Lincoln Electric Holdings Inc (LECO) 2003 Q2 法說會逐字稿

Welcome to the Lincoln Electric Holdings second quarter 2003 earnings conference call hosted by Mr. Jay Elliott, Senior Vice President and CFO and Treasurer. (CALLER INSTRUCTIONS). Sir, you may begin.

Thank you, Darcy. Good morning to all joining the call to discuss financial results for the 2003 second quarter and first half. We welcome your interest in Lincoln Electric.

Our results were released this morning prior to market open. If for any reason you do not have a copy you can find the announcement on our company's website as well as on a number of financial sites. We can also fax you a copy if you contact Investor Relations -- from our contact Investor Relations here in Cleveland.

Before we begin our discussion, let me remind you certain statements made during the call may well be forward looking. You should also be aware of the risk factors associated with our business. These risk factors are provided in our press release and more generally, our SEC filings.

Tony Massaro, Lincoln's Chairman and Chief Executive Officer, will lead the discussion today. We will cover the financials in detail, following Tony's remarks. Also joining us today is John Stropki, Executive Vice President and Chief Operating Officer. Following our formal remarks, the call will be open to your questions.

Now let me turn the call over to Tony Massaro.

Thanks Jay and let me also extend my greeting and thank you for joining the call.

We just completed a quarter in which our financial results were affected by higher pension costs and the continuing tough economic environment that has impacted industrial markets here in the US. But through great effort by our employees and our continuing focus on managing our costs, we put in a very good performance in the quarter and half against the realities of that sluggish market. We are proud of what we were able to accomplish.

Our net income in the quarter was $14.2 million or 34 cents per diluted share, sales of $265 million. These results compare with results in the same quarter last year of 19.7 million in net income or 46 cents per diluted share on sales of $259.7 million. The increase in pension costs in the quarter was $3.3 million after-tax over last year.

Our U.S. operations had sales of 155.3 million compared with 158.7 million in the quarter last year. Export sales were 17.3 million compared to 17.5 million last year.

From our vantage point, there has not been any appreciable change or recovery in the business environment for our industrial customers in the US domestic market. We do we do believe however, that we have seen the U.S. market stabilize. We posted solid results and performance in our international subsidiaries. Our global growth strategy continues to be bolstered by good results and market share growth in a number of regions, especially Asia, parts of Latin America and the Middle East. Our non U.S. net sales in the quarter were $109.7 million compared with $101 million in the 2002 quarter. In local currencies, sales were up in Asia and Latin America and down slightly in Europe, as Europe has slowed in recent months.

Turning to the half, net income in the six-month period was $26.4 million or 63 cents per diluted share. That compares with a $7.4 million net loss in the 2002 first half or 17 cent loss per diluted share. Incremental pension costs in the first half of this year were $5.4 million on an after-tax basis. In addition, net income in the just completed six months includes rationalization charges of approximately $1.3 million net of tax. Excluding the rationalization charges, net income was $27.7 million or 66 cents per diluted share. First half 2002 net income before taking into account the cumulative effect of an accounting change was 30.2 million or 71 cents per diluted share. Excluding the cumulative effect of an accounting change and rationalization charges, net income was $37.2 million or 87 cents per diluted share in 2002's first half.

Net sales in this year's half were 514.2 million compared with 508.1 million in the comparable half last year. First half net sales for the U.S. operations were 302.6 million compared with 314.3 million in the same period last year. Export sales were $31 million compared with 32.5 million in the same period last year. Our non U.S. net sales were $211.6 million compared with 193.8 million in the 2002 half.

Cash flow from operations in the 2003 first half was $45.6 million compared with 57.7 million in the same year ago period. First half cash flow from operations this year include $20 million in pension contributions to the U.S. benefit plans.

The Company paid quarterly cash dividend of 16 cents per share on July 15 to shareholders of record as of June 30.

Those are the overall numbers but before turning the call back to Jay for more detail, I would like to take a few minutes to quickly review activity in the regions and cover some other company items.

First off as previously announced, John Stropki was elected Executive Vice President and Chief Operating Officer of the Corporation. John is an exceptional executive and Lincoln veteran and I am proud to have him on our team. As you know, John previously headed up our largest operation, Lincoln North America. In his new role, he retains responsibility for North America as well as adding responsibility for our regional subsidiaries in Europe, Latin America and the market covering Russia, Africa and the Middle East.

In the first quarter, we mentioned the anticipated cost savings from actions that we took there. Those benefits did start to appear in the just completed quarter and we anticipate that those savings by year-end should amount to approximately six to $8 million pre-tax. As I mentioned on our previous calls, we are determined to take costs out of our operations and we are doing exactly that through Six Sigma, lean manufacturing, global sourcing and other initiatives.

Earlier this week, we announced the appointment Venod Capor (ph) as Vice President of Cleveland Operations. For the past three years, Venod has been instrumental in updating and transforming our manufacturing operations in Cleveland for lean manufacturing and total quality management techniques. He's also played a major role in coordinating manufacturing rationalization initiatives in our Canadian and Mexican subsidiaries.

Looking at the regions, as I mentioned, our performance in the quarter in Asia was strong. Although SARS did impact travel to Asia, Taiwan and other affected areas, we continued supplying that market and increased our market share. I should add that our joint venture with Quangtie (ph) in China and Taiwan performed quite well.

Performance in Latin America, specifically Mexico and Venezuela was very good. Contrary to the general economic and political environment in Venezuela, we are profitable and taking further market share.

In our market region comprised of Russia, Africa and the Middle East, business is good and increasing. We continue to receive very large orders for equipment and consumables as pipeline projects in Russia get underway. The early push to rebuild Iraq is having a positive effect on orders in the Middle East and we would anticipate that business will grow as programs to put that country back together move ahead.

In Europe, the recession is impacting a number of major economies. Our results held steady and in several regions, increased. The strength of the Euro against the Dollar benefited our exports into the region to a degree, and significantly decreased exports from Europe.

That's an overall view of the quarter. Now let me turn the call back over to Jay.

As Tony has explained, our results for the second quarter of 2003 have turned out to be as expected. Sales were up two percent with a business declined within the domestic U.S. welding market offset by the higher sales reported outside of the United States because of the impact of a weaker U.S. Dollar and local currency gains in several markets.

At the gross profit level, the U.S. business decline more than offset the improvement we have outside of the U.S.. Principal reasons for the inclusion of approximately $3.3 million higher pension costs in the quarter with approximately two-thirds of the increase being charged to the cost of sales, coupled with scheduling the plants at lower levels because of reduced product demand were the resulting smaller sales base over which to allocate fixed costs.

During the first quarter, the U.S. business unit took additional steps to reduce their fixed costs to bring it into better alignment with the current level of business by reducing overhead employment. These reductions have begun to bear fruit in our SG&A comparisons.

The cost of selling, general and administrative expenses in the quarter was $52 million, 4 percent lower than the $54.3 million of '02. This was made possible even though there had been a large increase in the translation rate of the Euro versus the U.S. dollar in the period and the increase in pension costs in the U.S.. The primary driver for the lower SG&A were the reductions in expenditures in the U.S. company.

Percent profit at the operating income level amounted to 6.8 percent in the quarter as compared to 10.5 percent in the prior year. The U.S. percentage operating profit was at 11 percent versus 19.5 percent in the prior year. As noted earlier, causes for this decline were the higher pension costs of the U.S. business coupled with lower overhead absorption because of lower plant operating levels and continuing competitive competition in the marketplace.

Business outside of the U.S. achieved a 6.7 percent operating profit in the quarter compared with 7.5 percent in the prior year's period. Despite the slight decline in year-over-year operating margins in our non U.S. businesses, Lincoln's international business continues to show better comparisons than the domestic operations.

Turning to cash flow and investments, approximately $5 million less was invested in working capital for the first half compared to 2002. Compared to the prior year, we spent $5 million less on purchases of property, plant and equipment plus acquisitions. Our working capital balances ended the quarter at $176 million of Accounts Receivable, $170 million of inventories and $74 million of Accounts Payable. A $45.6 million cash flow from operations included $20 million of contributions to the U.S. company's pension plan as Tony mentioned, which compares to $10 million in the prior year's first half. This reduced reported cash flow has negatively affected this year's comparison to the prior year's cash flow from operations of (ph) $57.7 million.

An additional use of cash in 2003 was the spending $14.1 million on repurchase of the Company shares, which was $12.4 million higher than the prior year's first half. Our outstanding shares now stand at 41,392,000 at June 30, 2003.

The Company's percentage debt to total capital is 29.5 percent and it is nil when the cash balances are reduced from the debt. We continue to be very conservatively leveraged and to be in a position to undertake significantly sized acquisitions which we continued to evaluate.

In summary, we continue to experience slowness in the U.S. market although the domestic sales year-over-year comparisons are better than the first quarter's comparisons. We are continuing to manage the efficiency of our operation in the face of lower volume in the U.S. in a very competitive marketplace throughout the world. We are focused on investing wisely within the business and looking to add to the business in areas of the world which offer enhanced growth opportunities. All this is progressing as we continue to share the success of our operations with our share holders through our quarterly dividend payouts and the stock buyback program, returning cash flow to our owners.

At this point, I would like to open the call to your questions.

(CALLER INSTRUCTIONS). Holden Lewis, BB&T.

Thank you. It seems like your U.S. revenues did fairly well compared to some of the releases out of one of your competitors. Can you give some sense of the relative performance between your machinery side and your sort of consumables side and what do you attribute to the relative strength? Do you feel like you're gaining share even in the U.S., any comments just adding some color to the US trends?

I'm going to let John Stropki answer that since that is his direct responsibility.

We had an increasing sale as we went through the quarter. Each month, we got a little progressively better than the previous quarter and actually, June sales on a year on year comparison were slightly ahead of the year before. I would though, echo Tony's comments; we don't feel that that is driven by any significant gain in the economy. We do think some of the creative programs we put into place and the relationships that we've had with our distributors and the long-term focus that we've put into place is beginning to pay some fruit. Our machine sales comparisons to consumables (ph) sales comparisons were better on the machine side than the consumables, which again, we think is really driven by market share gains, that capital investment has really not kicked in but we had a couple of creative programs that we think did a good job for us.

Okay. Now those creative programs you are referring to, are we talking -- specifically what accelerated? Are you looking at your core product sort of hitting the market and doing pretty well or are you talking about the retail? What exactly was the accelerating improvement?

I would say it came in several areas; our retail business continues to perform exceptionally well, up high double-digit type number. That is heavily driven equipment sales. We have over the course of the slowdown, introduced several new equipment models that are gaining a lot of traction, particularly in the effort of end-user customers to automate their facilities and take advantage of technology improvements into the marketplace. And then we do have a distributor-financing model that is in place that is doing particularly well, helping our distributors to gain new business with their end-user customers.

Okay. And then with regards to both the distributor financing model and then the machines being stronger than the consumables, does that have an implication on mix that may have contributed to the gross margin decline which is sort of an ongoing issue that you need to tackle?

Holden, it does have a bit of an effect but it's not substantial because the percentage between the several products has not really changed substantially over time. I think the biggest driver you have is lower production levels, which are impacting it in the quarter as a change in gross margins, the lower production had over two percent of the decline effect. Of course, the pensions are in there as well but we do still continue to have pricing pressure on all the markets that we are in. There are also raw material cost increases which affect us as well so it's generally a result of lower volume and the competitive marketplace and some cost increases, which are difficult to recover at the moment.

As a last thing and I will jump back in queue, one of your big competitors also reported that machines were stronger than consumables. You are commenting that maybe it was market share but it just seems like that was the landscape of the quarter, as much as anything else. Are you able -- you are not seeing any pick up in capital spending, what have you. To what do you attribute -- it seems like sort of an odd trend. To what do you attribute to the fact that machines would be noticeably stronger than consumables at this point, if not a capital spending recovery?

Well again, we think it's a market share gain. There are more than two players in this business and a number of them are not doing very well. So clearly, the introduction of new machines has had a big impact on that from our perspective.

I want to make one comment on the consumables side, is that we have seen some positive trends on consumables in two areas; one as we discussed at the last conference call, the impact of the weak U.S. Dollar in comparison primarily to the European currency has provided some positive growth, particularly in the mig (ph) wire side of our business and we think that trend will continue as people start to pull out of some of these past arrangements that they had and take a look at more of a North American sourcing arrangement. We are seeing particularly strong consumables sales in Canada for that reason and secondly, one of our last remaining competitors in Canada announced recently that they were closing their mig (ph) and cord (ph) wire capacities in Canada, looking for sourcing opportunities and that's in a period of time of which we are expanding both our cord and mig wire capacities in Canada.

Okay I will jump back in queue. Thank you.

Walt Linteck, McDonald Investments.

Thank you. Jay, you provided operating profit international versus North America. I wondered if you could give us that info for the gross margin?

Okay, let me take a look here. Within the quarter, U.S. growth (ph) margins was 24.8 and that compares to the prior year's 30.4. The non U.S. was 23.5 comparing to the prior year's 23.6. On a year-to-date basis, the U.S. was 25.1 versus 30 and non U.S. was 23.6 versus 22.9. So you see we had a rise outside the U.S. first quarter that turned around a bit in the second quarter.

Okay. Are you seeing any of these negative impacts on gross margin changing in the second half? For instance, energy prices, fuel prices, the competitive pricing environment, are any of those things expected to lighten up?

Well, apart from if we start getting some volume expansion, probably not. The same kind of market dynamics are likely to exist and what really is required is some volume recovery.

Okay. The inventory at 170 million was up a little bit, despite the production cuts. Are you expecting to keep production levels about the same in the third quarter?

There is a lot of currency impact on that because with the falling Dollar, the foreign inventory values convert to a lot more Dollars to actually inventory is down on a currency basis.

Okay, okay. I guess on foreign currency, what was the topline impact of foreign currency for the company?

Percentage-wise, on a year-to-date basis we had a 3.9 percent benefit.

3.9 percent year-to-date benefit from foreign currency?

Yes.

Okay and then with the sectors, you mentioned that North American sectors were stabilizing and in your commentary you mentioned the North American retail channel. Can you point to some other sectors of the welding industry or customers that you sell to that are seeing a stabilization and which ones might still be in a decline?

From a domestic standpoint Walt, it appears the construction in farm equipment business is improving. Caterpillar's results in the quarter and their forward-looking view were quite positive the other day. We are seeing similar trends with the other people who are in that sector, particularly in year on year and in comparisons to the last several years. The farm industry looks particularly improving. Oil and gas sector is still one of our critical sectors and it's doing good and looks to do potentially much better, particularly in the international market as Tony talked. We announced at the last conference call significant order that we had gotten from our yearhon (ph) and schwill (ph) subsidiary for pipe production in Russia. And we are now on the back end of that, getting the opportunity to participate in the construction side of those projects. They're very, very large and there are similar type activity taking place in the Middle East and Asia-Pacific, particularly in China. I think the automotive sector looks fairly flat although they are bleeding off their inventory and if the consumer confidence continues to improve, hopefully they will have a better third quarter than they had second and can close out the year strongly.

We are also seeing -- just one final point, the spend in the rental business in the first half of the year was particularly slow. But as the U.S. economy has stabilized, some of those people are coming back into the market. We have been able to book some nice orders in the first part of this month.

Okay, good. Okay and then you mentioned that Asia was up Tony. How much was Asia up year-over-year?

I will let Jay take that. Hold on a moment.

In the quarter, Asia-Pacific was up a very strong 21.5 percent. But it is still recovering to an extent to its former level. We are still not back to where we were, back in '98 but it did have a strong recovery.

Is there a foreign currency impact to the 21.5 percent or is that in local currencies?

This would have been calculated in Dollars. There is a little bit of foreign currency because the Australian Dollar has been stronger but a lot of our sales out there are in US dollars because of export business to the region.

This of course, does not include our joint venture with Qwongtai (ph).

Okay good and then a couple of other questions, the pension contribution, are you planning more pension contribution in the second half?

We will likely put in another 10 million this year. That would bring it to a total of 30.

Okay and then any restructuring actions, are you done restructuring North America?

We are never done restructuring but we have no immediate plans. There is not any program as such where you have encouragement, cost of encouraging people to say retire early but certainly a lot of activity is going on not only in North America, but in Europe as well as they are proceeding to run themselves more on a functional basis across all of the continent rather than on a country basis with a full complement of management there. Maybe John would like to talk about what he is doing over there.

Well, Jay is exactly correct. Says Ralph Hernandez has gone to Europe, he has taken a very aggressive view of the organizational structure there and through either attrition or through design, we've changed out a number of critical players into those marketplaces and gone more to a functional organization that we think not only streamlines the organization, and, but gives us an opportunity for a much better structure at a cost basis going forward and there is some work to do there but we are very encouraged by the progress that we have made.

Okay, I guess we will wait and see. One final question, the dividend question, you've got a lot of cash and acquisitions have been pretty slow here lately. Are you considering or would you consider a special dividend or dividend increase?

We think at the present time we have enough acquisition opportunities that we're looking at that we believe will come to fruition and we will use that cash and use that in the near future.

Okay good, thank you.

(CALLER INSTRUCTIONS). Holden Lewis.

On the restructuring guidance that you provided, I guess you said 6 to 8 million this year. I want to make sure, is that a year-end run rate or is that what you expect to recognize this year and in any case, how much have you recognized of that 6 to 8 through Q2 that has actually impacted your results so far?

We actually have close to 2 million in Q2 and that is Q2, it's not Q1. So we would retain that rate and build it as we go forward. That's where you get the six to 8 for this year.

Okay. So you recognized 2 million in Q2 or you got to a run rate of 2 million in Q2?

We recognized.

How much did you recognize in Q1?

It was basically done at the end of the quarter so I would say very, very little.

Okay, alright then you would do -- you were expecting to recognize another $2 million plus maybe a little more to get to 8 in Q3, Q4?

Correct.

But definitely it is in the baseline numbers for Q2?

Yes.

Can you give us some sense of what you're doing with Europe? Are the costs of shuffling that about material in the quarter and year or are the expected benefits material this year?

I would say that neither the costs nor the benefits are material this year.

Okay and I guess you alluded to competition. Can you make some formal comment on what you're seeing on the pricing side?

I think that was you that alluded to competition.

I mentioned it also. We do -- there is a very difficult market to sell into with consumables because there's so much capacity available. We are able to maintain pricing, gain a bit of pricing on machines but on the consumables side, there has been tremendous pressure because of the low-cost offerings that have been in the U.S. market driven by excess capacity in Europe basically and that pressure has changed greatly and interest in buying from these customers that will switch between regions, is very strong right now in North America so that should help volume as well as price.

Right. Presumably, are you seeing any real benefit from the Euro being stronger in terms of your ability to defend price on the consumable side?

No, they have not seen a change yet but we think it is going to come.

Okay. Fair enough. The last question, obviously Thermadine (ph) has come out of Chapter 11 and is back in the market full force. Any general commentary about the extent to which you think that is material on your business, they are coming out, presumably a healthy (ph) entity?

I really don't think it's material to Lincoln whatsoever. Thermadine was a competitor during the time they were in Chapter 11 and still a competitor when come out of Chapter 11 and we compete with them in various places around the world. I think maybe the new ownership probably has more interest in increasing profitability, which hopefully will stabilize pricing from Thermadine.

(indiscernible) cash flow previously, obviously.

Thanks guys.

(CALLER INSTRUCTIONS).

Well, if there are no additional questions --

We do have one additional question. Andrew Weiner, Sanford Bernstein.

One quick question for John. Though we might not be able to time when there will be a big industrial recovery in the economy, can you provide any kind of sort of directional guidance with respect to what you think your incremental margins should be? Is it 20 cents on the dollar? 30 cents on the dollar, more or less? I know you have a very variable labor cost structure, so sometimes the comparisons are not as straightforward as they might otherwise be? What is your sense for that?

This is Jay. Clearly it's going to be 40 cents on the dollar that drops, so it's going to be very strong.

40 cents --

Before tax.

Right. Is that the same sort of U.S., Europe, --

Not very different.

Okay, thank you.

At this time, we're showing no further questions. I will turn the call back over to Mr. Jay Elliott for any closing remarks.

I would like to thank you all for being with us again and we really do appreciate you following the Company and we look forward to talking to you in our next session in October. Thank you.