LINCOLN ELECTRIC HOLDINGS INC - Quarter Report: 2011 March (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2011

 

or

 

o 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)

 

 

(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 R   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 R   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 R		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 R      

 

The number of shares outstanding of the registrant’s common shares as of March 31, 2011 was 42,176,086.

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION		3
Item 1. Financial Statements		3
	CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)	3
	CONSOLIDATED BALANCE SHEETS (UNAUDITED)	4
	CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)	5
	NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3. Quantitative and Qualitative Disclosures About Market Risk		23
Item 4. Controls and Procedures		24
PART II. OTHER INFORMATION		24
Item 1. Legal Proceedings		24
Item 1A. Risk Factors		25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		25
Item 5. Other Information		25
Item 6. Exhibits		25
Signature		26
EX-31.1	Certification of the Chairman, 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 Chairman, 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 March 31,
		2011			2010
Net sales		$	599,179		$	470,958
Cost of goods sold		437,741			347,625
Gross profit		161,438			123,333
Selling, general & administrative expenses		101,619			87,775
Rationalization and asset impairment charges		357			801
Operating income		59,462			34,757
Other income (expense):
Interest income		608			635
Equity earnings in affiliates		830			430
Other income		1,295			433
Interest expense		(1,658		)	(1,514		)
Total other income (expense)		1,075			(16		)
Income before income taxes		60,537			34,741
Income taxes		13,595			10,975
Net income including noncontrolling interests		46,942			23,766
Noncontrolling interests in subsidiaries’ earnings		32			38
Net income		$	46,910		$	23,728
Basic weighted average shares outstanding		41,895			42,404
Effect of dilutive securities - stock options and awards		544			360
Diluted weighted average shares outstanding		42,439			42,764
Basic earnings per share		$	1.12		$	0.56
Diluted earnings per share		$	1.11		$	0.55
Cash dividends declared per share		$	0.31		$	0.28

 

See notes to these consolidated financial statements.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

 

		March 31, 2011			December 31, 2010
		(UNAUDITED)			(NOTE 1)
ASSETS
Current Assets
Cash and cash equivalents		$	341,415		$	366,193
Accounts receivable (less allowance for doubtful accounts of $8,359 in 2011; $7,855 in 2010)		376,857			321,948
Inventories:
Raw materials		105,718			85,232
Work-in-process		48,618			38,706
Finished goods		214,618			167,792
Total inventory		368,954			291,730
Other current assets		107,979			102,641
Total Current Assets		1,195,205			1,082,512
Property, Plant and Equipment
Land		44,908			43,701
Buildings		323,933			313,861
Machinery and equipment		731,341			712,362
		1,100,182			1,069,924
Less accumulated depreciation		610,362			591,358
Property, Plant and Equipment, Net		489,820			478,566
Non-current assets		228,545			222,710
TOTAL ASSETS		$	1,913,570		$	1,783,788
LIABILITIES AND EQUITY
Current Liabilities
Amounts due banks		$	12,003		$	11,283
Trade accounts payable		215,495			147,111
Other current liabilities		184,001			175,403
Current portion of long-term debt		83,370			1,795
Total Current Liabilities		494,869			335,592
Long-Term Liabilities
Long-term debt, less current portion		1,818			84,627
Accrued pensions		113,371			121,994
Other long-term liabilities		91,521			92,097
Total Long-Term Liabilities		206,710			298,718
Shareholders’ Equity
Common shares		4,929			4,929
Additional paid-in capital		171,587			167,376
Retained earnings		1,354,387			1,320,552
Accumulated other comprehensive loss		(118,352		)	(141,948		)
Treasury shares		(216,846		)	(217,412		)
Total Shareholders’ Equity		1,195,705			1,133,497
Noncontrolling interests		16,286			15,981
Total Equity		1,211,991			1,149,478
TOTAL LIABILITIES AND EQUITY		$	1,913,570		$	1,783,788

 

See notes to these consolidated financial statements.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

 

		Three Months Ended March 31,
		2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	46,910		$	23,728
Noncontrolling interests in subsidiaries’ earnings		32			38
Net income including noncontrolling interests		46,942			23,766
Adjustments to reconcile Net income including noncontrolling interests to Net cash provided by operating activities:
Rationalization and asset impairment charges		227			—
Depreciation and amortization		15,206			14,237
Equity earnings in affiliates, net		(362		)	(168		)
Deferred income taxes		11,635			(7,305		)
Stock-based compensation		1,468			1,976
Amortization of terminated interest rate swaps		(460		)	(460		)
Amortization of pension actuarial losses and prior service cost		5,457			5,311
Other non-cash items, net		740			(3,147		)
Changes in operating assets and liabilities, net of effects from acquisitions:
Increase in accounts receivable		(43,324		)	(40,279		)
Increase in inventories		(62,064		)	(23,017		)
Increase in other current assets		(2,318		)	(8,058		)
Increase in trade accounts payable		55,553			38,316
(Decrease) increase in other current liabilities		(2,112		)	21,486
Decrease in accrued pensions		(7,404		)	(7,582		)
Net change in other long-term assets and liabilities		(2,446		)	520
NET CASH PROVIDED BY OPERATING ACTIVITIES		16,738			15,596
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures		(15,503		)	(9,771		)
Acquisition of businesses, net of cash acquired		(17,881		)	—
Proceeds from sale of property, plant and equipment		142			42
NET CASH USED BY INVESTING ACTIVITIES		(33,242		)	(9,729		)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from short-term borrowings		4,780			10,644
Payments on short-term borrowings		(4,967		)	(13,642		)
Amounts due banks, net		(238		)	1,389
Proceeds from long-term borrowings		—			30
Payments on long-term borrowings		(894		)	(421		)
Proceeds from exercise of stock options		2,864			196
Tax benefit from exercise of stock options		715			78
Purchase of shares for treasury		(905		)	(2,869		)
Cash dividends paid to shareholders		(12,987		)	(11,885		)
NET CASH USED BY FINANCING ACTIVITIES		(11,632		)	(16,480		)
Effect of exchange rate changes on Cash and cash equivalents		3,358			(915		)
DECREASE IN CASH AND CASH EQUIVALENTS		(24,778		)	(11,528		)
Cash and cash equivalents at beginning of period		366,193			388,136
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	341,415		$	376,608

 

 See notes to these consolidated financial statements.

 

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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 three months ended March 31, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011.

 

The accompanying Consolidated Balance Sheet at December 31, 2010 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, 2010.

 

Certain reclassifications have been made to the prior year financial statements to conform to current year classifications.

 

Venezuela — Foreign Currency

 

Effective January 1, 2010, the financial statements of the Company’s Venezuelan operation have been remeasured into the Company’s reporting currency (U.S. dollar).  A currency control board exists in Venezuela that is responsible for foreign exchange procedures, including approval of requests for exchanges of the Venezuelan currency (the “bolivar”) for U.S. dollars at the official (government established) exchange rates.  An unregulated parallel market that existed for exchanging bolivars for U.S. dollars through securities transactions was terminated by the Venezuelan government on May 17, 2010 and subsequently established as a regulated market on June 9, 2010.

 

The official exchange rate in Venezuela had been fixed at 2.15 bolivars to 1 U.S. dollar for several years.  On January 8, 2010, the Venezuelan government announced the devaluation of its currency relative to the U.S. dollar.  The official exchange rate for imported goods classified as essential changed from 2.15 to 2.60 (the “Essential Rate”), while the official exchange rate for other non-essential goods moved to an exchange rate of 4.30 (the “Non-Essential Rate”).  In remeasuring the financial statements the Non-Essential Rate is used as this is the rate expected to be applicable to dividend repatriations.

 

In December 2010, the Venezuelan government announced the elimination of the Essential Rate effective as of January 1, 2011.  The impact of the elimination of the Essential Rate did not have a significant impact on the Company’s consolidated financial statements.

 

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.

 

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 net bolivar-denominated monetary liability position was $2,004 at March 31, 2011 and $4,715 at December 31, 2010.

 

The devaluation of the bolivar and the change to the U.S. dollar as the functional currency for the three months ended March 31, 2010 resulted in a foreign currency transaction gain of $2,632 in “Selling, general & administrative expenses” and higher “Cost of goods sold” of $2,621 due to the liquidation of inventory valued at the historical exchange rate.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

NOTE 2 — NEW ACCOUNTING PRONOUNCEMENTS

 

New Accounting Standards Adopted:

 

In December 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-29, “Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations a consensus of the FASB Emerging Issues Task Force.”  The objective of ASU No. 2010-29 is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations.  This standard is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  ASU 2010-29 was adopted by the Company on January 1, 2011 and did not have an impact on the Company’s financial statements.

 

In October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (Topic 605) Multiple-Deliverable Revenue Arrangements a consensus of the FASB Emerging Issues Task Force.”  This update provides amendments to the criteria in Accounting Standards Codification (“ASC”) Subtopic 605-25.  ASU No. 2009-13 provides principles for allocating consideration among multiple-elements and accounting for separate deliverables under an arrangement.  ASC 605-25, as amended, introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available and significantly expands related disclosure requirements.  This standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010.  Alternatively, adoption may be on a retrospective basis.  ASU 2009-13 was adopted by the Company on January 1, 2011 and did not have a significant impact on the Company’s financial statements.

 

NOTE 3 — ACQUISITIONS

 

On March 11, 2011, the Company completed the acquisition of OOO Severstal-metiz: welding consumables (“Severstal”) for approximately $16,555 in cash and assumed debt.  The preliminary fair value of the assets acquired were $8,182, resulting in goodwill of $8,373.  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 SSCO Manufacturing, Inc. (d/b/a Arc Products) (“Arc Products”) for approximately $3,280 in cash and a contingent consideration liability fair valued at $3,806.  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 preliminary fair value of the assets acquired were $3,613, resulting in goodwill of $3,473.  Arc Products was a privately-held 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.

 

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.

 

On October 29, 2010, the Company acquired all of the outstanding stock of Mezhgosmetiz-Mtsensk OAO (“MGM”), a privately-held welding wire manufacturer based in the Orel region of Russia, for approximately $28,500 in cash and assumed debt.  This acquisition represented the Company’s first manufacturing operation in Russia as well as established distribution channels to serve the growing Russian and CIS welding markets.  Annual sales at the date of acquisition were approximately $30,000.

 

NOTE 4 — 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 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 and Africa.  The other two welding

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

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.

 

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 March 31, 2011
Net sales		$	280,757		$	114,208		$	87,560		$	34,073		$	82,581		$	—		$	599,179
Inter-segment sales		35,127			3,835			3,213			—			2,233			(44,408		)	—
Total		$	315,884		$	118,043		$	90,773		$	34,073		$	84,814		$	(44,408	)	$	599,179
EBIT, as adjusted		$	46,636		$	5,912		$	126		$	2,048		$	6,543		$	679		$	61,944
Special items charge (gain)		—			358			(1		)	—			—			—			357
EBIT		$	46,636		$	5,554		$	127		$	2,048		$	6,543		$	679		$	61,587
Interest income																				608
Interest expense																				(1,658		)
Income before income taxes																				$	60,537
Total assets		$	959,142		$	494,139		$	355,236		$	103,952		$	293,471		$	(292,370	)	$	1,913,570
Three months ended March 31, 2010
Net sales		$	231,335		$	84,676		$	71,945		$	22,748		$	60,254		$	—		$	470,958
Inter-segment sales		24,908			3,558			2,501			194			1,731			(32,892		)	—
Total		$	256,243		$	88,234		$	74,446		$	22,942		$	61,985		$	(32,892	)	$	470,958
EBIT, as adjusted		$	30,996		$	1,098		$	982		$	1,335		$	2,741		$	(742	)	$	36,410
Special items charge (gain)		—			540			261			(11		)	—			—			790
EBIT		$	30,996		$	558		$	721		$	1,346		$	2,741		$	(742	)	$	35,620
Interest income																				635
Interest expense																				(1,514		)
Income before income taxes																				$	34,741
Total assets		$	879,670		$	370,571		$	314,274		$	76,773		$	263,900		$	(147,925	)	$	1,757,263

 

In 2011, special items include net charges of $357 for rationalization actions in the Europe Welding and Asia Pacific Welding segments, primarily related to employee severance and other costs associated with the consolidation of manufacturing operations.

 

In 2010, special items include charges of $540 for rationalization actions in the Europe Welding segment and a charge of $261 for rationalization actions in the Asia Pacific Welding segment, primarily related to employee severance and other costs associated with the consolidation of manufacturing operations.  The South America Welding segment includes a net gain of $11 for the impacts to the Company’s operation in Venezuela resulting from the change in functional currency to the U.S. dollar and devaluation of the Venezuelan currency.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

NOTE 5 — RATIONALIZATION AND ASSET IMPAIRMENTS

 

During 2009, the Company initiated rationalization actions including the consolidation of certain manufacturing operations in the Europe Welding, Asia Pacific Welding and The Harris Products Group segments.  The Company recognized a net charge of $357 for the three months ended March 31, 2011 related to these activities for employee severance, asset impairments, loss on disposal of equipment and other related charges.  At March 31, 2011, a liability relating to these actions of $1,316 was recognized in “Other current liabilities.”  The Company does not expect any further material costs associated with these actions in 2011 as they were substantially completed in 2010 and are expected to be substantially paid by the end of 2011.

 

The following table summarizes the activity related to the rationalization liabilities by segment:

 

		Europe Welding			Asia Pacific Welding			The Harris Products Group			Consolidated
Balance at December 31, 2010		$	411		$	90		$	930		$	1,431
Payments and other adjustments		(120		)	(89		)	(36		)	(245		)
Charged to expense		131			(1		)	—			130
Balance at March 31, 2011		$	422		$	—		$	894		$	1,316

 

NOTE 6 — STOCK-BASED COMPENSATION

 

The Company issued 67,284 and 8,275 shares of common stock from treasury upon exercise of employee stock options during the three months ended March 31, 2011 and 2010, respectively, and 1,069 shares of common stock from treasury for dividends earned on the vesting of restricted shares during the three months ended March 31, 2011.  The Company granted 1,200 and 800 stock options during the three months ended March 31, 2011 and 2010, respectively and 1,336 restricted shares during the three months ended March 31, 2010.  The restricted shares granted during the three months ended March 31, 2010 were issued from treasury.

 

For the three months ended March 31, 2011 and 2010, common shares subject to equity-based awards of 243,105 and 700,058, respectively, were excluded from the computation of diluted earnings per share because the effect of their exercise would be anti-dilutive.

 

NOTE 7 — COMMON SHARE REPURCHASE PROGRAM

 

The Company has a share repurchase program for up to 15 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 three months ended March 31, 2011, the Company purchased no shares in the open market under this plan.  As of March 31, 2011, there remained 3,081,493 shares available for repurchase under the stock repurchase program.  The treasury shares have not been retired.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

NOTE 8 — COMPREHENSIVE INCOME

 

The components of comprehensive income are as follows:

 

		Three Months Ended March 31,
		2011			2010
Net income including noncontrolling interests		$	46,942		$	23,766
Other comprehensive income:
Unrealized (loss) gain on derivatives designated and qualifying as cash flow hedges, net of tax of ($14) in 2011 and $148 in 2010		(228		)	278
Defined benefit pension plan activity, net of tax of $2,410 in 2011 and $2,122 in 2010		3,319			3,276
Currency translation adjustment		20,778			(6,707		)
Total comprehensive income		70,811			20,613
Total comprehensive income attributable to noncontrolling interests		305			37
Total comprehensive income attributable to shareholders		$	70,506		$	20,576

 

NOTE 9 — EQUITY

 

Changes in equity for the three months ended March 31, 2011 are as follows:

 

		Shareholders’ Equity			Noncontrolling Interests			Total Equity
Balance at December 31, 2010		$	1,133,497		$	15,981		$	1,149,478
Comprehensive income:
Net income		46,910			32			46,942
Other comprehensive income		23,596			273			23,869
Total comprehensive income		70,506			305			70,811
Cash dividends declared - $0.31 per share		(13,075		)	—			(13,075		)
Issuance of shares under benefit plans		5,682			—			5,682
Purchase of shares for treasury		(905		)	—			(905		)
Balance at March 31, 2011		$	1,195,705		$	16,286		$	1,211,991

 

Changes in equity for the three months ended March 31, 2010 are as follows:

 

		Shareholders’ Equity			Noncontrolling Interests			Total Equity
Balance at December 31, 2009		$	1,072,346		$	13,329		$	1,085,675
Comprehensive income:
Net income		23,728			38			23,766
Other comprehensive income		(3,152		)	(1		)	(3,153		)
Total comprehensive income		20,576			37			20,613
Cash dividends declared - $0.28 per share		(11,924		)	—			(11,924		)
Issuance of shares under benefit plans		2,249			—			2,249
Purchase of shares for treasury		(2,869		)	—			(2,869		)
Balance at March 31, 2010		$	1,080,378		$	13,366		$	1,093,744

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

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 $73,478 and $70,906 at March 31, 2011 and December 31, 2010, respectively.

 

NOTE 11 — ACCRUED EMPLOYEE COMPENSATION AND BENEFITS

 

“Other current liabilities” at March 31, 2011 and 2010 include accruals for year-end bonuses and related payroll taxes of $26,665 and $16,765, 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.  The increase in the accrual from March 31, 2010 to March 31, 2011 is due to the increase in profitability of the Company.

 

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 and manganese induced illnesses.  The claimants in the asbestos and manganese 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, primarily for product liability claims, was $5,780 as of March 31, 2011 and $5,711 as of December 31, 2010.  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 $1,591 as of March 31, 2011 and $1,616 as of December 31, 2010.  The asset is included in “Other current assets.”

 

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 (exclusive of defense costs), 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 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 three months ended March 31, 2011 and 2010 are as follows:

 

		Three Months Ended March 31,
		2011			2010
Balance at beginning of period		$	16,879		$	16,768
Charged to expense		2,557			1,482
Deductions		(2,588		)	(1,987		)
Foreign currency translation		247			(263		)
Balance at end of period		$	17,095		$	16,000

 

Warranty expense was 0.4 % and 0.3% of sales for the three months ended March 31, 2011 and 2010, respectively.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

NOTE 14 — DEBT

 

As of March 31, 2011, the Company was in compliance with its debt covenants.  The Company’s $80,000 Series C Note (the “Note”) is due in March 2012.  The Company has a line of credit totaling $150,000 through the Amended and Restated Credit Agreement (“Credit Agreement”) which was entered into on November 18, 2009, of which $145,903 was available on March 31, 2011.  The Credit Agreement has a three-year term and may be increased, subject to certain conditions, by an additional amount up to $75,000 at any time not later than 180 days prior to the last day of the term.

 

The Company historically utilized interest rate swaps to manage interest rate risks.  The Company terminated its remaining interest rate swaps in 2009 and had no interest rate swaps outstanding as of March 31, 2011.  The termination of interest rate swaps in 2009 resulted in a realized gain of $5,079.  This gain was deferred and is being amortized over the remaining life of the Note.  The amortization of this gain reduced “Interest expense” by $410 in the three months ended March 31, 2011 and 2010, respectively, and is expected to reduce annual interest expense by $1,661 during 2011.  At March 31, 2011, $1,579 remains to be amortized and is recognized in “Long-term debt, current portion.”  The weighted average effective interest rate on the Note, net of the impact of swaps, was 4.1 % for the three months ended March 31, 2011.

 

NOTE 15 — RETIREMENT AND POSTRETIREMENT BENEFIT PLANS

 

The components of total pension cost were as follows:

 

		Three Months Ended March 31,
		2011			2010
Service cost		$	4,335		$	4,044
Interest cost		10,957			10,895
Expected return on plan assets		(14,355		)	(12,281		)
Amortization of prior service cost		(15		)	(11		)
Amortization of net loss		5,472			5,322
Defined benefit plans		6,394			7,969
Multi-employer plans		235			278
Defined contribution plans		2,053			1,814
Total pension cost		$	8,682		$	10,061

 

The Company voluntarily contributed $7,000 to its defined benefit plans in the United States during the three months ended March 31, 2011 and expects to contribute a total of $30,000 to its defined benefit plans in the United States during 2011.

 

The expected return on plan assets increased in 2011 due to higher investment balances in plan assets at December 31, 2010 than at December 31, 2009.

 

NOTE 16 — INCOME TAXES

 

The Company recognized $13,595 of tax expense on pre-tax income of $60,537, resulting in an effective income tax rate of 22.5% for the three months ended March 31, 2011.  The effective income tax rate is lower than the Company’s statutory rate primarily because of income earned in lower tax rate jurisdictions, the utilization of foreign tax loss carryforwards for which valuation allowances had been previously recognized and a tax benefit of $4,844 for tax audit settlements.

 

The effective income tax rate of 31.6% for the three months ended March 31, 2010 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 carryforwards for which valuation allowances had been previously recognized.

 

The anticipated effective income tax rate for 2011 depends on the amount of earnings in various tax jurisdictions and the level of related tax deductions achieved during the year.

 

As of March 31, 2011, the Company had $33,405 of unrecognized tax benefits.  If recognized, approximately $19,959 would be recognized as a component of income tax expense.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

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 2005.  The Company is currently subject to an IRS audit for the tax years 2007 — 2008, various U.S. state audits, a Canadian tax audit for 2005 — 2007, a French tax audit for 2008 — 2009, a Russian tax audit for 2009 and an Indonesian tax audit for 2003 — 2007.  The Company does not expect the results of these examinations to have a material effect on the Company’s consolidated financial statements.

 

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 $10,705 in prior years’ unrecognized tax benefits by the end of the first quarter 2012.

 

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 three months ended March 31, 2011 and 2010.

 

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 March 31, 2011.  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 $44,329 and $33,221 at March 31, 2011 and December 31, 2010, respectively.  The effective portions of the fair value gains or losses on these cash flow hedges are recognized in “Accumulated other comprehensive income” (“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.

 

Fair Value Hedges

 

The Company had no fair value hedges outstanding at March 31, 2011 or December 31, 2010.

 

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 $184,409 and $173,116 at March 31, 2011 and December 31, 2010, 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.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

The Company had short-term silver and copper forward contracts with notional amounts of 380,000 troy ounces and 750 thousand pounds, respectively, at March 31, 2011.  The notional amount of short-term silver contracts was 380,000 troy ounces at December 31, 2010.  Realized and unrealized gains and losses on these contracts were recognized in earnings.

 

Fair values of derivative instruments in the Company’s Consolidated Balance Sheets follow:

 

		March 31, 2011						December 31, 2010
		Other			Other			Other			Other
		Current			Current			Current			Current
Derivatives by hedge designation		Assets			Liabilities			Assets			Liabilities
Designated as hedging instruments:
Foreign exchange contracts		$	360		$	932		$	381		$	728
Not designated as hedging instruments:
Foreign exchange contracts		310			1,075			252			1,228
Commodity contracts		67			1,355			—			1,051
Total derivatives		$	737		$	3,362		$	633		$	3,007

 

The effects of designated fair value hedges and undesignated derivative instruments on the Company’s Consolidated Statements of Income for the three months ended March 31, 2011 and 2010 consisted of the following:

 

				Three Months Ended
				March 31,
Derivatives by hedge designation		Classification of gains (losses)		2011			2010
Not designated as hedges:
Foreign exchange contracts		Selling, general & administrative expenses		$	(3,538	)	$	(1,989	)
Commodity contracts		Cost of goods sold		(2,877		)	(104		)
Commodity contracts		Other income		(12		)	—

 

The effects of designated cash flow hedges on AOCI and the Company’s Consolidated Statements of Income consisted of the following:

 

Total gain (loss) recognized in AOCI, net of tax		March 31, 2011			December 31, 2010
Foreign exchange contracts		$	(580	)	$	(352	)

 

				Three Months Ended
				March 31,
Derivative type		Gain (loss) reclassified from AOCI to:		2011			2010
Foreign exchange contracts		Sales		$	51		$	11
		Cost of goods sold		(573		)	(75		)
Commodity contracts		Cost of goods sold		—			(546		)

 

The Company expects a loss of $580 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.

 

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LINCOLN ELECTRIC HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Dollars in thousands, except per share amounts

 

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 March 31, 2011 measured at fair value on a recurring basis:

 

		Balance as of			Quoted Prices in Active Markets for Identical Assets or Liabilities			Significant Other Observable Inputs			Significant Unobservable Inputs
Description		March 31, 2011			(Level 1)			(Level 2)			(Level 3)
Assets:
Foreign exchange contracts		$	670		$	—		$	670		$	—
Commodity contracts		67			—			67			—
Total assets		$	737		$	—		$	737		$	—
Liabilities:
Foreign exchange contracts		$	2,007		$	—		$	2,007		$	—
Commodity contracts		1,355			—			1,355			—
Contingent consideration		3,892			—			—			3,892
Total liabilities		$	7,254		$	—		$	3,362		$	3,892

 

The following table provides a summary of assets and liabilities as of December 31, 2010 measured at fair value on a recurring basis:

 

		Balance as of			Quoted Prices in Active Markets for Identical Assets or Liabilities			Significant Other Observable Inputs			Significant Unobservable Inputs
Description		December 31, 2010			(Level 1)			(Level 2)			(Level 3)
Assets:
Foreign exchange contracts		$	633		$	—		$	633		$	—
Liabilities:
Foreign exchange contracts		$	1,956		$	—		$	1,956		$	—
Commodity contracts		1,051			—			1,051			—
Total liabilities		$	3,007		$	—		$	3,007		$	—

 

The Company’s derivative contracts are valued at fair value using the market approach.  The Company measures the fair value of foreign exchange 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 quarter ended March 31, 2011, there were no transfers between Levels 1, 2 or 3.

 

15