013 and 2012:
 
 
 
Three Months Ended September 30, 2013
 
 
Unrealized (loss) gain on derivatives designated and qualifying as cash flow hedges
 
Defined benefit pension plan activity
 
Currency translation adjustment
 
Total
Balance at June 30, 2013
 
$
667

 
$
(251,767
)
 
$
(8,687
)
 
$
(259,787
)
Other comprehensive (loss) income
   before reclassification
 
(1,203
)
 

 
19,808

3 

18,605

Amounts reclassified from AOCI
 
469

1 

4,314

2 

(31
)
3 

4,752

Net current-period other
   comprehensive (loss) income
 
(734
)
 
4,314

 
19,777

 
23,357

Balance at September 30, 2013
 
$
(67
)
 
$
(247,453
)
 
$
11,090

 
$
(236,430
)
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2012
 
 
Unrealized (loss) gain on derivatives designated and qualifying as cash flow hedges
 
Defined benefit pension plan activity
 
Currency translation adjustment
 
Total
Balance at June 30, 2012
 
$
353

 
$
(246,154
)
 
$
2,126

 
$
(243,675
)
Other comprehensive (loss) income
   before reclassification
 
(167
)
 

 
16,775

3 

16,608

Amounts reclassified from AOCI
 
162

1 

4,794

2 

(55
)
3 

4,901

Net current-period other
   comprehensive (loss) income
 
(5
)
 
4,794

 
16,720

 
21,509

Balance at September 30, 2012
 
$
348

 
$
(241,360
)
 
$
18,846

 
$
(222,166
)
 
 
 
 
 
 
 
 
 
_______________________________________________________________________________
1
During the 2013 period, this AOCI reclassification is a component of Net sales of $165 (net of tax of $29) and Cost of goods sold of $304 (net of tax of $145); during the 2012 period, the reclassification is a component of Net sales of $127 (net of tax of $13) and Cost of goods sold of $35 (net of tax of $59). (See Note 17 - Derivatives for additional details.)
2
This AOCI component is included in the computation of net periodic pension costs (net of tax of $2,050 and $2,755 during the three months ended September 30, 2013 and 2012, respectively). (See Note 15 - Retirement and Postretirement Benefit Plans for additional details.)
3
The Other comprehensive income before reclassifications excludes $114 and $207 attributable to Non-controlling interests in the three months ended September 30, 2013 and 2012, respectively. The reclassified AOCI component is included in the computation of Non-controlling interests. (See Note 9 - Equity for additional details.)



13

Table of Contents
LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

The following tables set forth the total changes in AOCI by component, net of taxes for the nine months ended September 30, 2013 and 2012:
 
 
Nine Months Ended September 30, 2013
 
 
Unrealized (loss) gain on derivatives designated and qualifying as cash flow hedges
 
Defined benefit pension plan activity
 
Currency translation adjustment
 
Total
Balance at December 31, 2012
 
$
80

 
$
(261,844
)
 
$
26,364

 
$
(235,400
)
Other comprehensive (loss) income
before reclassification
 
(1,067
)
 

 
(15,408
)
6 

(16,475
)
Amounts reclassified from AOCI
 
920

4 

14,391

5 

134

6 

15,445

Net current-period other
comprehensive (loss) income
 
(147
)
 
14,391

 
(15,274
)
 
(1,030
)
Balance at September 30, 2013
 
$
(67
)
 
$
(247,453
)
 
$
11,090

 
$
(236,430
)
 
 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2012
 
 
Unrealized (loss) gain on derivatives designated and qualifying as cash flow hedges
 
Defined benefit pension plan activity
 
Currency translation adjustment
 
Total
Balance at December 31, 2011
 
$
912

 
$
(255,369
)
 
$
6,576

 
$
(247,881
)
Other comprehensive (loss) income
before reclassification
 
(1,243
)
 

 
12,000

6 

10,757

Amounts reclassified from AOCI
 
679

4 

14,009

5 

270

6 

14,958

Net current-period other
comprehensive (loss) income
 
(564
)
 
14,009

 
12,270

 
25,715

Balance at September 30, 2012
 
$
348

 
$
(241,360
)
 
$
18,846

 
$
(222,166
)
 
 
 
 
 
 
 
 
 
4
During the 2013 period, this AOCI reclassification is a component of Net sales of $467 (net of tax of $78) and Cost of goods sold of $453 (net of tax of $136); during the 2012 period, the reclassification is a component of Net sales of $591 (net of tax of $104) and Cost of goods sold of $88 (net of tax of $164). (See Note 17 - Derivatives for additional details.)
5
This AOCI component is included in the computation of net periodic pension costs (net of tax of $8,232 and $8,593 during the nine months ended September 30, 2013 and 2012, respectively). (See Note 15 - Retirement and Postretirement Benefit Plans for additional details.)
6
The Other comprehensive income before reclassifications excludes $65 and $312 attributable to Non-controlling interests in the nine months ended September 30, 2013 and 2012, respectively. The reclassified AOCI component is included in the computation of Non-controlling interests. (See Note 9 - Equity for additional details.)


14

Table of Contents
LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

NOTE 9 — EQUITY
Changes in equity for the nine months ended September 30, 2013 are as follows:
 
Shareholders’
Equity
 
Non-controlling
Interests
 
Total Equity
Balance, December 31, 2012
$
1,342,373

 
$
15,948

 
$
1,358,321

Comprehensive income (loss):
 

 
 

 
 

Net income (loss)
205,456

 
(1,834
)
 
203,622

Other comprehensive income (loss)
(1,030
)
 
65

 
(965
)
Total comprehensive income (loss)
204,426

 
(1,769
)
 
202,657

 
 
 
 
 
 
Cash dividends declared - $0.60 per share
(49,353
)
 

 
(49,353
)
Issuance of shares under benefit plans
30,835

 

 
30,835

Purchase of shares for treasury
(113,641
)
 

 
(113,641
)
Balance, September 30, 2013
$
1,414,640

 
$
14,179

 
$
1,428,819

Changes in equity for the nine months ended September 30, 2012 are as follows:
 
Shareholders’
Equity
 
Non-controlling
Interests
 
Total Equity
Balance, December 31, 2011
$
1,176,946

 
$
16,296

 
$
1,193,242

Comprehensive income (loss):
 

 
 

 
 

Net income (loss)
195,327

 
(77
)
 
195,250

Other comprehensive income (loss)
25,715

 
(312
)
 
25,403

Total comprehensive income (loss)
221,042

 
(389
)
 
220,653

 
 
 
 
 
 
Cash dividends declared - $0.51 per share
(42,551
)
 

 
(42,551
)
Issuance of shares under benefit plans
25,002

 

 
25,002

Purchase of shares for treasury
(60,155
)
 

 
(60,155
)
Balance, September 30, 2012
$
1,320,284

 
$
15,907

 
$
1,336,191

 
NOTE 10 — INVENTORY VALUATION
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 $74,599 and $72,173 at September 30, 2013 and December 31, 2012, respectively.
 

15

Table of Contents
LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

NOTE 11 — ACCRUED EMPLOYEE BONUS
“Other current liabilities” at September 30, 2013 and 2012 include accruals for year-end bonuses and related payroll taxes of $107,049 and $105,685, respectively, related to the Company’s employees worldwide.  The payment of bonuses is discretionary and 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 Company’s fiscal year. 
 
NOTE 12 — 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 claimants in the asbestos cases seek compensatory and punitive damages, in most cases for unspecified amounts.  The Company believes it has meritorious defenses to these claims and intends to contest such suits vigorously.
The Company’s accrual for contingent liabilities was $3,930 as of September 30, 2013 and $5,636 as of December 31, 2012.  The accrual is included in Other current liabilities.  The Company also recognized an asset for recoveries from insurance carriers related to the insured claims outstanding of $545 as of September 30, 2013 and $1,311 as of December 31, 2012.  The asset is included in Other current assets. 
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.
Based on the Company's historical experience in litigating product liability claims, including a significant number of dismissals, summary judgments and defense verdicts in many cases and immaterial settlement amounts, as well as the Company's 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, will not have a material effect on the Company's consolidated financial statements.

NOTE 13 — 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.  Warranty services are generally provided for periods up to three years from the date of sale.  The accrual for product warranty claims is included in “Other current liabilities.”
The changes in the carrying amount of product warranty accruals for the nine months ended September 30, 2013 and 2012 are as follows:
 
Nine Months Ended September 30,
 
2013
 
2012
Balance at beginning of period
$
15,304

 
$
15,781

Accruals for warranties
8,430

 
7,847

Settlements
(9,193
)
 
(8,283
)
Foreign currency translation
(88
)
 
52

Balance at end of period
$
14,453

 
$
15,397

 

16

Table of Contents
LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

NOTE 14 DEBT
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 September 30, 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.
 
NOTE 15 RETIREMENT AND POSTRETIREMENT BENEFIT PLANS
The components of total pension cost were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Service cost
$
6,144

 
$
5,426

 
$
17,563

 
$
16,275

Interest cost
8,954

 
10,368

 
27,852

 
31,097

Expected return on plan assets
(14,667
)
 
(14,688
)
 
(45,931
)
 
(44,059
)
Amortization of prior service cost
(153
)
 
(23
)
 
(459
)
 
(68
)
Amortization of net loss
7,045

 
7,773

 
23,262

 
23,316

Defined benefit plans
7,323

 
8,856

 
22,287

 
26,561

Multi-employer plans
237

 
223

 
702

 
690

Defined contribution plans
2,599

 
2,435

 
7,791

 
7,032

Total pension cost
$
10,159

 
$
11,514

 
$
30,780

 
$
34,283

The Company voluntarily contributed $75,216 to its defined benefit plans in the United States during the nine months ended September 30, 2013.

NOTE 16 — INCOME TAXES
The Company recognized $91,431 of tax expense on pre-tax income of $295,053, resulting in an effective income tax rate of 31.0% for the nine months ended September 30, 2013.  The effective income tax rate is lower than the Company’s statutory rate primarily due to income earned in lower tax rate jurisdictions, reversal of valuation allowance on deferred tax assets more-likely-than-not to be realized, U.S. tax credits and deductions and the utilization of foreign tax loss carry-forwards for which valuation allowances had been previously provided partially offset by the establishment of deferred tax liabilities for the planned repatriation of foreign earnings.
The effective income tax rate of 30.8% for the nine months ended September 30, 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.
The anticipated effective income tax rate for 2013 depends on the amount of earnings in various tax jurisdictions and the level of related tax deductions achieved during the year.
As of September 30, 2013, the Company had $24,084 of unrecognized tax benefits.  If recognized, approximately $14,130 would be reflected as a component of income tax expense.
The Company files income tax returns in the U.S. and various state, local and foreign jurisdictions.  With few exceptions, the Company is no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities for years before 2009.  The Company is currently subject to an IRS audit for 2010-2011, various U.S. state audits, a Canadian tax audit for 2003-2010, an Indian tax audit for 2012 and an Indonesian tax audit for 2003-2007.  Except as discussed below, the Company does not expect the results of these examinations to have a material effect on the Company’s consolidated financial statements.

17

Table of Contents
LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

Unrecognized tax benefits are reviewed on an ongoing basis and are adjusted for changing facts and circumstances, including progress of tax audits and closing of statutes of limitations.  Based on information currently available, management believes that additional audit activity could be completed and/or statutes of limitations may close relating to existing unrecognized tax benefits.  It is reasonably possible there could be a reduction of $3,619 in prior years’ unrecognized tax benefits by the end of the third quarter 2014.
In July 2012, the Company received a Notice of Reassessment from the Canada Revenue Agency (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 $60,711 plus approximately $16,536 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 and is recorded as a non-current asset valued at $86,827 as of September 30, 2013.  Any Canadian tax ultimately due will be creditable in the parent company’s U.S. federal tax return.  The Company expects to be able to utilize the full amount of foreign tax credits generated in the statutorily allowed carry-back and carry-forward periods.  Accordingly, should the Company not prevail in this dispute, the income statement charge will approximate the deficiency interest, net of tax.
The Company believes it will prevail on the merits of the tax position.  In accordance with prescribed recognition and measurement thresholds, no income tax accrual has been made for any uncertain tax positions related to the CRA reassessment.  An unfavorable resolution of this matter could have a material effect on the Company’s financial statements in the quarter in which a judgment is reached.

NOTE 17 — DERIVATIVES
The Company uses derivatives to manage exposures to currency exchange rates, interest rates and commodity prices arising in the normal course of business.  Derivative contracts to hedge currency and commodity exposures are generally written on a short-term basis but may cover exposures for up to two years while interest rate contracts may cover longer periods consistent with the terms of the underlying debt.  The Company does not enter into derivatives for trading or speculative purposes.
All derivatives are recognized at fair value on the Company’s Consolidated Balance Sheets.  The accounting for gains and losses resulting from changes in fair value depends on the use of the derivative and whether it is designated and qualifies for hedge accounting.  The Company formally documents the relationship of the hedge with the hedged item as well as the risk-management strategy for all designated hedges.  Both at inception and on an ongoing basis, the hedging instrument is assessed as to its effectiveness, when applicable.  If and when a derivative is determined not to be highly effective as a hedge, the underlying hedged transaction is no longer likely to occur, or the derivative is terminated, hedge accounting is discontinued.  The cash flows from settled derivative contracts are recognized in operating activities in the Company’s Consolidated Statements of Cash Flows.  Hedge ineffectiveness was immaterial in the nine months ended September 30, 2013 and 2012.
The Company is subject to the credit risk of the counterparties to derivative instruments.  Counterparties include a number of major banks and financial institutions.  The Company manages individual counterparty exposure by monitoring the credit rating of the counterparty and the size of financial commitments and exposures between the Company and the counterparty.  None of the concentrations of risk with any individual counterparty was considered significant at September 30, 2013.  The Company does not expect any counterparties to fail to meet their obligations.
Cash Flow Hedges
Certain foreign currency forward contracts were qualified and designated as cash flow hedges.  The dollar equivalent gross notional amount of these short-term contracts was $45,359 and $39,597 at September 30, 2013 and December 31, 2012, respectively. The effective portions of the fair value gains or losses on these cash flow hedges are recognized in AOCI and subsequently reclassified to Cost of goods sold or Sales for hedges of purchases and sales, respectively, as the underlying hedged transactions affect earnings.

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LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

Net Investment Hedges
The Company has a foreign currency forward contract that qualifies and is designated as a net investment hedge.  The dollar equivalent gross notional amount of this short-term contract was $7,444 at September 30, 2013. The effective portion of the fair value gain or loss on this net investment hedge is recognized in AOCI and subsequently reclassified to Selling, general and administrative expenses, as the underlying hedged investment is liquidated.
Derivatives Not Designated as Hedging Instruments
The Company has certain foreign exchange forward contracts that are not designated as hedges.  These derivatives are held as economic hedges of certain balance sheet exposures.  The dollar equivalent gross notional amount of these contracts was $245,101 and $189,259 at September 30, 2013 and December 31, 2012, respectively.  The fair value gains or losses from these contracts are recognized in Selling, general and administrative expenses, offsetting the losses or gains on the exposures being hedged.
The Company had short-term silver and copper forward contracts with notional amounts of 310,000 troy ounces and 375,000 pounds, respectively, at September 30, 2013.  The notional amount of short-term silver and copper forward contracts was 275,000 troy ounces and 375,000 pounds, respectively, at December 31, 2012.  Realized and unrealized gains and losses on these contracts are recognized in Costs of goods sold.
Fair values of derivative instruments in the Company’s Consolidated Balance Sheets follow:
 
 
September 30, 2013
 
December 31, 2012
Derivatives by hedge designation 
 
Other Current Assets
 
Other Current Liabilities
 
Other Current Assets
 
Other Current Liabilities
Designated as hedging instruments:
 
 

 
 

 
 

 
 

Foreign exchange contracts
 
$
411

 
$
435

 
$
352

 
$
325

Net investment contracts
 

 
2

 

 

Not designated as hedging instruments:
 
 

 
 

 
 

 
 

Foreign exchange contracts
 
959

 
1,282

 
510

 
902

Commodity contracts
 
289

 
57

 
731

 

Total derivatives
 
$
1,659

 
$
1,776

 
$
1,593

 
$
1,227

The effects of undesignated derivative instruments on the Company’s Consolidated Statements of Income for the three and nine month periods ended September 30, 2013 and 2012 consisted of the following:
 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Derivatives by hedge designation
 
Classification of gain (loss)
 
2013
 
2012
 
2013
 
2012
Not designated as hedges:
 
 
 
 

 
 

 
 
 
 
Foreign exchange contracts
 
Selling, general & administrative expenses
 
$
3,186

 
$
1,547

 
$
194

 
$
2,308

Commodity contracts
 
Cost of goods sold
 
(556
)
 
(2,410
)
 
2,841

 
(2,504
)
The effects of designated hedges on AOCI and the Company’s Consolidated Statements of Income consisted of the following:
Total gain (loss) recognized in AOCI, net of tax
 
September 30, 2013
 
December 31, 2012
Foreign exchange contracts
 
$
(79
)
 
$
80

Net investment contracts
 
12

 

 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Derivative type
 
Gain (loss) reclassified from AOCI to:
 
2013
 
2012
 
2013
 
2012
Foreign exchange contracts
 
Sales
 
$
165

 
$
127

 
$
467

 
$
591

 
 
Cost of goods sold
 
304

 
35

 
453

 
88


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LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

The Company expects a loss of $67 related to existing contracts to be reclassified from AOCI, net of tax, to earnings over the next 12 months as the hedged transactions are realized. 

NOTE 18 - FAIR VALUE
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).  The following hierarchy is used to classify the inputs used to measure fair value:
 
Level 1                   Unadjusted quoted prices in active markets for identical assets or liabilities.
 
Level 2                   Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
 
Level 3                   Unobservable inputs for the asset or liability.

The following table provides a summary of assets and liabilities as of September 30, 2013, measured at fair value on a recurring basis:
Description
 
Balance as of September 30, 2013
 
Quoted Prices
in Active
Markets for
Identical Assets
or Liabilities
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 

 
 

 
 

 
 

Foreign exchange contracts
 
$
1,370

 
$

 
$
1,370

 
$

Commodity contracts
 
289

 

 
289

 

Total assets
 
$
1,659

 
$

 
$
1,659

 
$

 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

Foreign exchange contracts
 
$
1,717

 
$

 
$
1,717

 
$

Commodity contracts
 
57

 

 
57

 

Net investment contracts
 
2

 

 
2

 

Contingent consideration
 
5,250

 

 

 
5,250

Deferred compensation
 
19,278

 

 
19,278

 

Total liabilities
 
$
26,304

 
$

 
$
21,054

 
$
5,250


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LINCOLN ELECTRIC HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dollars in thousands, except per share amounts

The following table provides a summary of assets and liabilities as of December 31, 2012, measured at fair value on a recurring basis:
Description
 
Balance as of December 31, 2012
 
Quoted Prices
in Active
Markets for
Identical Assets
or Liabilities
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 

 
 

 
 

 
 

Foreign exchange contracts
 
$
862

 
$

 
$
862

 
$

Commodity contracts
 
731

 

 
731

 

Total assets
 
$
1,593

 
$

 
$
1,593

 
$

 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

Foreign exchange contracts
 
$
1,227

 
$

 
$
1,227

 
$

Contingent consideration
 
4,894

 

 

 
4,894

Deferred compensation
 
16,882

 

 
16,882

 

Total liabilities
 
$
23,003

 
$

 
$
18,109

 
$
4,894

The Company’s derivative contracts are valued at fair value using the market approach.  The Company measures the fair value of foreign exchange contracts and net investment contracts using Level 2 inputs based on observable spot and forward rates in active markets.  The Company measures the fair value of commodity contracts using Level 2 inputs through observable market transactions in active markets provided by financial institutions.  During the nine months ended September 30, 2013, there were no transfers between Levels 1, 2 or 3.
In connection with an acquisition, the Company recorded a contingent consideration fair valued at $5,250 as of September 30, 2013, which reflects a $356 increase in the liability from December 31, 2012.  The contingent consideration is based upon estimated sales 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 the contingent consideration is a Level 3 valuation and fair valued using a probability weighted discounted cash flow analysis.  The discounted cash flow utilized weighted average inputs, including a risk-based discount rate of 9.7% and a compounded annual revenue growth rate of 30.5%.  The discount rate was determined using discount rates of 3.5% reflective of the Company’s cost of debt and 14.1% as a risk adjusted cost of capital and the compounded annual revenue growth rate was determined using various scenarios with growth ranging from remaining relatively flat to growth rates of up to 65.6%.
The deferred compensation liability is the Company’s obligation under its executive deferred compensation plan.  The Company measures the fair value of the liability using the market values of the participants’ underlying investment fund elections.
The fair value of “Cash and cash equivalents,” “Accounts receivable,” “Amounts due banks” and “Trade accounts payable” approximated book value due to the short-term nature of these instruments at both September 30, 2013 and December 31, 2012.  The fair value of long-term debt at September 30, 2013 and December 31, 2012, including the current portion, was approximately $1,503 and $1,919, respectively, which was determined using available market information and methodologies requiring judgment.  The carrying value of this debt at such dates was $1,674 and $2,055, respectively.  Since considerable judgment is required in interpreting market information, the fair value of the debt is not necessarily the amount that could be realized in a current market exchange.

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (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 the Company’s unaudited consolidated financial statements and other financial information included elsewhere in this Quarterly Report on Form 10-Q.
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.  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 computer numeric controlled plasma and oxy-fuel cutting systems and 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’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. 
Results of Operations
Three Months Ended September 30, 2013 Compared with Three Months Ended September 30, 2012
 
Three Months Ended September 30,
 
2013
 
2012
 
Change
 
Amount
 
% of Sales
 
Amount
 
% of Sales
 
Amount
 
%
Net sales
$
691,875

 
100.0
%
 
$
697,552

 
100.0
%
 
$
(5,677
)
 
(0.8
%)
Cost of goods sold
459,178

 
66.4
%
 
484,190

 
69.4
%
 
(25,012
)