Lincoln Electric Holdings Inc (LECO) 2002 Q3 法說會逐字稿

Good afternoon and welcome to the third quarter earns he's conference call. All parties will be in the listen-only mode until the question and answer portion of the conference. This conference is being recorded. Should you have any objections, you may disconnect. Chief Financial Officer Jay Elliot, so you may begin when you're ready.

Thank you, Andrea. Good morning to all of you joining us today. Welcome to the conference call to discuss Lincoln Electric holding Inc.'s 2002 third quarter and nine-month results. We'll get into a discussion of the results in a minute, but first let me remind you that certain statements made during this call and during our discussion with you may well be forward looking. You also should be aware of the risk factors associated with our business. These risk factors are provided in our press release and more generally in our SEC files including our 10-K and 10-Q reports. In addition to Tony Massaro, Lincoln Electric Chairman and CEO, also joining us is John Stropki, Executive Vice President, and President of North America. We lead off with a discussion this morning, following Tony's remarks, we will review the financials in more detail. Let me now turn the call over to Tony. Tony?

Thanks, Jay and good morning, everyone. This has been quite a roller coaster of a year so far for the economy and the markets. With the bottom points of the roller curve going deep and the peaks barely a bump up. That's not niece I guess to any of you on this call. At no time in recent business history have the markets been so impacted and investor and consumer confidence eroded by so many different issues. The manufacturing sector and more specifically our domestic industrial market remains stagnant. Industrial production weakened in the last three months. And manufacturing activity declined in September. The forecast isn't encouraging either. We believe the United States domestic industrial economy will remain soft through the rest of this year and to 2003 first quarter.

Lincoln Electric, of course, has been impacted by the domestic economy. But despite that, we put in a very good performance during the quarter. We were able to maintain our profitability and cash flows. Our global business strategy is proving to be a significant contributor to our overall sales and profit picture. Our gains outside the United States are helping balance the down turn in the domestic industrial market. This is reflected in the excellent performance of our foreign subsidiaries which include, of course, acquisitions made earlier in the year in Poland and Venezuela.

Turning to the numbers, in the 2002 third quarter, our net income was 7.4% of sale, 18.3 million dollars or 43 cents per dilute share. This compares with $19.2 million or 45 cents per diluted share in the last year's quarter. Sales were $247.5 million compared with $239.9 million into 2001 third quarter, or 3.2% increase. In the United States, sales were $154.2 million compared with $159.2 million in the same quarter in 2001.

Export sales in quarter increased to $15.6 million from $14.8 million in the year ago third quarter. Sales outside the United States were $93.3 million in the quarter, up from the comparable period last year, which had sales of $80.7 million.

In local currencies, non-US sales increased 15.8% over the last quarters last year. This percentage includes the affect of the acquisitions in Poland and Venezuela, as well as the divestiture of the small non-core business in Norway. Excluding the effects of acquisitions, non-US. sales increased 9.4% as measured in local currencies compared with last year's third quarter.

Looking at the numbers for the nine-month period, net income was $10.9 million or 26 cents per diluted share. This compares with $63 million in the prior year or $1.48 per diluted share. The lower figure for this year, of course, is related to the first quarter of the year, which included special charges related to the write off of goodwill and costs associated with a rationalization program. They have both been reported earlier.

Excluding the rationalization charges and the goodwill write off, our earnings for the first nine months of this year were $55.5 million or $1.36 per diluted share. In the nine-month period, we had sales of $755.5 million, compared with $741.9 million in the 2001 like period. U.S. sales in first nine months totaled $268.9 million compared with $489.9 million year. Export sales in the nine months were $48 million compared with $45.1 million last year. Sales outside the United States were $287.1 million, compared with $252 million in the same period last year. Non-US sales in local currencies and including the effect of acquisitions increased 14.1% compared with the 2001 nine-month period. Again in local currencies, excluding the affect of the acquisitions, non-US. sales increased 9.6% for the first nine months of 2002.

In looking across the economic horizon as I mentioned, we continue to believe that the U.S. industrial markets will remain weak. In our view, international markets should remain stable in the months ahead into 2003. Although we are seeing some weakness in the European markets.

Our cash flow remains very strong with $81.8 million generated over the nine-month period this current year. This is a reflection of both our continuing strong underlying operations, and balance sheet. The company also paid a quarterly cash dividend of 15 cents per share on October 15, 2002 to shareholders of record as of September 30, 2002. Earlier this week, we announced that starting January 1, 2003, Lincoln will begin expensing employee stock options under the guidelines of FFAS of the financial accounting standards board. This decision supports our goals of always maintaining clarity and transparency in our financial statements and our reporting. We expect the cost of expensing these options to be one cent per diluted share in 2003, rising to possibly six cents per diluted share by 2006.

Now, let me take a moment to discuss some other items of interest to our company. As I said earlier, we continue to combat the economic challenges facing the industrial sector. In every challenge, however, there are opportunities, and the opportunities are driving us to find new and better ways to produce product, increase market share and to meet and exceed the needs of our customers. This has meant a constant focus on better managing our operations. We have also looked to better serve and preserve value for our shareholders. Our stock is a good value at present, and during the quarter we repurchased $133,350 shares under a $10 million share repurchase authorization. The most recent buy back brings the total number of shares purchased to approximately 7.6 million shares.

In turning attention to marketing and sales initiatives, here in North America, specifically the United States, we have rolled out a number of new products to compete in the marketplace. Along with the new product rollouts we have initiated sales programs for our distributors and customers. This will ensure our industrial market share leadership. Lincoln is in an enviable position relative to most of our competitors in that we continue to earn significant profits that allow us to reinvest in our businesses. We are also increasing our product offerings to the home improvement market with additional offerings to several of the big box retailers. The retail and rental channels have experienced strong growth and we anticipate that that will continue in the future. We are moving ahead with our manufacturing initiatives and our six sigma programs in order to improve our productivity to better serve our market and customer base. In other regions, we continue to sharpen our operations and expand market share. Europe has been performing quite well, particularly in eastern Europe and the Mediterranean region. Our new European Region President, Ralph Fernandez, continues to strengthen and recast the organization and operations to improve productivity and efficiency. Overall, Asia Pacific continues to produce very positive results. And our Australian operations continue to improve performance. In late August, Asia Pacific president Mike Gillespie and I hosted a meeting with our key Asia Pacific distributors with over 50 representatives coming together to discuss the business environment, review and test new and in development product and do strategic planning as well. It was a very successful event, both from the relationship building aspects and from the strategic viewpoint.

Our customer distributor relations around the globe are extremely important, and we take care to preserve and nurture those relationships. Back over in this hemisphere and Latin America, a number of countries still present challenges related to their own political, social and economic environment. Even with those hurdles, the region turned in a very good performance with increases in sales and margins. David LeBlanc, our new head of the Latin American region, reported that August was particularly strong in Mexico, led by improved sales mix and helped by results from our ongoing cost reduction programs. Our Brazilian operations experienced stronger machine sales and higher exports, maintaining stability in that tumultuous economy. Venezuela continues to benefit from business-related to the energy sector, and our new acquisition there continues to grow and meet our expectations. The market region covering Russia, Africa and the Middle East continues to experience good results and the gains we are making are coming from energy-related projects there. That's the economic picture from Lincoln's point of view.

As I mentioned, we continued to pursue our global growth strategy. That strategy is proven to be on target as we witnessed the gains made from our ability as a truly global company to benefit from our presence in regional markets and the ability to source from our global platform. The last item I'd like to mention before turning the call back to Jay is the election of a new board member. He is Harold Adams, Chairman of RTKL associates, who was elected to the board in July. Based in Baltimore, RTKL is a worldwide planning architecture design and creative services organization. Among its many global projects, the firm served as the executive architect for the restoration of the pentagon. And its master plan and urban design was chose foreign the Beijing World Exhibition and Sports Center. Harold is an exceptional person, and I am sure he will prove to be an excellent addition to our board. Now, I turn the call back over to Jay and he will review some details for you. Thank you.

Thank you, Tony. The business in our third quarter has more positive comparisons to the prior years' third quarter than were present in the second quarter. Which we explained three months ago was also better comparison than in our first quarter. We have continuing good news from our operations outside of the U.S. company, and we have decreasing negative comparisons in the U.S. company.

We are continuing to focus on what we can do within the company and within our markets, which means attention to our customer needs, focusing on market share gains, as we position ourself to fill their needs, and making sure that we are absolutely as efficient internally as we can possibly be. Our focus on customer satisfaction, cost control and balance sheet management is enabling us to continue to generate a very positive net operating cash flow, even though the domestic operating environment has yet to return to a positive growth scenario.

Gross profit percentages continue to have an improved comparison versus the previous quarters. The margin declined in our most difficult market which is that in the U.S. amounted to a 1.2 point decliner have sauce 7.2 decline in the second quarter. The gross profit margins outside of the U.S. market grew by 1.9 points in the quarter, which compares to a 0.7 growth in the previous quarter. The sales price and cost squeeze in U.S. market has lessened in the quarter just completed, and gains in profitability have been achieved at an even higher level in our global markets versus the previous quarters. Markets continue to be very demanding and competitive, but volume increases and cost containment actions have again helped in the quarters comparison be the prior year versus the like comparison in the second and first quarters. Spending for sales general and administrative expense continues to be well controlled. And the percentage of these expense to sales improved slightly in 2002 versus the 2001 third quarter. As well as in comparison to our second quarter. Maximizing our sales potential and control the cost in the plants and throughout the company are the order of the day. And the results of these actions have been to allow us to continue to weather the difficult industrial marketplace in a fashion which we think is very positive in comparison to industrial firms in general.

Our operating income of 10.1% in the quarter was just short of a 10.7% of the prior year's third quarter. And compares more favorably than the 2.3 point drop which we experienced in our second quarter. We are hopeful that a turning point is about to be reached in our operating profit comparisons with the prior year. While the quarter's tax rate was higher than that booked in 2001, as 2001's third quarter included an adjustment to the two prior two quarters, year to date income tax expense was 24.3% of pretax income, versus 28% last year. Applying the 28% 2001 full-year income tax rate to the 2001 third quarter to eliminate the accumulative tax adjustment in the quarter producing a normalized net income in last year's third quarter of $17.9 million. This compares to 2002's third quarter net income of $18.3 million.

Further, in 2002, we have the after-tax carrying cost of our cash pending investment which was $600,000 in the quarter or 3.3% of sales. If this cost were to be adjusted in the quarter as well, the business on an after-tax operating basis would have exceeded normalized 2001 net income by $1 million. Or an increase of 6%. Not bad for a company in the industrial economy.

Turning to the balance sheet, we continue to be a strong cash flow generator with a year to date cash flow from operations of $81.8 million which represents 14.2% of our sales volume. Inventory control, even though sales volume continues to disappoint our expectations, has been maintained and is contributing to the cash flow generation.

Though the business environment continues to be challenging, we are not neglecting the need of our operations to continue to increase their ability to produce quality products from plants that are efficient, environmentally positive and provide safe work environments.

Year to date, we have invested $18.6 million in capital improvements, which is obviously less than a $26.6 million invested last year. As 2001 included additions to plant capacity. Looking at the national press with its discussions of accounting irregularity, credit constraints and even bankruptcies in many industries, we are pleased when we look at our balance sheet which has on the net basis no debt and with significant financial resources available to invest in growth opportunities, which surely must present themselves as the U.S. economy and the world economies move towards better prospects.

We continue to honor our covenant of supporting our customers welding needs, providing meaningful employment the our employees in support of their families and their communities, paying dividends to our shareholders, and readying the company for future opportunities-- which we define as providing increased profit generation, cash flow and increased return of our cash flow to our shareholders, be it with dividends or share buy back. At this point, it is time to open the call to your questions.

Thank you. Please press star one on your phone. You will be announced prior to asking your question. Once again, to ask a question, please press star one. Our first question comes from Gary McManus, J.P. Morgan.

Good morning, Tony and Jay.

Good morning.

Can you -- you talked about the international, up 16%, but if we take out acquisitions it's up 9. If we strip out foreign currency impact, how much are revenues, you know, compare that 9%?

I think that was taken out the foreign currency. So the 9 was with volume.

What was the impact from acquisition? 16% is the reported number, so you said 9% is excurrency, but what was it-- acquisitions then?

Are you talking about the quarter?

Yeah.

Excluding the effects of the acquisition, non-US sales increased 9.4% in local currency.

But I'm wondering --so that does take into account -- you didn't have any benefit from a weaker dollar?

Well this is in local currency.

Yeah, we calculated that. As the item-- There are some places where currency is down. Some places obviously Europe the currency was up. But we have some devaluation as well. But that number we presented to you was the calculation on a equal currency value for the foreign operations.

Okay. So was currency a big effect in the number? That's what I want to --

Not a big effect. And also, exchange, gain or loss was equal to the prior year's third quarter.

Okay. How about can you provide a forecast for 2002 capital spending and maybe 2003 as well, at least directionally?

Well, I think 2002 is go tock a continuation of the rate that you saw, so divide that by three plummet ply it by four and that's where we'll be. The next year will depend upon market requirements. We would not look to spend more next year if in fact the market is as constrained in the demand next year as this year. We of course hope that isn't the case, so there may be some increased spending if the market demands it.

I think it will probably be the same next year, Gary. Won't be any more. We don't need any capacity additions.

It will stay below depreciation and amortization, for sure?

I'm talking of course without any acquisitions.

Sure. The thing, I know this has been addressed on the previous conference call, but all the cash that's just sitting on the balance sheet., Haven't been all that active in acquisitions. Historically, just year to date, can you again explain, you know, Lincoln for years never kept this much cash. It was normally around $20 million or so. Why do we have so much cash on the balance sheet?

Well the reason we have it is we have a good deal to go get it. But the reason for having the cash is for acquisitions and other strategic investments. Now, I will tell you- and I've said this before-- we aren't going to make any stupid acquisitions. We have been evaluating several potential acquisitions for the past nine months. We are still evaluating some of those acquisitions, and I believe some of them will come to fore in the very near future. However, we aren't going to put the shareholders at risk with these acquisitions, so if they don't come to fore, then that cash will be used to buy back shares of Lincoln stock, assuming the stock is in the neighborhood that it is now.

And, I mean --

That's the plan.

I think, Gary, it's a measure of our confidence that we are going to be able to do something significant on the acquisition front, but there's no guarantee that that will happen.

Sure. So you think the prospects of spending $200 million for acquisitions in the next year or so is reasonably high?

Yes.

Thank you.

Our next question comes from Matthew Levinson with Matthew Levinson & Company.

Yes. In previous calls, you have referred to a problem with import competition, particularly in consumer bulls. I wonder if that's still the case and as this there been any impact on the company pro or con on the west coast docks?

I'll let John Stropki, President of North America, answer that.

First off, on the importation issue, we have seen a slowing and maybe even a bit of a retrenchment in the importation issue as the currency has moved U.S. currency has moved negative to most foreign currencies. There's still a few place of the world where that's not the case, but generally Europe had been the primary importer of low-cost consumables and we think that pace has slowed and may turn around. As far as the west coast dock situation is concerned, we did have some of our Asia Pacific shipments head up -- held up either here or in transit through that process. Fortunately, we took some defensive measures and looked for alternate routes for some of the product. As we planned for that. We do think there may be some benefit from imported Asian consumables that come through traditional west coast operations, but it's still a little bit too early to tell. As they would have carried enough inventory to but buffer a bit, it's question of how they can replenish that inventory.

Thank you very much.

Our next question comes from Walt Liptech with McDonald Investments.

Hi, good morning, guys.

Hi.

A couple of questions. Can you talk a little bit about the weakness that you're seeing in North America? I guess, you know, by sector. I mean S there anything -- you know, I guess automotive, commercial construction, pipelines are some of the things that you have talked about in the past. You know, where are you seeing strength and weakness?

Well, again John should cover that, but I don't think this is a particular sector that is weak. The industrial economy of the United States and capital goods spending in the United States is probably the lowest it has been in years. But I'll let John cover that.

Walt, the thing that we look at, you know, as kind of a benchmark is capacity utilization, and again if you look at that number, I mean, it is considerably below a five-year benchmark type trend. There are a few segments that have done well, you know, that's no secret to anybody. The automotive segment was very strong in the third quarter, but had a bleak result in September and early part of October type time frame. So, yeah, this is a general industry segment malaise, and a few segment are a little better than other, but none of them are very great right now.

Okay. And kind of along those lines in your comments, you know, you kind of say that things are going to stay weak or you expect them to stay weak through the first quarter. Does that mean that you expect a pickup in the second quarter of '03 and I guess why?

My Crystal ball isn't that good, Walt. I was employing that I think the U.S. domestic markets will be stagnant through throughout the first quarter. A quarter from now, I'll be able to tell you a little bit more what they'll be in the second quarter.

My only comment to that, Walt, would be that if you look at historical trends, I would guess that this is the longest continuous slow down that we have seen in our traditional industrial markets in the past 25 years. And I think just the normal build-up of the industrial economy should start to play out and hopefully some of the complications of potential war with Iraq and the uncertainties of that go away, and we get back to business as normal.

Okay. Thanks. The -- just going into the income statement, you mentioned that the gross margin -- I think this is what I understood it --gross margin was a little under pressure because of competitive markets. Were you referring to equipment pricing or consumable pricing?

I think more in the consumable area than equipment, Walt.

Okay. That's related to the cheap imports and you're saying that that may be coming to an end?

Right.

Okay. Good. And the SG&A was done $6 million. How much of that -- and you mentioned you said it was related to cost reduction, but was there an impact from foreign currency as well?

No. Not in the quarter. There's an impact from bonus accruals still, Walt, and that was about a million in the quarter.

Okay. Thanks very much.

Once again, to ask a question, please press star one now. We have a follow-up question from Walt Liptech.

Okay. Just on the balance sheet accounts receivable, what was the number inventory in accounts payable? What were those numbers too? All right.

Are you ready for next question?

Yeah. Our total receivable at the end of September was $169 million. The total inventory was $169 million as well. And the accounts payable, trade accounts payable was $64 million.

Okay. And just to clarify on the question about acquisitions, can you tell me the dollar amount that acquisitions added during the quarter?

Yeah. The actual sales value of them?

Yes.

Let's see, we have $5.2 million, Walt.

Okay. How big was the divestiture?

It was fairly small. It was about $100,000 at -- well it was not in the sales area for the -- in this period, in this quarter.

And then just like, you know, one other question. You mentioned that there's --you're starting or at the beginning of a new sales program for your distributors and customers. Is that related to the new products or are you talking about a new sales program related to some kind of pricing or terms, something to gain market share?

Well, it's a program or programs that are focusing on market share, and really are focused on taking a look at our global production capabilities and maximizing the product offerings, and the potential for lower cost products driven in the consumable area by fuel costs and some of the challenges that the north American duties have put on steel costs. And in the machine side, looking at lower labor cost production coming out of our Mexican or European assets.

And also, just to continue a little bit, it includes all products. That's not just like new products.

Okay. Thanks very much.

Our next question comes from Kyle Cavanaugh, Palisades Capital Management.

Good morning, gentlemen.

Good morning.

I have a question. I have trying -- maybe I missed something, but I was trying to reconcile the comments you made earlier in the call with regard to the gross profit margin improving sequentially, you know T comparisons are not as negative as they were two quarters ago. And also the -- you know, with regard to international and domestic. And then the comments relating to the softer economy this quarter and next quarter, and kind of if you could expand upon that. Because, you know, one it seems to me that it seems you're saying things are improving and the other one seems to suggest that things are staying about flat. So I was wondering if you could comment on that with regard with regard to the external environment or is it more related to what you're doing internally?

Well, I think there's a third factor that there's too. The comparisons are getting easier each quarter because the slowdown was under way last year. But we do believe things are improving as far as the decline which was very strong when we were looking at the last two quarters of the prior year and even the first quarter of this year. That has certainly changed.

Improving for us.

Yes. The decline has slowed remarkably in the U.S. compared to what it was before, and the foreign operations are improving in sales and in profitability at an increasing rate.

So when you say the decline, are you referring to units and sales?

Units, pricing, and both, yes.

Okay. Okay.

So that's not to predict what it's going to be in the fourth quarter. We have to yet to see what that is, but there has been an improving trend with less negativity as we've gone through quarter by quarter, so far this year. If that continues to improve even half as much as it did in the third quarter, we should be at a position with -- at least a flat comparison or slightly up in the fourth quarter. But that will depend upon what the market brings to us.

Okay. And just a related follow on question, I don't know how much you can share with us Burke as you talk to some of your larger customers domestically and internationally, is there any kind of initial indications as to what they're planning for next year or anything like that?

I think it's reflected in what we said. I think our domestic customers believe that the domestic industrial market's going to be flat into the first quarter of next year and I think that our European customers probably think things are going to be flat where they have been slightly up, and I mentioned in my remarks I saw somewhat of a degradation in the European market, particularly in Germany. But the customer seemed to think it was going to be flat next year. Asia everybody is still --northern Asia they think is going to be up again, and Latin America is sort of a coin toss depending on what happens with Chavez in Venezuela and what happens in Brazil with Venezuela and the social and economic turmoil they've got going on down there.

Thank you very much.

Our last question comes from Andrew Weiner, Bernstein Investment Management.

Hi, Andrew.

Good morning. Can you provide some guidance as to what you think the incremental margins are on your business? At some point, you know T U.S. economy is going to recover and, you know, granted none of Cus predict the timing but at some point there will be a turn for the better, does we hope. What do you think of as the incremental margin on your business? I understand that there's some operating live that is offset by the additional variable contributions you guys pay. What is sort of a good ballpark number to think about?

Well, we have certainly had a benefit in our variable labor cost as the business has slowed down, especially in the U.S. And that benefit shows in smaller decline in margins and the better result. The bottom line than we would have otherwise. And we've paid that benefit back a bit when it turns the other way at first. After we make the turn and continue to go up, then we are able to collect on our -- we believe much higher variable contribution that we have over the whole business cycle. But I would say in the upturn which is the next thing we hope we see that the margin -- the variable margins that we have are more typical of a normal industrial firm. So we're probably going to be looking at a variable contribution of 40, 45% rather than I think we have over the long-term business cycle.

Okay. My second question is historically if you look back at you know T last couple of down turns, what has been your experience with respect to unit pricing when the economy recovers? Is there -- you know, aggressive competition to try to get the volume back? Are there opportunities to actually move prices up and take advantage of an improving economy or any comments?

This is for John.

Well, I mean, clearly in the stronger economic periods that we have had, we have benefited from the ability to increase costs - or excuse me, prices above our cost increase. I believe those same type of opportunities will exist because this have been some consolidations that have taken place on the production sides of our competitors, not only in North America, but on a global basis. And there is also a demand for the higher technology products that we think we have a leadership position in. And as people move to increase their productive capacities to take advantage of approved economic cycle, they're going to look at the higher technology products to do that versus looking at the commodity prices to do that. We think we will be a huge beneficiary of that. An example of that would be our automation business, which continues to do very well, even in a depressed business as we are chosen to be the leader in developing automation for arc welding in the North American market. So we do obviously believe there will be good opportunities there.

That's helpful. Thank you.

At this time, there are no further questions. I'll turn the conference back to you, Mr. Elliot.

Yes. With that, we would like to thank you all for your continuing interest in our company, and we look forward to our next call in 2003.

Good morning.

Thank you.

Thank you. This ends today's conference. --- 0