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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2004

For the transition period from              to            

Commission file number 1-4801

BARNES GROUP INC.

(Exact name of registrant as specified in its charter)

(860) 583-7070

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

The aggregate market value of the voting stock (Common Stock) held by non-affiliates of the registrant as of the close of business on June 30, 2004 was approximately $625,418,597, based on the closing price of the Common Stock on the New York Stock Exchange on that date. The registrant does not have any non-voting common equity.

The registrant had outstanding 23,317,830 shares of common stock as of February 22, 2005.

Documents Incorporated by Reference

Portions of the registrant’s definitive proxy statement to be delivered to stockholders in connection with the Annual Meeting of Stockholders to be held April 21, 2005 are incorporated by reference into Part III.

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Barnes Group Inc.

Index to Form 10-K

Year Ended December 31, 2004

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PART I

Item 1. Business

THE COMPANY⁽¹⁾

The Company is a diversified international manufacturer of precision metal components and assemblies and distributor of industrial supplies, serving a wide range of markets and customers. Founded in 1857 and headquartered in Bristol, Connecticut, the Company was organized as a Delaware corporation in 1925. As of December 31, 2004, the Company had 6,047 employees at over 60 locations worldwide. The Company consists of three businesses:

Barnes Distribution, an international, full-service distributor of maintenance, repair, operating and production supplies;

Associated Spring, one of the world’s largest manufacturers of precision mechanical and nitrogen gas springs and a global supplier of retaining rings, reed valves and injection-molded plastic components and assemblies; and

Barnes Aerospace, a manufacturer and repairer of highly engineered components and assemblies for aircraft engines, airframes, and land-based industrial gas turbines.

BARNES DISTRIBUTION

Barnes Distribution is an industry leader in the distribution of maintenance, repair, operating and production (“MROP”) supplies. Since 1927, it has grown into one of the largest value-added MROP distributors in North America. Barnes Distribution also distributes products in 31 countries supported by distribution/sales centers in the United Kingdom, France, Ireland, Spain, Mexico, Singapore, Brazil and China. Barnes Distribution provides related inventory management and logistics services to its customers, too.

Barnes Distribution distributes over 50,000 stocked replacement parts and other products under the brand names of Bowman^®, Curtis^®, Kar Products^®, Mechanics Choice^®, Autoliaisons^® and Motalink^®. These parts and products include fasteners, electrical supplies, hydraulic components, chemicals and security products. Die springs and nitrogen gas springs, mechanical struts and standard parts, such as coil and flat springs, are distributed under the brand names of Raymond^® and SPEC^®. Most of the products sold under the Raymond and SPEC brand names are manufactured by Associated Spring. With the exception of the products from Associated Spring, the products sold by Barnes Distribution are obtained from outside suppliers.

Barnes Distribution faces active competition. The products sold by Barnes Distribution are not unique, and its competitors carry substantially similar products. Barnes Distribution competes based on service alternatives, timeliness and reliability of supply, price and product breadth and quality.

Barnes Distribution offers an array of service options, built around a vendor-managed inventory business model, which are designed to improve the productivity of its customers while substantially reducing procurement and transaction costs. Barnes Distribution has a well-diversified customer base ranging from small repair shops to the largest railroads, utilities, food processors, chemical producers, and vehicle fleet operators. Barnes Distribution’s products are sold through its sales force of approximately 1,500 employees and through distributors.

ASSOCIATED SPRING

Associated Spring is the largest manufacturer of precision mechanical and nitrogen gas springs in North America, and one of the largest precision spring manufacturers in the world. Associated Spring is equipped to

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produce virtually every type of precision spring, from fine hairsprings for electronics and instruments to large heavy-duty springs for machinery. Associated Spring also manufactures nitrogen gas manifold systems used to precisely control stamping presses; retaining rings that position parts on a shaft or other axis; reed valves that are custom-engineered critical components used in compressors; and injection-molded plastic-on-metal and metal-in-plastic components and assemblies used in electronics, medical devices and consumer products.

Associated Spring provides complete engineering solutions from concept to manufacturing. These include product design and development, product and material testing, rapid prototyping and reduction of manufacturing cycle times. Associated Spring’s products are sold globally to manufacturers in many industries, chiefly for use as components in their own products. Products are sold primarily through Associated Spring’s direct sales force and through the Raymond division of Barnes Distribution.

Nearly all of Associated Spring’s products are highly engineered custom solutions. These products are purchased primarily by durable goods manufacturers in industries such as transportation, consumer products, farm equipment, telecommunications, medical devices, home appliances, and electronics.

Associated Spring has a global and diverse customer base. The customers are primarily durable goods manufacturers in industries such as transportation, consumer products, farm equipment, telecommunications, medical devices, home appliances and electronics. In the transportation industry, the customers include both original equipment manufacturers (“OEMs”) and their suppliers. Sales by Associated Spring to its three largest customers accounted for approximately 25% of its business in 2004.

Associated Spring has manufacturing operations in the United States, Brazil, Canada, China, Germany, Mexico, Singapore, Sweden, Thailand and the United Kingdom, and has retained a minority interest of 15% in its former subsidiary in Argentina.

Associated Spring competes with many large and small companies engaged in the manufacture and sale of custom metal components and assemblies. Associated Spring competes on the basis of quality, service, reliability of supply, technology, innovation, design and price.

Associated Spring owns a 45% interest in a joint venture corporation in the United States with NHK Spring Co., Ltd. of Japan. The joint venture corporation, NHK-Associated Spring Suspension Components Inc. (“NASCO”), manufactures suspension springs at its facility in Bowling Green, Kentucky.

BARNES AEROSPACE

Barnes Aerospace produces precision machined and fabricated components and assemblies for OEM turbine engine, airframe and industrial gas turbine builders throughout the world and the United States military. Barnes Aerospace also provides jet engine component overhaul and repair services for many of the world’s major commercial airlines and the United States military. Barnes Aerospace participates in Revenue Sharing Programs with a large aerospace manufacturer under which Barnes Aerospace receives the exclusive right to supply designated aftermarket parts for the life of the related aircraft engine program. Barnes Aerospace products and services are sold primarily through its sales force. Sales by Barnes Aerospace to General Electric Co. and four other manufacturers in the aerospace industry accounted for approximately 72% of its business.

Barnes Aerospace’s machining and fabrication operations, with facilities in Arizona, Connecticut, Michigan, Ohio, Utah and Singapore, produce critical engine and airframe parts through processes such as creep feed grinding, multi-axis milling and turning, and electrical discharge machining, and specialize in hot and cold forming of complex parts made from titanium and other aerospace alloys. Additional capabilities include superplastic forming and diffusion bonding, machining of high temperature superalloys and various automated and manual welding processes. Customers include airframe and gas turbine engine manufacturers for commercial and military jets, business jets, and land-based industrial gas turbines.

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Barnes Aerospace’s OEM business competes primarily with both the leading jet engine OEMs and a large number of machining and fabrication companies. Competition is based mainly on quality, engineering and technical capability, product breadth, service and price.

Barnes Aerospace’s aftermarket facilities, located in Connecticut, Ohio and Singapore, specialize in the refurbishment of jet engine components such as cases, rotating air seals, honeycomb air seals and housings. Processes performed at these facilities include electron beam welding, plasma coating, vacuum brazing, and water jet cleaning. Customers include airlines and engine overhaul businesses throughout the world and the United States military.

Competition for the repair and overhaul of turbine engine components comes from three principal sources: OEMs, major commercial airlines and other independent service companies. Some major commercial airlines own and operate their own service centers and sell repair and overhaul services to other aircraft operators. OEMs also maintain service centers that provide repair and overhaul services for the components that they manufacture. Other independent service organizations also compete for the repair and overhaul business of other users of aircraft components. Turnaround time, technical capability, price, quality and overall customer service are important competitive factors.

FINANCIAL INFORMATION

The backlog of the Company’s orders believed to be firm at the end of 2004 equaled $280 million as compared with $210 million at the end of 2003. Of the 2004 year-end backlog, $194 million was attributable to Barnes Aerospace and all of the balance was attributable to Associated Spring. $56 million of Barnes Aerospace’s backlog is not expected to be shipped in 2005. Substantially all of the remainder of the Company’s backlog is expected to be shipped during 2005.

General Electric Co. and its affiliates, accounted for 12% of the Company’s total sales in 2004. For an analysis of the Company’s revenue from sales to external customers, operating profit and assets by business segment as well as revenues from sales to external customers and long-lived assets by geographic area, see Note 16 of the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K (“Annual Report”).

ACQUISITIONS

On September 17, 2004, the Company completed the acquisition of DE-STA-CO Manufacturing (“DE-STA-CO”), a world leader in the design and manufacture of specialty spring products--reed valves and shock discs. For more information regarding the acquisition, see Note 2 of the Notes to the Consolidated Financial Statements of this Annual Report.

RAW MATERIALS

The principal raw materials used by Associated Spring to manufacture its products are high-grade steel spring wire and flat rolled steel. The principal raw materials used by Barnes Aerospace to manufacture its products are titanium and inconel; however, Barnes Aerospace also requires special materials such as cobalt and other complex aerospace alloys. Prices for steel, titanium and inconel, as well as other specialty materials, have been rising due to increased demand and in some cases reduction of the availability of materials used to make the raw materials. If this combination of events continues, the availability of certain raw materials used by the Company may be negatively impacted.

RESEARCH AND DEVELOPMENT

Although most of the products manufactured by the Company are custom parts made to customers’ specifications, the Company is engaged in continuing efforts aimed at discovering and implementing new

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knowledge that is useful in developing new products or services or significantly improving existing products or services. In particular, Associated Spring’s Product Development Center is focused on design, development, and prototype work and testing of new products and material. The Company spent approximately $6 million on research and development activities in 2004, as compared to expenditures of approximately $5 million in 2003 and $4 million in 2002.

PATENTS AND TRADEMARKS

Patents, trademarks, licenses, franchises and concessions are not significant to any of the Company’s businesses.

EXECUTIVE OFFICERS OF THE COMPANY

For information regarding the Executive Officers of the Company, see Part III, Item 10 of this Annual Report.

ENVIRONMENTAL

Compliance with federal, state, and local laws which have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment has not had a material effect, and is not expected to have a material effect, upon the capital expenditures, earnings, or competitive position of the Company.

AVAILABLE INFORMATION

The Company’s Internet address for its website is www.barnesgroupinc.com. The Company makes its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports available without charge on its website as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission. In addition, the Company has posted on its website, and will make available in print to any stockholder who makes a request, its corporate governance guidelines, its code of business ethics and conduct and the charters of the Audit Committee, Compensation and Management Development Committee and Corporate Governance Committee (the responsibilities of which include serving as the nominating committee) of the Company’s Board of Directors.

FORWARD-LOOKING STATEMENTS

This Annual Report may contain certain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those contained in the statements. Investors are encouraged to consider these risks and uncertainties as described within the Company’s periodic filings with the Securities and Exchange Commission, including the following: the ability of the Company to integrate newly acquired businesses and to realize acquisition synergies on schedule; changes in market demand for the types of products and services produced and sold by the Company; the Company’s success in identifying, and attracting customers in new markets; the Company’s ability to develop new and enhanced products to meet customers’ needs timely; the effectiveness of the Company’s marketing and sales programs; uninsured claims; increased competitive activities that could adversely affect customer demand for the Company’s products; the availability of raw material at prices that allow the Company to make and sell competitive products; changes in economic, political and public health conditions worldwide and in the locations where the Company does business; interest and foreign exchange rate fluctuations; and regulatory changes. The Company assumes no obligation to update any forward-looking statements contained in this report.

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Item 2. Properties

As shown on the following table, at December 31, 2004, the Company had 60 manufacturing, sales, and distribution sites worldwide. Ten of the manufacturing sites are leased. The majority of the distribution centers are leased.

The above table does not include the Corporate Office of the Company, which is owned, or the headquarters for each of the businesses, one of which is owned and the other two of which are leased.

Item 3. Legal Proceedings

The Company is subject to litigation from time to time in the ordinary course of business. There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party, or of which any of their property is the subject.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of 2004.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a) Market Information

The Company’s common stock is traded on the New York Stock Exchange under the symbol “B”. The following table sets forth, for the periods indicated, the low and high closing prices per share, as reported by the New York Stock Exchange.

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Stockholders

As of February 22, 2005, there were 6,712 holders of record of the Company’s common stock and approximately 13,000 holders, which includes holders of record, brokers and other institutions.

Dividends

Payment of future dividends will depend upon the Company’s financial condition, results of operations and other factors deemed relevant by the Company’s Board of Directors, as well as any limitations resulting from financial covenants on net worth under the Company’s credit facilities. See table above for dividend information for 2004 and 2003.

(c) Issuer Purchases of Equity Securities

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Item 6. Selected Financial Data

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

OVERVIEW

2004 Highlights

The Company achieved record sales of $994.7 million and 7.5% growth in operating income, to $55.9 million in 2004. The record sales year was driven by organic growth in all of the Company’s operating groups with the most significant growth in Barnes Aerospace.

During 2004, Barnes Aerospace entered into three new aftermarket Revenue Sharing Programs (“RSPs”), committing approximately $64.0 million with a major aerospace company, securing long-term relationships for aftermarket sales of engine parts with attractive financial returns. These programs had a positive impact on 2004 results and are expected to continue to have a positive impact going forward.

Profit shortfalls at Associated Spring and Barnes Distribution were attributed to increases in raw material prices and efforts to improve customer service, respectively. As of year end, Barnes Distribution customer service levels, as measured by fill rate, have returned to their targeted range and the integration efforts that contributed to these service issues have been completed. In late 2004, the Company incurred discrete charges of approximately $4.5 million, or $0.12 per share, related to actions to offset higher raw material costs going forward at Associated Spring and enable the realization of benefits from the Kar Products integration and improved customer service levels at Barnes Distribution. These charges included $3.5 million related to personnel reductions, which are estimated to generate annual savings of approximately $5.5 million, and $1.0 million in inventory and facility charges. These charges were partially offset by $0.7 million of benefits related to the reduction of lease obligations on idle facilities within Barnes Distribution.

Management Objectives

Management has embraced a corporate culture within Barnes Group that has as its common goals the generation of sustainable, profitable growth and building lasting value for its stockholders. The Company’s strategies for generating growth include organic growth from new products and services, markets and customers; and growth from strategic acquisitions, of which nine have been completed since 1999.

Our Business

Barnes Group consists of three operating segments: Barnes Distribution, an international distributor of industrial MROP supplies; Associated Spring, one of the world’s largest manufacturers of precision mechanical and nitrogen gas springs, and a global supplier of retaining rings, specialty spring products--reed valves and shock discs, and injection-molded plastic components; and Barnes Aerospace, a manufacturer and repairer of highly engineered assemblies and products for aircraft engines, airframes, and land-based industrial gas turbines.

In each of these businesses, Barnes Group is among the leaders in the market niches it serves, and has highly recognized brands for many of the products it sells or manufactures.

Key Performance Indicators

Management evaluates the performance of its reportable segments based on the operating profit of the respective businesses, which includes net sales, cost of sales, selling and administrative expenses and certain components of other income and other expenses, as well as the allocation of corporate overhead expenses. Management also uses an internal measurement tool called PPAT, or Performance Profit After Tax. PPAT is an economic value added (“EVA^®”) -like metric that calculates operating profit after tax, less a charge for the capital employed by the business. Management utilizes PPAT in economic decision making, such as capital expenditures, investments in growth initiatives, customer pricing decisions, and evaluation of acquisitions. The goal of utilizing PPAT is to create a mindset among all employees to use capital in the most efficient way possible and to link decisions to stockholder value creation.

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In addition to PPAT, which is a measurement tool common among each of the operating groups, each business has its own key performance indicators (“KPIs”), a number of which are focused on customer satisfaction.

In Barnes Distribution, KPIs include daily sales average, or DSA; average order size; fill rate, which is the percentage of order lines filled on the first pass from the distribution center assigned to that customer; and order turnaround, which tracks the time between order receipt and shipment to the customer.

At Associated Spring, KPIs include sales and orders per day, which together provide visibility on sales in the next 60 days. Management tracks inventory turns and sales per employee to gauge efficiency, and measures on-time delivery and the number of defective parts per million as means of evaluating customer service levels.

At Barnes Aerospace, important KPIs are customer orders and backlog, which are utilized to forecast how sales will develop over the next 12 months. In the OEM operations, management closely tracks quality measurements and on-time delivery to its customers. In the aftermarket operations, management measures turnaround time of overhauled or repaired parts returned to the customers.

Key Industry Data

In each business, management also tracks a variety of economic and industry data as indicators of the health of a particular sector.

At Barnes Distribution, these data include the Institute for Supply Management’s PMI Composite Index (the “PMI”) and the Federal Reserve’s Industrial Production Index (the “IPI”), which are monthly indicators of the health of U.S. manufacturing activity. Management tracks similar indices in Canada, France and the United Kingdom and also utilizes the Business Conditions Report of the Precision Metalforming Association, which correlates well with demand for Barnes Distribution’s Raymond products.

For Associated Spring, key data include the production of light vehicles, both in the U.S. and globally; new vehicle platform, engine and transmission programs; durable goods orders; handset purchases for cell phones; and capital investments in the telecommunications and electronics industries.

At Barnes Aerospace, for its OEM operations, management regularly tracks orders and deliveries for each of the major aircraft manufacturers, as well as engine purchases made for new aircraft. In the aftermarket operations, management monitors the number of aircraft in the active fleet, the number of planes temporarily or permanently taken out of service, and aircraft utilization rates for the major airlines. Management also monitors annual appropriations for the U.S. military related to new aircraft purchases and maintenance.

Acquisitions

Acquisitions have been a key growth driver for the Company in each of its three business segments. The Company acquired a number of businesses during the past three years, the most recent of which is DE-STA-CO, described more fully below. The Company continues to look for acquisitions that will broaden product line offerings and expand geographic reach, and that provide synergistic opportunities.

In September 2004, the Company acquired DE-STA-CO, formerly an operating division of Dover Resources, Inc., a subsidiary of Dover Corporation. DE-STA-CO is a world leader in the design and manufacture of specialty spring products--reed valves and shock discs. This acquisition expands the presence of the Associated Spring segment in these markets, internationally and domestically. The purchase price of this acquisition was $17.8 million.

In February 2003, the Company acquired Kar Products, LLC and certain assets of a related company, A.&H. Bolt & Nut Company Ltd. (“Kar”), which was a leading full-service distributor of maintenance, repair and operating (“MRO”) supplies to industrial, construction, transportation and other markets. The consideration

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for the acquisition was $76.1 million. This acquisition expanded both the geographic scope and product line reach of the Barnes Distribution segment. Kar had a diversified customer base operating in all 50 states of the U.S., Puerto Rico, and Canada, further enhancing Barnes Distribution’s leadership position within the MROP market and its international presence. In connection with the acquisition, management had approved and committed to certain activities aimed at achieving a number of post-acquisition cost savings and other synergies through headquarters and infrastructure consolidation. This plan included combining the headquarters functions and consolidating warehousing and distribution networks. The Kar integration was completed during 2004, within 15 months of the acquisition.

In 2002, the Company completed two acquisitions for a total purchase price of $34.0 million. In February 2002, the Company acquired substantially all of the manufacturing assets of Seeger-Orbis GmbH & Co. OHG of Germany (“Seeger-Orbis”) from TransTechnology Corporation. Seeger-Orbis is a leading manufacturer of retaining rings used in a number of transportation and industrial applications. The Seeger-Orbis acquisition expanded Associated Spring’s product line and geographic reach, particularly into the automotive and industrial manufacturing markets of Western Europe. In April 2002, the Company acquired Spectrum Plastics Molding Resources, Inc. of Ansonia, Connecticut (“Spectrum”). Spectrum is a manufacturer of plastic injection-molded components and assemblies that are used primarily in the telecommunications, electronics, medical and consumer goods industries. Spectrum, which is included in the Associated Spring segment, provides Associated Spring with the capability of providing more complete product solutions with discrete or continuous metal-in-plastic and plastic-on-metal injection-molded components.

For a further description of acquisitions made over the past three years, refer to Notes 2 and 7 of the Notes to the Consolidated Financial Statements of this Annual Report.

RESULTS OF OPERATIONS

Sales

Barnes Group reported record net sales of $994.7 million in 2004, an increase of $103.9 million, or 11.7%, over 2003 net sales of $890.8 million. The sales increase was driven mainly by organic sales growth of $69.3 million; $6.9 million at Barnes Distribution, $23.0 million at Associated Spring and $40.2 million at Barnes Aerospace which was offset in part by an increase of $0.8 million in intersegment sales. The Company’s recent acquisitions contributed $10.4 million to Barnes Distribution’s sales and $8.5 million to Associated Spring’s sales. Additionally, the strengthening of foreign currencies against the U.S. dollar, primarily in Europe and Canada, increased sales by approximately $15.7 million. Geographically, the Company’s international sales increased 16.1% year-over-year and domestic sales increased 10.6%. Excluding the positive impact on sales of foreign currency translation, the Company’s international sales increased 9.8% in 2004 over 2003.

In 2003, Barnes Group’s net sales were up $106.8 million, or 13.6%, over 2002 net sales of $784.0 million. The sales increase reflected the Company’s recent acquisitions, which contributed $108.3 million to Barnes Distribution’s sales and $14.5 million to Associated Spring’s sales. Also contributing to the sales increase was continued growth of Associated Spring’s nitrogen gas business. The strengthening of foreign currencies against the U.S. dollar, primarily in Europe and Canada, had a positive impact of $11.7 million. This growth was partially offset by a decrease in Associated Spring’s North American and Asian sales and a 9.4% decline in sales at Barnes Aerospace, which coincided with the continuing decline in the commercial aerospace markets.

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Expenses and Operating Income

Operating income was $55.9 million in 2004, an increase of 7.5% when compared with 2003. Operating income included a $3.5 million pre-tax charge taken in the fourth quarter of 2004 related to costs of personnel reductions at Associated Spring and Barnes Distribution which will occur in the first quarter of 2005. These costs relate to actions to offset higher raw material costs going forward at Associated Spring and enable the realization of benefits from the Kar Products integration and improved customer service levels at Barnes Distribution. Operating income also included $1.0 million in inventory and facility charges which were partially offset by $0.7 million of benefits related to the reduction of lease obligations at idle facilities. These results reflect significantly higher operating profit at Barnes Aerospace offset by lower operating profits at both Barnes Distribution and Associated Spring, which are more fully discussed in the Financial Performance by Business Segment section below. Operating income margin declined from 5.8% in 2003 to 5.6% in 2004. Cost of sales, as a percentage of sales, increased to 65.8%, or a 13.5% increase, which is slightly more than the growth rate in sales for the year. This reflects a shift in overall sales mix to the manufacturing businesses which have lower gross margins than the distribution business combined with lower gross profit margins at Barnes Distribution and Associated Spring. Gross profit margins at Barnes Distribution were negatively impacted by a shift in sales mix to larger accounts which traditionally have lower pricing and to additional costs incurred to improve customer service levels. Associated Spring’s margin compression resulted from higher raw material costs. Gross profit margins for the Company were also negatively impacted by a $1.7 million LIFO inventory adjustment in 2004. Total selling and administrative expenses decreased as a percentage of sales to 28.6% from 29.4% in 2003. This decrease was also driven by the higher proportion of sales in the manufacturing businesses, which have a lower selling expense component than the distribution business. Impacting both cost of sales and selling and administrative expenses were higher benefit costs including medical and pension costs. Included in selling and administrative expenses in 2004 was $3.5 million related to the fourth quarter severance charge discussed above as well as approximately $1.0 million of incremental external costs related to the Company’s Sarbanes-Oxley Section 404 compliance effort.

Operating income was $52.0 million in 2003, an increase of 16.0% compared with $44.8 million in 2002. These results reflect higher operating profit at Barnes Distribution. Overall operating income margin increased to 5.8% in 2003 compared with 5.7% in 2002. Cost of sales, as a percentage of sales, decreased to 64.8% reflecting improvements in gross profit margins at Barnes Distribution combined with the shift in overall sales mix to the higher margin distribution business, a result of the Kar acquisition. Total selling and administrative expenses increased to 29.4% as a percentage of sales, from 26.7% in 2002. This increase was also driven by the higher proportion of sales in the distribution business, which has a higher selling expense component. Impacting both cost of sales and selling and administrative expenses were higher postretirement benefit expenses at Associated Spring and lower pension income Company-wide. Pension income decreased by $4.8 million due primarily to reduced investment performance of plan assets in 2001 and 2002 and a lower discount rate. The cost of postretirement benefits, other than pensions, increased $1.1 million due in part to a higher medical cost trend, lower discount rate and the full year impact of increased benefit levels provided to certain U.S. employees.

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Other Income/Expense

Other income totaled $2.1 million in 2004, compared with $3.3 million in 2003. The reduction is principally due to lower equity income from NASCO, the Company’s joint venture investment. Additionally, investment of foreign cash in the RSPs reduced short-term investments and related interest income.

The decrease in other income in 2003 compared with 2002 was due to foreign exchange transaction gains of $1.2 million in 2002 compared with foreign exchange losses of $0.7 million in 2003, which were included in other expenses. The foreign exchange transaction gains and losses related primarily to exposure on U.S. dollar-denominated financial instruments, primarily in the Company’s operation in Brazil. The Company’s policy is to hedge foreign currency transaction exposure except in locations where the local currency has historically weakened against the U.S. dollar, which includes Mexico and Brazil. The decrease in foreign exchange gains was partially offset by higher interest income due to higher interest rates in Brazil and increased short-term investments in Canada.

Although average borrowings increased in 2004 compared to 2003, interest expense decreased due to a reduction in average interest rates. The lower average interest rates resulted from principal payments on higher cost fixed rate debt and favorable terms negotiated in the amended and restated revolving credit agreement completed in the second quarter of 2004.

Interest expense increased in 2003 compared to 2002 as a result of higher borrowings related primarily to the Kar acquisition, and a reduction in the amount of debt subject to variable interest rate swaps.

Income Taxes

The Company’s effective tax rate was 19.2% in 2004, compared with 14.0% in 2003 and 18.0% in 2002. The increase in the tax rate in 2004 when compared to 2003 reflects the absence of two discrete beneficial tax matters included in 2003 that effectively reduced the 2003 tax rate from 19.4% to 14.0%. The benefits recorded in 2003 were associated with a Brazilian tax matter which was resolved in 2003 and the anticipated utilization of minimum asset tax carryforwards in Mexico. When compared to 2002, the benefits of these reversals were partially offset by the absence in 2003 of an additional deduction which was taken during 2002 for the Company’s Retirement Savings Plan dividends. The 2002 dividend deduction resulted from a retroactive election in 2002 for the 2001 dividend distribution, pursuant to an amendment to the Plan. Among other items impacting the future tax rate is the mix of income between U.S. and foreign operations. See Note 10 of the Notes to the Consolidated Financial Statements of this Annual Report for a reconciliation of the U.S. federal statutory income tax rate to the consolidated effective income tax rate.

In the normal course of business, the Company and its subsidiaries are examined by various tax authorities, including the Internal Revenue Service (“IRS”). The IRS is currently reviewing the Company for the tax years 2000 through 2002. The Company currently has one disputed IRS tax issue with a potential tax cost of approximately $16.5 million. The Company and its advisors believe the Company will prevail on this issue. Any additional impact on the Company’s liability for income taxes cannot presently be determined, but the Company believes the outcome will not have a material impact on its financial statements.

Net Income and Net Income Per Share

Net income in 2004 increased slightly compared with 2003, however, an increase in basic and diluted average shares outstanding adversely impacted net income per share. The increase in shares resulted mainly from

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the issuance of Company common stock in a May 2003 follow-on public offering, shares used as partial price consideration for the acquisition of Kar, and shares issued for stock compensation awards.

Financial Performance by Business Segment

Barnes Distribution

Barnes Distribution achieved record sales of $424.8 million for 2004, a 6.0% increase over 2003. Organic sales increased $6.9 million or 1.7% while Kar, which the Company purchased on February 6, 2003, contributed incremental sales of $10.4 million and the favorable impact of foreign exchange rates provided incremental sales of $6.8 million. Key performance indicators in the U.S., such as the daily sales average and average order size, improved in each quarter of 2004. Customer service levels improved and returned to historical levels by year-end. Organic sales growth was driven mainly by positive results in the U.S. from strategic growth initiatives including national accounts, e-commerce platforms and Tier 2 relationships with industrial distributors, offset in part by decreases in sales to other customers. The national accounts selling team opened over 40 new relationships during 2004. Geographically, sales in Europe increased over 2003 while sales in Canada decreased. Additionally, Barnes Distribution’s Raymond business reported higher year-over-year sales as a result of the general industrial recovery and new product introductions.

Barnes Distribution’s operating profit decreased from 2003 which was partially due to a $1.3 million charge for severance costs and $1.0 million in inventory and facility charges taken in the fourth quarter of 2004. The reduction in operating profit was also driven by incremental costs of approximately $2.1 million related to strategic growth initiatives, including costs to strengthen the sales force, and approximately $2.4 million in costs incurred to address customer service issues. These costs were partially offset by incremental synergistic savings from the Kar acquisition of approximately $5.9 million and lower integration costs of $0.8 million and $0.7 million of benefits related to the reduction of lease obligations on idle facilities during 2004. The Kar integration was completed during 2004, within 15 months of the acquisition. Profit was adversely impacted by a shift in sales mix to large accounts which traditionally have lower pricing than Barnes Distribution’s core business. Gross profit was negatively impacted by higher product costs particularly related to steel supply and freight costs. These increases in costs were largely offset by customer pricing increases. In addition, the year-over-year profit comparison was negatively impacted by the $1.3 million gain on the sale of a distribution center in 2003.

Outlook: Management believes the outlook for markets served by Barnes Distribution, particularly those which are the focus of our strategic growth initiatives and those which are located in the U.S., continues to strengthen. Additionally, Barnes Distribution has continued to improve its performance in its KPIs, specifically customer service levels, or fill rates, which returned to historical levels and should have a positive impact on sales going forward. Discrete charges incurred in late 2004 related to personnel reductions are estimated to generate annual savings of $1.7 million. Steel supply issues, particularly for fasteners, continue to negatively impact Barnes Distribution. Suppliers have indicated that they are having difficulty procuring steel to meet customer demand which has affected availability and pricing, a trend that is expected to continue into 2005. Management is seeking to recover the increased costs through price increases to its customers and is looking for new offshore sources to mitigate any negative impact going forward.

Sales increased in 2003 due mainly to the acquisition of Kar, which contributed approximately $108.3 million of sales. Sales were also favorably impacted by the strengthening of foreign currencies against the U.S. dollar. New growth initiatives contributed approximately $20 million in sales and the Raymond business expanded product lines and generated higher sales in markets outside the U.S. These increases were offset by decreases in other customer markets.

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The Kar acquisition also had a favorable impact on operating profit in 2003. Discrete costs of $2.8 million were incurred related to the Kar integration into Barnes Distribution’s base business. However, these discrete costs were more than offset by the realization of estimated cost savings of $5.7 million. The 2003 operating profit also included a gain of $1.3 million from the sale of a distribution center and severance costs of $1.2 million.

Associated Spring

Associated Spring reported record sales of $373.5 million in 2004. This performance was driven in large part by organic sales growth of $23.0 million. Growth came in all of its key market segments, most notably in the industrial product markets which realized sales growth of 23.4% driven primarily by success of our reed products in Brazil. Additionally, the heavy truck, light vehicle, telecommunications and electronics, and nitrogen gas spring markets had positive year-over-year sales trends. DE-STA-CO, which the Company acquired in September 2004, contributed approximately $8.5 million in sales in 2004. The strengthening of foreign currencies against the U.S. dollar, primarily in Europe, had a positive impact on sales of approximately $8.9 million during 2004.

Associated Spring’s operating profit decreased in 2004 resulting in a 6.0% operating margin, compared to 8.0% in 2003. Operating profit in 2004 was positively impacted by increased sales, mainly in Associated Spring’s international locations. However, overall operating profit was reduced by raw material cost increases and unfavorable LIFO adjustments aggregating $6.5 million in 2004 and a $2.2 million charge for severance costs recorded in the fourth quarter. The personnel reductions, which are expected to reduce the Associated Spring workforce by approximately 4%, are aimed at offsetting the higher raw material costs going forward and are expected to generate estimated annual savings of $3.8 million. Additionally in 2004, the Company incurred approximately $2.5 million in costs related to operating improvement initiatives focused on capacity, quality issues and lean manufacturing, approximately $0.8 million of higher medical costs and approximately $0.4 million of cost of sales expense related to the purchase accounting step-up of inventory to fair value at DE-STA-CO.

Outlook: The outlook for the markets served by Associated Spring appears to be somewhat positive. An improving U.S. economy is expected to positively impact the industrial market. Published data have indicated that sales in the heavy truck segment are expected to remain robust through 2005, but sales in the light vehicle market are expected to be a bit soft in early 2005 due to high dealer inventory levels at the end of 2004. Management also expects near-term growth in the telecommunications and electronics market and the nitrogen gas springs market. During the first quarter of 2005, Associated Spring will begin shipping from its recently opened manufacturing facility in Monterrey, Mexico which should positively impact cost and capacity issues. Raw material issues, particularly for steel, continue to affect operating profit as suppliers are exerting cost pressures on Associated Spring and worldwide steel supplies remain challenging. Associated Spring has attempted to counter the higher raw material costs with the expected savings from the 2005 headcount reductions going forward and will continue to work aggressively with its customers to reach a mutually beneficial outcome in terms of cost sharing and ensuring product availability. Further, the Company will be negotiating two labor agreements and one master pension and retiree healthcare agreement affecting three U.S. facilities that will expire in the first half of 2005. Any resulting cost increases or labor actions could negatively impact 2005 profit margins.

Associated Spring generated sales of $333.1 million in 2003. This 3.5% increase over 2002 reflected incremental sales from the 2002 acquisitions combined with the positive impact on sales, primarily in Europe, from the strengthening of foreign currency against the U.S. dollar and higher sales of nitrogen gas springs.

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Incremental sales in 2003 from the acquisitions of Seeger-Orbis in February 2002 and Spectrum in April 2002 were $14.5 million. Offsetting these increases were declines in sales in the North American light vehicle market, a drop in sales related to a planned withdrawal from the heavy truck brake spring market, and lower sales in the Asian telecommunications and electronics market. In 2003, Associated Spring outperformed the 3.3% decline in North American light vehicle production.

Associated Spring’s operating profit decreased in 2003 and reflected an 8.0% operating margin, compared to 8.7% in 2002. Profits in 2003 were positively impacted by increased sales in Europe, the closure of the Texas plant in 2002 and the absence of $1.1 million of discrete costs related to purchase accounting adjustments recorded in 2002. However, overall margins were dampened by a decrease in sales in the higher margin telecommunications and electronics market, approximately $5.5 million of higher personnel costs, including pension, postretirement and medical costs, and a $0.5 million reduction in the carrying value of the Texas facility, held for sale at the end of 2003.

Barnes Aerospace

Barnes Aerospace achieved record sales of $205.9 million in 2004. Increased sales reflect solid growth in aftermarket sales, which increased 53.7% and were driven by $9.6 million in sales from the RSPs and a 19.0% increase in the overhaul and repair business. Barnes Aerospace entered into three additional aftermarket RSPs during 2004 which drove the incremental RSP sales. Additionally, OEM sales increased 19.5%.

Total orders for 2004 were $253.6 million, compared with $161.9 million in 2003 and $177.9 million in 2002. Included in the 2004 orders were $50.4 million in orders for a large commercial engine program and $61.6 million of direct and indirect military orders. Order backlog increased to a record $193.8 million at December 31, 2004, from $147.7 million at December 31, 2003. Orders and order backlog were affected by the same factors that generated record sales.

In 2004, Barnes Aerospace’s operating profit nearly doubled from 2003. Operating profit was positively impacted by the sharply higher aftermarket and OEM sales volumes and the profit contribution from the RSPs. Partially offsetting these factors were higher incentive compensation expense and an unfavorable LIFO inventory adjustment.

Outlook: Sales at Barnes Aerospace are expected to remain robust into 2005 on the strength of sales from a large commercial engine program, higher military sales and the aftermarket RSPs. Additionally, based upon published information, recovery in the sales of commercial aircraft is anticipated in 2006, which is expected to impact aerospace component suppliers such as Barnes Aerospace beginning in 2005. However, continuing high fuel prices may adversely impact near-term aftermarket sales as airlines defer heavy maintenance to offset higher fuel costs. Also, higher raw material costs driven by raw material availability could negatively impact sales and profit in 2005.

Sales in 2003 were down from 2002 due mainly to the decline in commercial aircraft deliveries compared to 2002. The sales decline reflected the fall off in the commercial airline market in the wake of the events of 9/11. Operating profit remained relatively unchanged in 2003 and 2002 as a result of headcount reductions and productivity actions taken in 2002 that were aimed at positioning the business for a period of lower commercial aerospace volume.

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LIQUIDITY AND CAPITAL RESOURCES

Management assesses the Company’s liquidity in terms of its overall ability to generate cash to fund its operating and investing activities. Of particular importance in the management of liquidity are cash flows generated from operating activities, capital expenditure levels, dividends, capital stock transactions, effective utilization of surplus cash positions overseas and adequate bank lines of credit.

The Company’s ability to generate cash from operations in excess of its internal operating needs is one of its financial strengths. Management continues to focus on cash flow and working capital and anticipates that operating activities in 2005 will generate significant cash. This operating cash flow may be supplemented with external borrowings to meet near-term organic business expansion and the Company’s current financial commitments. Any future acquisitions are expected to be financed through internal cash, borrowings and equity, or a combination thereof.

Cash Flow

NM – not meaningful

Operating activities are the principal source of cash flow for the Company, generating $54.2 million in cash during 2004. The decrease in operating cash flow in 2004 resulted mainly from the increased use of cash for working capital. In particular, investments in working capital were required to support organic sales growth including a higher investment in receivables at Barnes Aerospace and Associated Spring, and a higher investment in inventory at Barnes Aerospace. In addition, Barnes Distribution increased inventory to improve customer service levels and to mitigate certain price increases, particularly on steel products.

Cash used by investing activities in 2004 included $32.0 million in participation fees related to the aftermarket RSPs which are more fully discussed in Note 5 of the Notes to the Consolidated Financial Statements of this Annual Report. These payments were funded mainly with cash held outside the U.S. As of December 31, 2004, the Company had a $49.0 million liability for participation fees under the RSPs which is included in accounts payable and will also be paid using cash outside the U.S. The payment schedule for the RSPs follows (in millions):

Investing activities also include the acquisitions of DE-STA-CO and Kar in 2004 and 2003, respectively. The Company’s capital spending program focuses on business growth and improvements in productivity and quality. Capital expenditures in 2004 were $28.5 million, a $10.1 million increase over 2003. The majority of this increase relates to investments in new distribution centers for Barnes Distribution in Dallas, Chicago, and Ontario, Canada and a new manufacturing plant for Associated Spring in Monterrey, Mexico. The Company expects capital spending in 2005 to be in the range of $30-33 million. Investing activities in 2002 include the acquisitions of Seeger-Orbis and Spectrum.

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Cash from financing activities in 2004 included a net increase in borrowings of $25.2 million. The proceeds were used, in part, to fund capital expenditures, a portion of the DE-STA-CO acquisition and dividends. In 2003, the Company’s public offering of its common stock provided proceeds of approximately $42.2 million (net of expenses incurred) that were used to reduce borrowings under its revolving credit facility. Cash dividends remained at $0.80 per share for the fourth year. Total cash used to pay dividends increased in 2004 by $0.9 million to $18.5 million due to the increase in shares outstanding. In 2002, cash from financing activities included $4.7 million of cash proceeds from the termination of an interest rate swap.

At December 31, 2004, the Company held $36.3 million in cash and cash equivalents, nearly all of which are held outside the U.S. Since the repatriation of this cash to the U.S. has historically had adverse tax consequences, the balances remain outside the U.S. to fund future international growth investments, including acquisitions and RSP participation fees. See Note 10 to the Notes to the Consolidated Financial Statements of this Annual Report for a discussion of the impact of the favorable foreign dividend provisions of the recently enacted American Jobs Creation Act of 2004.

The Company maintains borrowing facilities with banks to supplement internal cash generation. During 2004, the Company amended and restated its revolving credit agreement with 11 participating banks. The amended and restated revolving credit agreement extended the maturity date until June 2009, increased the borrowing facility from $150.0 million to $175.0 million, decreased the interest rate to LIBOR plus a spread ranging from 0.8% to 1.4% depending on the Company’s debt ratio at the time of the borrowing, and amended various financial and restrictive covenants. At December 31, 2004, $98.0 million was borrowed under the revolving credit facility at an interest rate of 3.41%. Additionally, the Company pays a facility fee, calculated on the full amount of the borrowing facility, at a rate ranging from 0.20% to 0.35%, depending on the Company’s debt ratio at the end of each calendar quarter.

Borrowing capacity is limited by various debt covenants in the revolving credit agreement. The most restrictive borrowing capacity covenant requires the Company to maintain a ratio of Total Debt to EBITDA, as defined in the revolving credit agreement, of not more than 3.25 times at December 31, 2004. The ratio requirement will decrease to 2.75 times on June 30, 2008. The actual ratio at December 31, 2004 was 2.70 times and would have allowed additional borrowings of $53.5 million.

The Company believes its credit facilities, coupled with cash generated from operations, are adequate for its anticipated future requirements.

The funded status of the Company’s pension plans is dependent upon many factors, including returns on invested assets, the level of market interest rates and benefit obligations. In 2004, the fair value of pension plan securities traded in equity markets increased, which had a positive impact on the funded status of the plans. However, the increase in the fair value of plan assets was more than offset by an increase in the benefit obligation due to normal service costs and a reduction in the discount rate. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 87, “Employers’ Accounting for Pensions,” the Company records a minimum pension liability adjustment for under-funded plans through a non-cash after-tax charge to accumulated other non-owner changes to equity. As of December 31, 2003, the under-funded status of the plans improved, resulting in a reduction of $5.7 million of this non-cash after-tax charge to equity. As of December 31, 2004, the under-funded status of the plans increased, resulting in an $8.9 million non-cash after-tax charge to equity. From a cash perspective, approximately $4.6 million in cash contributions were made by the Company to its various pension plans in 2004 including the required minimum contributions to its qualified U.S. pension plans. The Company expects to contribute approximately $3.3 million to its various plans in 2005.

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Contractual Cash Obligations and Commitments

At December 31, 2004, the Company had the following contractual cash obligations and commercial commitments:

OTHER MATTERS

Inflation

Inflation generally affects the Company through its costs of labor, equipment and raw materials. Increases in the costs of these factors have historically been offset by price increases, operating improvements, and other cost savings initiatives. During 2004, the Company, particularly the Associated Spring segment, experienced significant inflation in raw material prices, specifically steel, the majority of which was not recovered.

Critical Accounting Policies

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant accounting policies are disclosed in Note 1 of the Notes to the Consolidated Financial Statements of this Annual Report. The most significant areas involving management judgments and estimates are described below. Actual results could differ from such estimates.

Inventory Valuation: Inventories are valued at the lower of cost or market. The last-in, first-out (“LIFO”) method is used to value the majority of domestic inventories. Provisions are made to reduce excess or obsolete inventories to their estimated net realizable value. Loss provisions, if any, on contracts are established when estimable. Loss provisions are based on the projected excess of manufacturing costs over the net revenues of the products or group of related products under contract. The process for evaluating the value of excess and obsolete inventory often requires the Company to make subjective judgments and estimates concerning future sales levels, quantities and prices at which such inventory will be sold in the normal course of business. Accelerating the disposal process or incorrect estimates of future sales potential may necessitate future adjustments to these provisions.

Business Acquisitions: Assets and liabilities acquired in a business combination are recorded at their estimated fair values at the acquisition date. At December 31, 2004, the Company had $221.9 million of goodwill, representing the cost of acquisitions in excess of fair values assigned to the underlying net assets of acquired companies. In accordance with SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment testing. The assessment of goodwill involves the estimation of the fair value of “reporting units,” as defined by SFAS No. 142. Management completed this annual assessment during the second quarter of 2004 based on the best information available as of the date of the assessment, which incorporated management assumptions about expected future cash flows. Based on this

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assessment, there was no goodwill impairment in 2004. Future cash flows can be affected by changes in the global economy and local economies, industries and markets in which the Company sells products or services, and the execution of management’s plans, particularly with respect to integrating acquired companies. There can be no assurance that future events will not result in impairment of goodwill or other intangible assets.

Revenue Sharing Programs: The Company participates in aftermarket RSPs under which the Company receives an exclusive right to supply designated aftermarket parts over the life of the related aircraft engine program. As consideration, the Company pays participation fees, which are recorded as long-lived intangible assets, and are recognized as a reduction to sales over the life of the program. The recoverability of the intangible asset is subject to significant estimates about future revenues related to the program’s aftermarket parts. Management updates revenue projections periodically, which includes comparing actual experience against projected revenue and obtaining industry projections. The potential exists that actual revenues will not meet expectations due to a change in market conditions. A shortfall in future revenues may indicate an impairment of the intangible asset. The Company evaluates the remaining useful life of this asset to determine whether events and circumstances warrant a revision to the remaining period of amortization. The intangible asset is reviewed for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The Company has not revised the amortization period or identified any impairment of these intangible assets. See Note 5 of the Notes to the Consolidated Financial Statements of this Annual Report.

Reorganization of Businesses: For non-acquisition related reorganizations as of and subsequent to January 1, 2003, the Company records the cost of reorganization initiatives at the time the liability is incurred. For reorganization initiatives in connection with acquisitions, and for all other reorganization initiatives prior to January 1, 2003, the Company records liabilities at the time that management has approved and committed to a reorganization plan. Such a plan identifies all significant actions to be taken and specifies an expected completion date that is within a reasonable period of time. The liability includes those costs that can be reasonably estimated. These estimates are subject to adjustments based upon actual costs incurred.

Pension and Other Postretirement Benefits: Accounting policies and significant assumptions related to pension and other postretirement benefits are disclosed in Note 9 of the Notes to the Consolidated Financial Statements of this Annual Report.

The following table provides a breakout of the current targeted mix of investments, by asset classification, along with the historical rates of return for each asset class and the long-term projected rates of return for the U.S. plans.

The historical rates of return were calculated based upon compounded average rates of return of published indices. The 25% target for fixed income and cash investments is lower than the fixed income and cash component of a typical pension trust. The fixed income investments include a higher-than-average component of

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yield-aggressive investments, including high-yield corporate bonds. Based on the overall historical and projected rates of return, management is projecting the long-term rate of return on its U.S. pension assets to be 9.5%.

A one-quarter percentage point change in the assumed long-term rate of return would impact the Company’s pretax income by approximately $0.8 million annually. A one-quarter percentage point change in the discount rate would impact the Company’s pretax income by approximately $0.5 million annually. The Company reviews these and other assumptions at least annually.

During 2004, the fair value of the Company’s pension plan assets increased by $20.6 million compared to an increase in projected benefit obligations of $29.2 million. The higher increase in the benefit obligation is driven by a 50 basis point decrease in the assumed discount rate. The Company’s pension expense for 2004 was $1.0 million. Pension expense for 2005 is expected to increase by $0.5 million over 2004 expense, primarily due to lower discount rates.

Income Taxes: As of December 31, 2004, the Company had recognized $50.6 million of deferred tax assets, net of valuation reserves. The realization of these benefits is dependent in part on future taxable income. For those jurisdictions where the expiration date of tax loss carryforwards or the projected operating results indicate that realization is not likely, a valuation allowance is provided. Management believes that sufficient income will be earned in the future to realize deferred income tax assets, net of valuation allowances recorded. The recognized net deferred tax asset is based on the Company’s estimates of future taxable income. The realization of these deferred tax assets can be impacted by changes to tax codes, statutory tax rates and future taxable income levels.

Recent Accounting Changes

During the second quarter of 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” The FSP provides guidance on the accounting for the effects of the Act for employers that sponsor postretirement health care plans that provide prescription drug benefits and also increases the disclosure regarding the effect of the federal subsidy provided by the Act. This FSP superseded FSP No. 106-1 and was effective for the Company in the third quarter of 2004. Management estimated the effects of the Act on the Company’s accumulated postretirement benefit obligations. Management, along with the Company’s actuaries, determined that, based on regulatory guidance currently available, benefits provided by certain of the Company’s postretirement benefit plans were at least actuarially equivalent to Medicare Part D and, accordingly, the Company expects to be entitled to the Federal subsidy. See Note 9 of the Notes to the Consolidated Financial Statements of this Annual Report for the disclosures required by the FSP.

During the second quarter of 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 03-6 “Participating Securities and the Two-Class Method under FASB Statement No. 128, ‘Earnings per Share’.” The Issue, effective for fiscal periods beginning after March 31, 2004, defines a participating security and addresses how to treat participating securities in the calculation of earnings per share. Adoption of this consensus did not have an effect on the Company’s financial position, results of operations or cash flows.

In October 2004, the EITF ratified the consensuses included in Issue No. 04-1, “Accounting for Preexisting Relationships between the Parties to a Business Combination.” Among other things, these consensuses address whether a consummation of a business combination between two parties that have a preexisting relationship should be evaluated to determine if a settlement of a preexisting relationship exists, and the accounting for the preexisting relationship. The consensuses should be applied to any business combinations and goodwill impairment tests performed after the ratification in October 2004. The Company will comply with the provisions of the Issue, as applicable, subsequent to this date.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” This Statement amends the guidance in ARB No. 43 to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material and requires that those items be recognized

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as current-period charges. Additionally, the Statement requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this Statement will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company is currently evaluating the impact this Statement will have on the Company’s financial position, results of operations and cash flows.

In December 2004, the FASB issued a revision to FASB No. 123. SFAS No. 123R, “Share-Based Payment,” focuses primarily on the accounting for transactions in which a company obtains employee services in exchange for stock options or share-based payments. Currently, the Company grants stock options and other equity-based compensation to its employees and discloses the pro forma effect of compensation expense had the Company applied the provisions of SFAS No. 123 in Note 1 of the Notes to the Consolidated Financial Statements of this Annual Report. Under SFAS No. 123R, the Company will be required to record this compensation expense in the Company’s results of operations. SFAS No. 123R will be effective for the Company beginning in the third quarter of 2005. The Company is currently evaluating its transition alternatives and the effect of this Statement on the Company, which will be dependent in large part upon future equity-based grants. Management believes the impact upon adoption will be significantly lower than previous amounts disclosed in Note 1 of the Notes to the Consolidated Financial Statements of this Annual Report based on anticipated changes to the structure of the equity-based compensation program.

In December 2004, the FASB issued FSP No. 109-1, “Application of FASB Statement No. 109, ‘Accounting for Income Taxes,’ to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004.” The American Jobs Creation Act of 2004 includes a tax deduction of up to 9% of the lesser of qualified production activities income, as defined, or taxable income, after the deduction for the utilization of any net operating loss carryforwards. The FSP clarified that this deduction should be accounted for as a special tax deduction in accordance with SFAS No. 109. Because of the Company’s tax loss carryforwards, this FSP will not have a material effect on the Company’s financial position, results of operations or cash flows in 2005.

EBITDA

Earnings before interest, taxes, depreciation and amortization (“EBITDA”) for 2004 were $90.9 million compared to $88.8 million in 2003. EBITDA is a measurement not in accordance with generally accepted accounting principles (“GAAP”). The Company defines EBITDA as net income plus income taxes, interest expense and depreciation and amortization. The Company does not intend EBITDA to represent cash flows from operations as defined by GAAP, and the reader should not consider it as an alternative to net income, net cash provided by operating activities or any other items calculated in accordance with GAAP, or as an indicator of the Company’s operating performance. The Company’s definition of EBITDA may not be comparable with EBITDA as defined by other companies. The Company believes EBITDA is commonly used by financial analysts and others in the industries in which the Company operates and, thus, provides useful information to investors. The Company’s non-GAAP measure of EBITDA excludes incomes taxes, depreciation and amortization, and interest expense which the Company incurs in the normal course of business. Accordingly, the calculation has limitations depending on its use.

Following is a reconciliation of EBITDA to the Company’s net income (in millions):

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the potential economic loss that may result from adverse changes in the fair value of financial instruments. The Company’s financial results could be impacted by changes in interest rates, foreign currency exchange rates and commodity price changes. The Company uses financial instruments to hedge its exposure to fluctuations in interest rates and foreign currency exchange rates. The Company does not use derivatives for speculative or trading purposes.

The Company’s long-term debt portfolio consists of fixed-rate and variable-rate instruments and is managed to reduce the overall cost of borrowing while also minimizing the effect of changes in interest rates on near-term earnings. In August 2002, the Company entered into an interest rate swap agreement that effectively converts its 7.13% fixed-rate Senior Notes to variable-rate debt. The underlying debt is currently being repaid in equal installments with a corresponding reduction in the interest rate swap. This interest swap agreement had a positive impact on 2004 earnings, reducing interest expense by $0.2 million.

The Company’s primary interest rate risk is derived from its outstanding variable-rate debt obligations. At December 31, 2004, the result of a hypothetical 1% increase in the average cost of the Company’s variable-rate debt, including debt subject to the interest rate swap agreement, would have reduced annual pretax profit by $1.1 million.

At December 31, 2004, the fair value of the Company’s fixed-rate debt was $173.3 million, compared with its carrying amount of $154.2 million. The Company estimates that a 1% decrease in market interest rates at December 31, 2004 would have increased the fair value of the Company’s fixed-rate debt to $178.5 million.

The Company has manufacturing, sales and distribution facilities around the world and thus makes investments and conducts business transactions denominated in various currencies. The currencies of the locations where the Company’s business operations are conducted are the U.S. dollar, Singapore dollar, euro, British pound, Mexican peso, Brazilian real, Canadian dollar, Swedish krona, Chinese yuan and Thai baht. The Company is exposed primarily to U.S. dollar-denominated financial instruments at its international locations. A 10% adverse change in all currencies at December 31, 2004 would have resulted in a $0.3 million loss in the fair value of those financial instruments.

Foreign currency commitments and transaction exposures are managed at the operating units as an integral part of their businesses in accordance with a corporate policy that addresses acceptable levels of foreign currency exposures. The Company does not hedge its foreign currency net investment exposure. To reduce foreign currency exposure, management maintains the majority of foreign cash and short-term investments in local currency and uses forward currency contracts for other U.S. dollar-denominated assets in an effort to reduce the effect of the volatility of changes in foreign exchange rates on the income statement. In weaker currency countries, such as Brazil and Mexico, management assesses the strength of these currencies relative to the U.S. dollar and may elect during periods of local currency weakness to invest excess cash in U.S. dollar-denominated instruments.

The Company’s exposure to commodity price changes relates to certain manufacturing operations that utilize high-grade steel spring wire, titanium and other specialty metals. The Company attempts to manage its exposure to increases in those prices through its procurement and sales practices.

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Item 8. Financial Statements and Supplementary Data

BARNES GROUP INC.

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

See accompanying notes.

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BARNES GROUP INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)