Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENERAL

The Company is the world’s largest designer and manufacturer of arc welding and cutting products, manufacturing a full line of arc welding equipment, consumable welding products and other welding and cutting products.

The Company is one of only a few worldwide broad line manufacturers of both arc welding equipment and consumable products. Welding products include arc welding power sources, wire feeding systems, robotic welding packages, fume extraction equipment, consumable electrodes and fluxes. The Company’s welding product offering also includes regulators and torches used in oxy-fuel welding and cutting.

The Company continues to invest in the research and development of these arc welding equipment and consumable products in order to continue its market leading product offering. Although the industry is considered mature, the Company continues to invest in technologies that improve the quality and productivity of welding products. The Company believes its continued investment in research and development and its highly trained technical sales force provides a competitive advantage in the marketplace.

The Company’s products are sold in both domestic and international markets. In the United States, products are sold principally through industrial distributors, retailers and also directly to users of welding products. Outside of the United States, the Company also has an international sales organization comprised of Company employees and agents who sell products from the Company’s various manufacturing sites to distributors, agents, dealers and product users.

The Company’s major end user markets include:

•		general metal forming and fabrication,
•		infrastructure including oil and gas pipelines and platforms, buildings and bridges and power generation,
•		the transportation and defense industries (automotive/trucks, rail, ships and aerospace),
•		equipment manufacturers in construction, farming and mining,
•		retail resellers, and
•		rental market.

The Company has manufacturing facilities located in the United States, Australia, Brazil, Canada, England, France, Germany, Indonesia, Ireland, Italy, Mexico, the Netherlands, People’s Republic of China, Poland, Spain, Taiwan, Turkey and Venezuela.

The Company’s sales and distribution network, coupled with its manufacturing facilities, are managed through five regions: North America, Latin America, Europe, Asia-Pacific and Russia, Africa and Middle East regions.

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The principal raw materials essential to the Company’s business are various chemicals, electronics, steel, brass, copper and aluminum alloys which are normally available for purchase in the open market.

The Company’s facilities are subject to environmental regulations. To date, compliance with these environmental regulations has not had a material effect on the Company’s earnings. The Company is ISO9001 certified at nearly all Lincoln facilities worldwide. In addition, the Company is ISO14001 certified at the Mentor, Ohio manufacturing facility and is in the process of achieving ISO14001 certification at its Euclid, Ohio manufacturing facility.

Key indicators

Key economic measures relevant to the Company include industrial production trends, steel consumption, purchasing manager indices, and capacity utilization within durable goods manufacturers. Key industries which provide a relative indication of demand drivers to the Company include farm machinery and equipment, construction and transportation, fabricated metals, electrical equipment, ship and boat building, defense, truck manufacturing and railroad equipment. Although these measures provide key information on trends relevant to the Company, the Company does not have available a more direct correlation of leading indicators which can provide a forward-looking view of demand levels in the markets which ultimately use the Company’s welding products.

Key operating measures utilized by the operating units to manage the Company include orders, sales, inventory and fill-rates which provide key indicators of business trends. These measures are reported on various cycles including daily, weekly, and monthly depending on the needs established by operating management.

Key financial measures utilized by the Company’s executive management and operating units in order to evaluate the results of its business and in understanding key variables impacting the current and future results of the Company include: sales, gross profit, selling, general and administrative expenses, earnings before interest, taxes and bonus, operating cash flows and capital expenditures, including applicable ratios such as return on investment and average operating working capital. These measures are reviewed at monthly, quarterly and annual intervals and compared with historical periods as well as objectives established by the Board of Directors of the Company.

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RESULTS OF OPERATIONS

The following table shows the Company’s results of operations:

2003 COMPARED TO 2002

Net Sales . Net sales for 2003 were $1,040.5 million, a $46.4 million increase from $994.1 million last year. Net sales from U.S. operations were $614.5 million for 2003, compared to $612.4 million for last year. This increase reflects increased demand in the industrial segment of the U.S. market during the second half of 2003 partially offset by lower demand in the first half of the year. Export sales from the U.S. of $62.1 million were down $1.1 million, or 1.7% from last year. U.S. exports have increased into the Russia, Africa & Middle East and Europe regions but were more than offset by lower exports into Latin America and Canada. Non-U.S. net sales increased 11.6% to $426.0 million in 2003, compared with $381.7 million last year. The weakening of the U.S. dollar continues to have a positive impact on non-U.S. net sales compared with last year. This positive impact on consolidated net sales was $43.5 million, or 4.4% for 2003. In local currencies, the Company’s non-U.S. net sales were flat compared with the prior year. Although overall non-U.S. net sales were flat compared to prior year, there was growth in Latin America, and Eastern Europe, which was offset by lower demand in the rest of Europe.

Gross Profit. Gross profit of $280.6 million for 2003 declined 6.5%, or $19.4 million from last year. Gross profit as a percentage of net sales declined to 27.0% from 30.2%, compared with last year. Gross profit margins in the U.S. declined because of lower sales volumes in the first half of the year, product mix, higher

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material costs and higher pension expense. Pension expense included in cost of sales increased $10.0 million year-over-year. The Company anticipates this portion of pension expense will decrease approximately $4 million in 2004. During 2003, the Company has experienced an increase in raw material prices, including metals and chemicals. In addition, energy costs continue to increase resulting in higher operating costs including transportation and freight. As demand continues to increase in the U.S. industrial sector, the Company expects these costs to remain at relatively high levels. If these costs continue to increase, the Company’s gross profit margin may be negatively affected. Non-U.S. gross margins were comparable to prior year. Foreign currency exchange rates had a positive effect on gross profit of approximately $9.9 million, or 3.6% during 2003 and were immaterial in 2002.

Selling, General & Administrative (SG&A) Expenses . SG&A expenses increased $12.7 million, or 6.4% to $210.7 million for 2003, compared with $198.0 million for 2002. The increase was attributable to the translation effect of foreign exchange rates of $9.9 million, higher pension expense of $4.7 million and higher professional services offset by lower bonus expense of $6.3 million and cost reduction efforts. The Company anticipates this portion of pension expense will decrease approximately $2 million in 2004. Foreign exchange transaction losses had a negative impact of $3.2 million on SG&A during 2003 and were immaterial in 2002.

Rationalization Charges . During the first quarter of 2003, the Company recorded rationalization charges of $1.7 million ($1.3 million after-tax). The rationalization charges were related to asset impairments and severance charges. Non-cash asset impairment charges of $0.9 million relate to property, plant and equipment at one of the Company’s European subsidiaries where management believes the carrying values are unrecoverable. Severance charges were $0.8 million primarily covering 57 U.S. employees. Severance charges were incurred to eliminate redundancies and improve organizational efficiency. As of December 31, 2003, approximately $0.2 million of severance payments remain to be paid.

During the first quarter of 2002, the Company recorded rationalization charges of $10.5 million ($7.0 million after-tax). The rationalization charges were principally related to a voluntary retirement program affecting approximately 3% of the Company’s U.S. workforce and asset impairment charges. Workforce reduction charges were $5.4 million, while non-cash asset impairment charges were $5.1 million. The total number of employees accepting the voluntary retirement program was 108, including 22 salaried and 86 hourly. The asset impairment charges represented write-downs of property, plant and equipment in the U.S., Europe and Other Countries geographic segments.

These rationalization programs are expected to result in future annual cost savings of between $6 and $8 million.

Equity Earnings in Affiliates . Equity earnings in affiliates increased to $2.9 million in 2003 from $1.9 million in 2002. The increase was due to higher earnings from the Company’s investments in Kuang Tai in Asia and AS Kaynak in Turkey.

Other Income . Other income increased to $3.0 million in 2003 from $0.4 million in 2002. The increase was due primarily to higher investment income on long-term investments, gains on asset sales and higher royalty income.

Interest Expense . Interest expense was $8.1 million in 2003, compared to $9.1 million last year, a decrease of 10.9%. The decrease in interest expense was primarily due to amortization of a gain on the termination of interest rate swaps, as described below. In March 2002, the Company issued $150 million of Senior Unsecured Notes with a weighted average interest rate of 6.1% (see Note G). Also in March 2002, the Company entered into floating rate interest rate swaps totaling $80 million to effectively swap fixed interest rates with variable rates. In May 2003, these swap agreements were terminated. The gain on the termination

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of these swaps of approximately $10.6 million has been deferred and is being amortized as an offset to interest expense over the terms of the related debt. The amortization of this gain reduced interest expense by $1.4 million in 2003 and is expected to reduce interest expense by $2.3 million in each of 2004 and 2005. Additionally, in July 2003, the Company entered into floating rate interest rate swaps totaling $50 million to effectively swap fixed interest rates with variable rates. The weighted-average effective rates after considering the effect of the interest rate swaps on the Notes for 2003 and 2002 were 4.27% and 4.82%, respectively compared to the stated weighted average rates of 6.1% for both 2003 and 2002.

Income Taxes . Income taxes for 2003 were $14.7 million on income before income taxes of $69.2 million, an effective rate of 21.2%, as compared with income taxes of $21.0 million on income before income taxes and the cumulative effect of an accounting change of $87.9 million, or an effective rate of 23.9% for the same period in 2002. The effective rates for 2003 and 2002 are lower than the Company’s statutory rate primarily because of the utilization of foreign and domestic tax credits in both periods and lower taxes on non-U.S. earnings in 2003. The Company anticipates the effective rate for 2004 will be between 25% and 27%, depending on the level of earnings and related tax deductions.

Cumulative Effect of a Change in Accounting Principle . Prior to January 1, 2002, the Company amortized goodwill on a straight line basis over periods not exceeding 40 years. Goodwill had previously been tested for impairment under the provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 121, “ Accounting for the Impairment of Long-lived Assets and Long-lived Assets to be Disposed of.” Effective January 1, 2002, the Company adopted SFAS No. 142, “ Goodwill and Other Intangible Assets.” SFAS No. 142 requires cessation of goodwill amortization and a fair value approach to testing the impairment of goodwill and other intangibles. As a result, the Company recorded an impairment to goodwill of $37.6 million, net of tax (See Note A).

Net Income . Net income for 2003 was $54.5 million compared to $29.3 million last year. Diluted earnings per share for 2003 was $1.31 per share compared to $0.68 per share in 2002. In 2003, the Company recorded after-tax rationalization charges of $1.3 million. In 2002, the Company recorded after-tax rationalization charges of $7.0 million and the after-tax cumulative effect of an accounting change of $37.6 million, or $0.88 per diluted share. Foreign currency exchange rate movements did not have a material effect on net income for 2003 while 2002 was negatively impacted by $3.0 million or 10.3%.

2002 COMPARED TO 2001

Net Sales . Net sales for 2002 were $994.1 million, a $15.2 million or 1.6% increase from $978.9 million in the prior year. Third-party net sales from U.S. operations were $612.4 million, down 4.3% from $639.9 million in 2001. U.S. domestic sales declined 5.5% from 2001. The U.S. sales decrease reflects lower demand due to continued softening in the industrial segment of the U.S. market. Export sales from the U.S. of $63.2 million were up $4.8 million or 8.1% from in 2001. Exports increased into Europe, Asia Pacific and Russia, Africa and the Middle East regions. Non-U.S. third-party sales increased 12.6% to $381.7 million in 2002, compared with $339.0 million in 2001. The weakening of the U.S. dollar had a positive impact on non-U.S. sales compared with the prior year. This positive impact on net sales was $2.8 million or 0.3%. In local currencies, European sales increased 6.4%. Excluding the results of Bester, which was acquired in January 2002, European sales increased 2.5% in local currencies. In the rest of the world, the Company’s sales increased 17.9% in local currencies. Excluding the results of Lincoln Soldaduras de Venezuela, which was acquired in December 2001, rest of the world sales increased 11.9% in local currencies. Non-U.S. and export sales were 44.8% of the Company’s total sales compared with 40.6% in 2001.

Gross Profit . Gross profit of $300.0 million for 2002 declined 2.4% or $7.3 million compared with the prior year. Gross profit as a percentage of net sales declined to 30.2% from 31.4% in the prior year. Gross

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profit margins in the U.S. declined because of lower sales volumes and the related unfavorable production variances. Non-U.S. gross margins were up slightly year-over-year due to product mix.

Selling, General & Administrative (SG&A) Expenses . SG&A expenses increased $7.8 million or 4.1% to $198.0 million for 2002, compared with $190.2 million for 2001. SG&A expenses as a percentage of net sales increased to 19.9% from 19.4% in 2001. The increase in SG&A expenses is due primarily to the incremental costs incurred by newly acquired businesses of $4.5 million, the foreign currency translation effect of a weakening U.S. dollar of $1.7 million, an increase in accounts receivable allowances of $3.0 million and an increase in R&D expenditures of $1.2 million, which were partially offset by the non-amortization of goodwill of $1.6 million as a result of the adoption of SFAS No. 142, “ Goodwill and Other Intangible Assets ” (See Note A).

Rationalization Charges. During the first quarter of 2002, the Company recorded rationalization charges of $10.5 million ($7.0 million after-tax). The rationalization charges were principally related to a voluntary retirement program affecting approximately 3% of the Company’s U.S. workforce and asset impairment charges. Workforce reduction charges were $5.4 million, while non-cash asset impairment charges were $5.1 million. The total number of employees accepting the voluntary retirement program was 108, including 22 salaried and 86 hourly. The asset impairment charges represented write-downs of property, plant and equipment in the U.S., Europe and Other countries geographic segments.

Interest Income. Interest income increased to $3.2 million for 2002 from $1.1 million for 2001. The increase is primarily due to higher cash balances attributable to the proceeds received from a new $150 million borrowing (see Note G).

Equity Earnings in Affiliates . Equity earnings in affiliates increased to $1.9 million in 2002 from $0.6 million for 2001. The increase was due to higher earnings from the Company’s investments in Kuang Tai in Asia and AS Kaynak in Turkey.

Other Income. Other income for 2002 decreased to $0.4 million from $2.7 million for 2001. Other income in 2001 included a pre-tax gain on the sale of property of $3.1 million ($2.0 million after-tax) in Europe.

Interest Expense . Interest expense increased to $9.1 million in 2002 from $5.5 million in 2001. In March 2002, the Company issued $150 million of Senior Unsecured Notes (the “Notes”) with a weighted-average interest rate of 6.1% (see Note G). Also in March 2002, the Company entered into floating rate interest rate swap agreements with amounts totaling $80.0 million to effectively swap fixed interest rates for variable rates. The weighted-average effective interest rate on the Notes after considering the effect of the interest rate swaps was 4.82% for 2002.

Income Taxes . Income taxes for 2002 were $21.0 million on income before income taxes and the cumulative effect of a change in accounting principle of $87.9 million, an effective rate of 23.9%, as compared with income taxes of $32.4 million on income before income taxes of $116.0 million, or an effective rate of 28.0% for 2001. The decrease was primarily attributable to the utilization of foreign tax credits.

Cumulative Effect of a Change in Accounting Principle . Prior to January 1, 2002, the Company amortized goodwill on a straight line basis over periods not exceeding 40 years. Goodwill had previously been tested for impairment under the provisions of FASB SFAS No. 121, “ Accounting for the Impairment of Long-lived Assets and Long-lived Assets to be Disposed of. ” Effective January 1, 2002, the Company adopted SFAS No. 142, “ Goodwill and Other Intangible Assets.” SFAS No. 142 requires cessation of goodwill amortization and a fair value approach to testing the impairment of

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goodwill and other intangibles. As a result, the Company recorded an impairment to goodwill of $37.6 million, net of tax (See Note A).

Net Income . Net income for 2002 was $29.3 million compared to $83.6 million in 2001. Diluted earnings per share for 2002 was $0.68 per share compared to $1.96 per share in 2001. Excluding the rationalization charges and the accounting change, net income for 2002 would have been $73.9 million and diluted earnings per share would have been $1.73. Net income in 2001 included an after-tax gain of $1.2 million, without which net income would have been $82.3 million or $1.93 per diluted share. Foreign currency exchange rate movements negatively affected 2002 net income by $3.0 million or 10.3%, and had no material impact on 2001 net income.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s cash flow from operations, while cyclical, has been highly reliable and consistent relative to the liquidity requirements of the Company. The Company has relatively unrestricted access to capital markets. Operational cash flow is a key driver of liquidity, providing cash and access to capital markets. In assessing liquidity, the Company reviews working capital measurements to define areas of improvement.

Cash and cash equivalents decreased 3.2%, or $5.6 million, to $170.5 million as of December 31, 2003, from $176.1 million as of December 31, 2002. The Company’s debt levels decreased from $188.5 million at December 31, 2002, to $173.3 million at December 31, 2003. Total percent of debt to total capitalization decreased to 26.6% at December 31, 2003, from 30.5% at December 31, 2002. Management anticipates the Company will be able to satisfy cash requirements for its ongoing businesses for the foreseeable future primarily with cash generated by operations, existing cash balances and, if necessary, borrowings under its existing credit facilities.

Cash provided from operations was $95.7 million in 2003, a decrease of $7.9 million from $103.6 million in 2002. The decrease was primarily related to a decrease in net income before rationalization charges and cumulative effect of a change in accounting principle and voluntary funding of $40.0 million to the Company’s U.S. pension plans, which was an increase of $20.0 million over 2002, partially offset by a decrease in inventories, as days sales in inventory decreased from 126.8 in 2002 to 115.1 in 2003, and an increase in accounts payable.

Capital expenditures during 2003 were $34.8 million, a $6.9 million increase from 2002. The Company anticipates capital expenditures should approximate depreciation in 2004, or approximately $35 to $40 million. Management critically evaluates all proposed capital expenditures and requires each project to either increase efficiency, reduce costs or promote business growth. Management does not anticipate any unusual future cash outlays relating to capital expenditures. In addition, the Company plans to invest approximately $24 million in its new investment in China (see below). If additional acquisitions and major projects providing financial benefits become available, additional expenditures may be made.

The Company continues to expand globally and periodically looks at transactions that would involve significant capital expenditures. The Company’s operational cash flow can fund the global expansion plans, but a significant acquisition would require access to the capital markets, in particular, the public and/or private bond market, as well as the syndicated bank loan market. The Company’s financing strategy is to fund itself at the lowest after-tax cost of funding. Where possible, the Company utilizes operational cash flows and raises capital in the most efficient market, usually the U.S., and then lends funds to the specific subsidiary that requires funding.

During January 2002, the Company acquired 85% of Bester S.A., a leading manufacturer of welding equipment located in Poland, for approximately $8 million, including assumed debt. The results of Bester’s

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operations, which were not material during 2003 and 2002, have been included in the consolidated financial statements since that date. During 2002, the Company invested an additional $3.5 million for capital expenditures, which had the effect of increasing the Company’s ownership by 6%.

On October 30, 2003, the Company purchased the Century and Marquette welding and cutting equipment accessories and the Century battery charger businesses of Clore Automotive LLC for approximately $2.9 million. These products and brands, which have leading positions in the automotive after-market and retail channels, are complementary to Lincoln’s existing retail and professional products business. Annual sales for these businesses are expected to be approximately $14 million.

On January 12, 2004, the Company signed a preliminary agreement to acquire a controlling interest in three different welding businesses located in China for additional investments of approximately $24 million in the aggregate. For two of these businesses, the Company currently has a minority ownership through either its investments in Kuang Tai Metal Industrial Co., Ltd. (“Kuang Tai”) or Tenwell Development, PTE Ltd. One of the businesses, in which the Company will own an 85% interest, is a newly formed welding equipment company expected to begin production in the second half of 2004. These investments will provide a strong equipment manufacturing base in China, improve the Company’s distribution network, and strengthen the Company’s market position in the Asia Pacific region. Annual sales of between $50 - $60 million are expected from these businesses. The Company anticipates these investments to be accretive to earnings by approximately $0.02 per share in the first year. The Company anticipates the purchase of the two existing businesses to be completed during the first quarter of 2004.

During March 2002, the Company issued Notes totaling $150 million through a private placement. Maturities and interest rates on the Notes are $40 million at 5.58% in 2007, $30 million at 5.89% in 2009 and $80 million at 6.36% in 2012. Interest is payable semi-annually in March and September. The proceeds are being used for general corporate purposes, including acquisitions and to purchase shares under the share repurchase program. A majority of the proceeds were invested throughout the year in short-term, highly liquid investments. At December 31, 2003, the Company had approximately $159 million invested in these short-term, highly liquid funds. The Notes contain certain affirmative and negative covenants, including restrictions on asset dispositions and financial covenants (interest coverage and funded Debt-to-EBITDA ratios). As of December 31, 2003, the Company is in compliance with all of its debt covenants.

During March 2002, the Company entered into floating rate interest rate swap agreements totaling $80 million, to convert a portion of the outstanding Notes from fixed to floating rates. These swaps were designated as fair value hedges, and as such, the gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk were recognized in earnings. Net payments or receipts under these agreements are recognized as adjustments to interest expense. In May 2003, the Company terminated these swap agreements. The gain on the termination of approximately $10.6 million has been deferred and is being amortized as an offset to interest expense over the term of the related debt. Interest expense related to the $150 million private placement is further reduced by the interest income earned on the cash balances. These short-term, highly liquid investments earned 1.5%, or approximately $1.7 million during 2003.

On July 24, 2003, the Company entered into floating rate interest rate swap agreements totaling $50 million, to convert a portion of the outstanding Notes from fixed to floating rates based on the London Inter-Bank Offered Rate (“LIBOR”), plus a spread of between 201.75 and 226.5 basis points. The variable rates will be reset every six months, at which time payment or receipt of interest will be settled. These swaps are designated as fair value hedges, and as such, the gain or loss on the derivative instrument, as well as the offsetting gain or loss on the hedged item attributable to the hedged risks will be recognized in earnings. Net payments or receipts under these agreements will be recognized as adjustments to interest expense. These

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interest rate swaps reduced 2003 interest expense on the Notes by 0.4%. The fair value of these interest rate swaps at December 31, 2003 is $0.4 million.

The Company’s contractual obligations and commercial commitments ( as defined by Section 13(j) of the Securities Exchange Act of 1934) as of December 31, 2003 are as follows (in thousands):

Additionally, the Company has provided a guarantee on a loan for a joint venture. The Company’s estimated maximum exposure under this arrangement at December 31, 2003 was approximately $2 million, expiring in 2005.

The Company’s Board of Directors has authorized share repurchase programs for up to 15 million shares of the Company’s common stock. During 2003, of the Company purchased 808,900 shares of its common stock on the open market at a cost of $16.4 million. In addition, during the fourth quarter of 2003, the Company also purchased 1,108,122 shares of its common stock from the Lincoln Foundation, Inc. in a privately negotiated block transaction. These shares were purchased at a price of $23.08 per share, a 6% discount from the average of the high and low prices of the previous day. Total shares purchased through the share repurchase programs were 9,657,811 shares at a cost of $199.1 million through December 31, 2003.

A total of $26.7 million in dividends was paid during 2003. In January 2004, the Company paid a quarterly cash dividend of 16 cents per share to shareholders of record on December 31, 2003.

Although net product liability expenses were relatively flat in 2003 (approximately $4 million) compared to 2002, gross product liability expenses, before insurance reimbursements, were up significantly, particularly with respect to the increased number of welding fume claims. The costs associated with these claims are predominantly defense costs, which are recognized in the periods incurred. See Note N. The long term impact of the welding fume loss contingency in the aggregate on operating cash flows and capital markets access is difficult to assess, particularly since claims are in many different stages of development and the Company benefits significantly from cost sharing with co-defendants and insurance carriers. Moreover, the Company has been largely successful to date in its defense of these claims and indemnity payments have been immaterial. If cost sharing dissipates for some currently unforeseen reason, or the Company’s trial experience changes overall, it is possible on a longer term basis that the cost of resolving this loss contingency could reduce the Company’s operating cash flows and restrict capital market access.

Effective January 1, 2003, the Company adopted the fair value method of recording stock options contained in SFAS No. 123, “ Accounting for Stock-Based Compensation ,” which is considered the preferable accounting method for stock-based employee compensation. All future employee stock option grants beginning January 1, 2003 will be expensed over the stock option vesting period based on the fair value at the date the options are granted. The adoption of this Statement did not have a material impact on the financial statements of the Company in 2003. The Company estimates the effect of the adoption will increase annually over the next several years to approximately $0.02 per share by 2006. This estimate

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assumes the number and fair value of options granted is similar for all years. The actual impact per share would be different depending on the types of options granted, the number of options granted or changes in the fair value of options from the current estimate. Historically, the Company has applied the intrinsic value method permitted under SFAS No. 123, as defined in Accounting Principles Board (“APB”) Opinion No. 25, “ Accounting for Stock Issued to Employees ” and related interpretations, in accounting for the Company’s stock option plans. Accordingly, no compensation cost has been recognized in past years.

In May 2003, the 1998 Stock Plan was amended by the shareholders to allow for the issuance of Tandem Appreciation Rights (TARs), deferred shares and restricted shares of the Company’s Common Shares. TARs payable in cash require the recording of a liability and related compensation expense to be measured by the difference between the quoted market price of the number of Common Shares covered by the grant and the option price per Common Share at grant. Any increases or decreases in the market price of the Common Share between grant date and exercise date would result in changes to the Company’s compensation expense. TARs will require a charge against income or a reduction of expense periodically representing any increases or decreases in the value of the anticipated benefits. This compensation expense is accrued over the vesting period. For TARs payable in Common Shares, the TAR would be accounted for as a Stock Option and the fair value method of accounting under SFAS No. 123 would be utilized. Subsequent changes in share values do not affect compensation expense. During the fourth quarter of 2003, 396,000 TARs were issued, which did not materially impact earnings.

Restricted Shares and Deferred Shares require compensation expense to be measured by the quoted market price on the grant date. Expense is recognized by allocating the aggregate grant date fair value over the vesting period. No expense is recognized for any shares ultimately forfeited because the recipients fail to meet the vesting requirements.

The Company accounts for its defined benefit plans in accordance with SFAS No. 87 “Employers’ Accounting for Pensions.” SFAS No. 87 requires that a liability (“minimum pension liability”) be recorded when the accumulated benefit obligation exceeds the fair value of plan assets. For the years 2000 through 2002, the Company experienced a material decline in the fair market value of assets in the U.S. company’s non-contributory defined benefit pension plan trust. This decline was due, in large part, to general declines in the market value of investments. In addition, the declining U.S. interest rate environment has significantly increased the present value of pension benefit obligations. At December 31, 2003, the Company recorded an after-tax increase to shareholders’ equity of approximately $18.6 million, reducing the balance of the minimum pension liability to $62.8 million (net of tax) as of December 31, 2003 from $81.4 million (net of tax) at December 31, 2002.

During 2003, the Company’s U.S. pension plans investments experienced an approximate 26% investment gain. In addition, over $40 million of voluntary contributions to U.S. pension trusts were made by the Company. Although interest rates have declined in 2003, the substantial increase in invested assets will reduce 2004 pension expense. The Company estimates pension expense in 2004 will decrease by approximately $6 million. The Company expects to voluntarily contribute $30 million to the U.S. pension plans during 2004.

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS

The Company utilizes letters of credit to back certain payment and performance obligations. Letters of credit are subject to limits based on amounts outstanding under the Company’s Credit Agreement. Outstanding letters of credit at December 31, 2003 were immaterial. The Company has also provided a guarantee on a loan for a joint venture. The Company believes the likelihood is remote that material payment will be required under this arrangement because of the current financial condition of the joint

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venture. The Company’s estimated maximum exposure under this arrangement at December 31, 2003 was approximately $2 million.

NEW ACCOUNTING PRONOUNCEMENTS

Effective January 1, 2002, the Company adopted SFAS No. 144, “ Accounting for the Impairment or Disposal of Long-Lived Assets. ” SFAS No. 144 supercedes SFAS No. 121, “ Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of ” and APB Opinion No. 30, “ Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events. ” SFAS No. 144 retains the requirements of SFAS No. 121 whereby an impairment loss is recognized if the carrying value of the asset is not recoverable from its undiscounted cash flows or fair values are less than carrying values. SFAS No. 144 broadens the scope of APB Opinion No. 30 provisions for the presentation of discontinued operations to include a component of an entity. The Statement requires that a component of an entity sold or considered held for sale be presented as a discontinued operation. In addition, expected future operating losses from discontinued operations must be reflected in the periods incurred, rather than at the measurement date as previously required by APB Opinion No. 30. The adoption of this Statement did not have a material impact on the financial statements of the Company.

Effective January 1, 2003, the Company adopted SFAS No. 146, “Accounting for Exit or Disposal Activities.” SFAS No. 146 is effective for disposal activities initiated after December 31, 2002. SFAS No. 146 requires liabilities for one-time termination benefits incurred over future service periods be measured at fair value as of the termination date and recognized over the future service periods. This Statement also requires liabilities associated with disposal activities be recorded when incurred instead of when probable as currently required by SFAS No. 5 “ Accounting for Contingencies.” These liabilities are adjusted for subsequent changes resulting from revisions to either the timing or amount of estimated cash flows, discounted at the original credit-adjusted risk-free rate. Interest on the liability is accreted and charged to expense as an operating item. The adoption of this Statement did not have a material impact on the financial statements of the Company.

Effective January 1, 2003, the Company adopted the fair value provisions of FASB Interpretation No. 45, “ Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. ” Interpretation No. 45 requires certain disclosures be made by a guarantor in its financial statements about its obligations under certain guarantees, including product warranties. The disclosure provisions of this Statement were effective for the Company as of the fourth quarter of 2002. This Statement also requires a guarantor to recognize, at inception, for all guarantees issued or modified after December 31, 2002, a liability for the fair value of the obligations it has undertaken in issuing a guarantee. The adoption of this Statement did not have a material impact on the financial statements of the Company.

Effective January 1, 2003, the Company adopted the fair value method of recording stock options contained in SFAS No. 123, “ Accounting for Stock-Based Compensation ,” which is considered the preferable accounting method for stock-based employee compensation. All future employee stock option grants beginning January 1, 2003 will be expensed over the stock option vesting period based on the fair value at the date the options are granted. The adoption of this Statement did not have a material impact on the financial statements of the Company in 2003. The Company estimates the impact per share will increase annually over the next several years to approximately $0.02 per share by 2006. This estimate assumes the number and fair value of options granted is similar for all years. The actual impact per share would be different depending on the types of options granted, the number of options granted or changes in the fair value of options from the current estimate. Historically, the Company has applied the intrinsic value method permitted under SFAS No. 123, as defined in Accounting Principles Board (“APB”) Opinion No. 25, “ Accounting for Stock Issued to Employees ” and related interpretations, in accounting for the Company’s

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stock option plans. Accordingly, no compensation cost has been recognized in past years. (See also discussion of the Company’s stock-based compensation on page 17 of “Liquidity and Capital Resources” and Note E).

Effective December 31, 2003, the Company adopted SFAS No. 132 (revised) “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” SFAS No. 132 requires additional disclosures relating to pensions and other postretirement benefits. The adoption of this Statement did not have a material impact on the financial statements of the Company (see Note I).

In January, 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” as amended by FASB Staff Position No. FIN 46-6. Interpretation No. 46 provides guidance for identifying a controlling interest in a Variable Interest Entity (“VIE”) established by means other than voting interests. Interpretation No. 46 also requires consolidation of a VIE by an enterprise that holds such a controlling interest. The effective date for this Interpretation for the Company will be January 1, 2004. The adoption of this Statement is not expected to have a material impact on the financial statements of the Company.

CRITICAL ACCOUNTING POLICIES

The Company’s consolidated financial statements are based on the selection and application of significant accounting policies, which require management to make estimates and assumptions. These estimates and assumptions are reviewed periodically by management and compared to historical trends to determine the accuracy of estimates and assumptions used. If warranted, these estimates and assumptions may be changed as current trends are assessed and updated. Historically, the Company’s estimates have been determined to be reasonable and accurate. No material adjustments to the Company’s accounting policies have been made in 2003 or 2002. The Company believes the following are some of the more critical judgment areas in the application of its accounting policies that affect its financial condition and results of operations.

Legal And Tax Contingencies

The Company, like other manufacturers, is subject from time to time to a variety of civil and administrative proceedings arising in the ordinary course of business. Such claims and litigation include, without limitation, product liability claims and health, safety and environmental claims, some of which relate to cases alleging asbestos and manganese-induced illnesses. The costs associated with these claims are predominantly defense costs, which are recognized in the periods incurred. Insurance reimbursements mitigate these costs and, where reimbursements are probable, they are recognized in the applicable period. With respect to costs other than defense costs (i.e., for liability and/or settlement or other resolution), reserves are recorded when it is probable that the contingencies will have an unfavorable outcome. The Company accrues its best estimate of the probable cost, 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 in lieu of reserves. Many of the current cases are in preliminary procedural stages and insufficient information exists upon which judgments can be made as to the validity or ultimate disposition of such actions. Therefore, a range of possible losses cannot be made at this time. Reserves are adjusted as facts and circumstances change and related management assessments of the underlying merits and the likelihood of outcomes change. Moreover, reserves only cover identified and/or asserted claims. Future claims could, therefore, give rise to increases to such reserves. See Note N to the Consolidated Financial Statements and the Legal Proceedings section of this Annual Report on Form 10-K for further discussion of legal contingencies.

The Company often faces challenges from domestic and foreign tax authorities regarding the amount of taxes due. These challenges include questions regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the exposure associated with various

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filing positions, the Company records reserves for probable exposures. Based on management’s evaluation of those tax positions, the Company believes it has appropriately accrued for probable exposures. To the extent the Company were to prevail in matters for which accruals have been established or be required to pay amounts in excess of recorded reserves, the effective tax rate in a given financial statement period may be materially impacted.

Deferred Income Taxes

Deferred income taxes are recognized at currently enacted tax rates for temporary differences between the financial reporting and income tax bases of assets and liabilities and operating loss and tax credit carryforwards. The Company does not provide deferred income taxes on unremitted earnings of non-U.S. subsidiaries, as such funds are deemed permanently reinvested. As of December 31, 2003, the Company has approximately $71 million of deferred tax assets related to deductible temporary differences and tax loss and credit carryforwards which will reduce taxable income in future years.

In assessing the realizability of deferred tax assets, the Company assesses whether it is more likely than not that a portion or all of the deferred tax assets will not be realized. The Company considers the scheduled reversal of deferred tax liabilities, tax planning strategies, and projected future taxable income in making this assessment. At December 31, 2003, a valuation allowance of $13.1 million has been recorded against these deferred tax assets based on this assessment. The Company believes it is more likely than not that the tax benefit of the remaining net deferred tax assets will be realized. The amount of net deferred tax assets considered realizable could be increased or reduced in the future if the Company’s assessment of future taxable income or tax planning strategies changes.

Pensions

The Company accounts for its defined benefit plans in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” which requires amounts recognized in financial statements be determined on an actuarial basis. A substantial portion of the Company’s pension amounts relate to its defined benefit plan in the United States.

A significant element in determining the Company’s pension expense is the expected return on plan assets. The expected return on plan assets is determined based on the expected long-term rate of return on the plan assets and the market-related value of plan assets. Upon adoption of SFAS No. 87, the market-related value of plan assets could be determined by either fair value or a calculated value recognizing changes in fair value in a systematic and rational manner over not more than five years. The method chosen must be applied consistently year to year. The Company used fair values at December 31 for the market-related value of plan assets. The assumed long-term rate of return on assets is applied to the market value of plan assets. This produces the expected return on plan assets included in pension expense. The difference between this expected return and the actual return on plan assets is deferred. The amortization of the net deferral of past losses will increase future pension expense. The Company used between 8.9% and 9.1% as the expected long-term rate of return on assets during the period 2000 through 2002. From 2000 through 2002, the plan assets had earned a rate of return substantially less than these assumed rates. The Company lowered the expected rate of return on plan assets to approximately 8.6% for 2003. As a result of lower investment returns and interest rates, pension expense increased $14.7 million in 2003 compared to the prior year.

During 2003, investment gains in the Company’s U.S. pension plans were approximately 26%. In addition, the Company made $40 million of voluntary contributions during 2003, an increase of $20 million over 2002. Although interest rates have declined in 2003, the substantial increase in invested assets will reduce 2004 pension expense. The Company estimates pension expense in 2004 will decrease by approximately $6

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million. The Company expects to make voluntary contributions of $30 million to the U.S. pension plans during 2004.

At the end of each year, the Company determines the discount rate to be used for plan liabilities. In estimating this rate, the Company looks to rates of return on high quality, fixed-income investments that receive one of the two highest ratings given by a recognized ratings agency. At December 31, 2003, the Company determined this rate to be 6.2%.

Inventories and Reserves

Inventories are valued at the lower of cost or market. For domestic inventories, cost is determined principally by the last-in, first-out (LIFO) method, and for non-U.S. inventories, cost is determined by the first-in, first-out (FIFO) method. The valuation of LIFO inventories is made at the end of each year based on inventory levels and costs at that time. The excess of current cost over LIFO cost amounted to $40.6 million at December 31, 2003. The Company reviews the net realizable value of inventory in detail on an on-going basis, with consideration given to deterioration, obsolescence and other factors. If actual market conditions differ from those projected by management, and the Company’s estimates prove to be inaccurate, write-downs of inventory values and adjustments to cost of sales may be required. Historically, the Company’s reserves have approximated actual experience.

Accounts Receivable and Allowances

The Company maintains an allowance for doubtful accounts for estimated losses from the failure of its customers to make required payments for products delivered. The Company estimates this allowance based on knowledge of the financial condition of customers, review of historical receivables and reserve trends and other pertinent information. If the financial condition of customers deteriorates or an unfavorable trend in receivable collections is experienced in the future, additional allowances may be required. Historically, the Company’s reserves have approximated actual experience.

Impairment of Long-Lived Assets

In accordance with SFAS No. 144, “ Accounting for the Impairment or Disposal of Long- Lived Assets. ” the Company periodically evaluates whether current facts or circumstances indicate that the carrying value of its depreciable long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, or the appropriate grouping of assets, is compared to the carrying value to determine whether an impairment exists. If an asset is determined to be impaired, the loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows.

The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management’s judgment. Any changes in key assumptions about the Company’s businesses and their prospects, or changes in market conditions, could result in an impairment charge.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

From time to time, information provided by the Company, statements by its employees or information included in its filings with the Securities and Exchange Commission (including those portions of this Management’s Discussion and Analysis that refer to the future) may contain forward-looking statements that are not historical facts. Those statements are “forward-looking” within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements involve risks and uncertainties. Such

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forward-looking statements, and the Company’s future performance, operating results, financial position and liquidity, are subject to a variety of factors that could materially affect future results, including:

•		Competition. The Company operates in a highly competitive global environment and is subject to a variety of competitive factors such as pricing, the actions and strength of its competitors, and the Company’s ability to maintain its position as a recognized leader in welding technology. The intensity of foreign competition is substantially affected by fluctuations in the value of the United States dollar against other currencies. The Company’s competitive position could also be adversely affected should new or emerging entrants become more active in the arc welding business.
•		Economic and Market Conditions. The Company is subject to general economic, business and industry conditions which can adversely affect the Company’s results of operations. The Company’s revenues and profits depend significantly on the overall demand for arc welding and cutting products. Capital spending in the manufacturing and other industrial sectors can adversely affect the Company’s results of operations. If economic and market conditions deteriorate, the Company’s results of operations could to be adversely affected.
•		International Markets. The Company’s long-term strategy is to increase its share in growing international markets, particularly Asia, Latin America, Eastern Europe and other developing markets. However, there can be no certainty that the Company will be successful in its expansion efforts. The Company is subject to the currency risks of doing business abroad, and the possible effects of international terrorism and hostilities. Moreover, international expansion poses challenging demands within the Company’s infrastructure.
•		Cyclicality and Maturity of the Welding and Cutting Industry. The United States arc welding and cutting industry is both mature and cyclical. The growth of the domestic arc welding and cutting industry has been and continues to be constrained by numerous factors, including increased cost of steel and the substitution of plastics and other materials in place of fabricated metal parts in many products and structures. Increased offshore production of fabricated steel structures has also decreased the domestic demand for arc welding and cutting products in the Company’s largest market.
•		Litigation . The Company, like other manufacturers, is subject in the U.S. market to a variety of product liability lawsuits and potential lawsuits that arise in the ordinary course of business. While past experience has generally shown these cases to be immaterial, product liability cases in the U.S. against the Company, particularly with respect to welding fumes, continue to increase and past experience may not be predictive of the future.
•		Operating Factors. The Company is highly dependent on its skilled workforce and efficient production facilities, which could be adversely affected by its labor relations, business interruptions and short-term or long-term interruptions in the availability of supplies or raw materials or in transportation of finished goods.
•		Research and Development. The Company’s continued success depends, in part, on its ability to continue to meet customer welding needs through the introduction of new products and the enhancement of existing product design and performance characteristics. There can be no assurances that new products or product improvements, once developed, will meet with customer acceptance and contribute positively to the operating results of the Company, or that product development will continue at a pace to sustain future growth.

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The above list of factors that could materially affect the Company’s future results is not all inclusive. Any forward-looking statements reflect only the beliefs of the Company or its management at the time the statement is made.