Lincoln Electric Holdings Inc (LECO) 2005 Q1 法說會逐字稿

At this time, I would like to welcome everyone to the Lincoln Electric Holdings, Inc.

First Quarter 2005 Earnings Conference Call. [OPERATOR INSTRUCTIONS.] I would now like to turn the call over to Mr. Vince Petrella, CFO of Lincoln Electric Holdings, Inc.

Mr. Petrella, please go ahead.

Thank you.

Good morning, and welcome to all joining us for the 2005 first quarter conference call.

Earnings for the quarter were released this morning, prior to market open.

For those of you who don’t have a copy of the earnings announcement, you can obtain a copy from our website, view it on other financial or business news sites, or contact our Investor Relations office.

Before we begin the review of the quarter’s results, I would like to remind you that certain statements made during this morning’s call and discussion may be forward-looking, and that actual results may differ from our expectations.

Risks and uncertainties that may affect our results are provided in our press release, and in our SEC filings on Form 10K and 10Q.

Joining me this morning is Lincoln Electric’s Chairman and CEO, John Stropki, who will cover the general results, and give an overview of our operations and market.

After John’s commentary, I will be back with more details on the financials.

Let me now turn the call over to John Stropki.

Thank you Vince.

And good morning once again to all.

Looking at the first quarter, we are very pleased with the results.

We had a solid quarter, with gains in both sales and net income.

Net income increased 22%, to $22.2 million, or $0.53 per diluted share, on sales of $362.9 million.

The quarter included rationalization charges of $1.25 million.

That’s $848,000 after tax, or $0.02 per share, related to previously announced actions taken by the Company, affecting our European operations.

Excluding rationalization charges, diluted earnings per share increased to $0.55.

And net income was $23 million, an increase of 26.3%.

Demand in our North American industrial markets was steady.

And export sales from North America grew over 30%.

We continue to see positive market dynamics around the globe, and we have increased sales levels throughout all market regions, while improving overall operating margins.

Sales outside North America were $131.4 million in the quarter, as our international managers continued to adjust to specific market challenges and opportunities in their territories, which delivered profitable contributions to our results.

During the quarter, demand was relatively stable across all operations in the United States and Canada, with North America sales increasing 13% to $231.5 million.

Industrial activities, represented by key measured, such as industrial production, and capacity utilization across the factories in the United States and Canada, provided a steady operations environment during the first quarter.

Certain industries continued to show healthy year over year growth.

For example, heavy-duty truck manufacturing, farm machinery and equipment, and mining and gas field machinery continued strong.

But in general, we have experienced a more flattening business environment, especially in the automotive related industries.

In our primary industrial product channels, we continue to see strong sales dollars.

Although consumable unit volumes are tempered on a comparative basis, as the 2004 first quarter saw a significant ramp up in business levels.

We continue to see investment patterns that suggest that plant activity in modernizing or upgrading facilities remain positive.

As an example, I just returned from the American Welding Show in Dallas.

Attendance was better than expected.

And our new equipment and consumable products drew significant interest.

And important new orders were placed.

In our consumable product lines, supply is stable, and we have seen more steady material costs in most commodities, particularly carbon steel rod.

As a result, we have not introduced additional price increases for carbon steel welding consumables during this first quarter.

On balance, our operating profit improved on a year over year basis, and the quarter to quarter trend represented a more normal profit level than we experienced in the latter part of 2004, as a result of the LIBO-based accounting we discussed in our last call, and which we used for U.S. based inventories.

Looking forward, we believe the industrial environment in the United States and Canada should provide for steady business levels through at least the second quarter.

Turning to the other regional markets, first, Latin America.

In Mexico, industrial production increased 2% year over year in February.

In addition, the sustained increase in industrial jobs helped boost consumer spending, which has provided additional support to Mexico’s 2005 GDP growth prospects.

Mexicana sales increased over 30% in the quarter.

In Brazil, the prospects for GDP growth during 2005 remain solid at 3.6%, with economic and business indicators pointing to good, sustainable growth rates.

The real continues to show strength against the dollar.

Sales for the quarter remained relatively strong, at 38% above last year, driven by domestic electrode sales, as distributors and user begin to replenish inventories and replace competitive products with Lincoln.

In Venezuela operations, sales in the quarter rose over 40%, with sales strength across all product lines, both domestic and export, driven mostly by a sharp rebound in the oil sector.

In that regard, I should mention that in March, Lincoln Latin America held our Second International Pipe Welding Seminar, to demonstrate our unique capabilities and product line for serving the oil and gas exploration, production and transportation sectors.

Attendance was strong.

And results were excellent.

Turning to Europe, Lincoln’s Europe first quarters were strong, with the region recording sales growth of almost 20%, despite a flat to down turn in the market in many of the continent’s countries.

From our view, we continued to take market share in several important regions in Europe.

Revenue growth was particularly strong in the U.K. and Eastern Europe.

Sales in France in the quarter were also up, showing an over 30% increase.

As we announced in our last call, the restructuring of our operations in France, to transfer machine production from our French plant to our Italian, Polish, and U.S. operations, are proceeding as scheduled.

Eastern Europe results were very strong, despite the severe weather in the winter months, which stopped customer operations in many large shipyards for several weeks.

Driving the growth in the region were our sales in Poland, our largest market in Eastern Europe, which grew by over 50%.

We are continuing to make significant investments in Poland, particularly at our Bester S.A. company, where overall sales, including exports, were up over 60%.

In addition, sales in the Czech Republic, Hungary, Lithuania, and Estonia, all saw high double digit growth.

Results in Turkey, where we have a 50% joint venture with AS Kaynak, and where we are the welding consumable market leader, were very strong.

Sales in the region continued to be strong, with record sales and earning in the quarter.

The market conditions in Turkey remained very positive for the foreseeable future.

As previously announced, we, with our joint venture partner, are expanding in Turkey, and are building a new factory, with expanded capacity for welding consumable production.

This new facility is scheduled to start initial production by first quarter 2006.

This additional capacity will help us better serve the region, including the CIS countries, and the Middle East market.

Export sales results from Europe were also very positive, given the tough position of the Euro, with respect to the U.S. dollar.

We believe these results should bode well for a generally positive looking second quarter as well.

Several new product introductions in equipment and consumables will continue to gain momentum, for sales improvement and market share gains in the coming months.

On the other side of the world, the growth in Asia Pacific is still showing continued strength, especially in the China market.

During the quarter, our recent Chinese acquisition contributed $8.9 million to sales.

We recently bolstered our management structure in Asia to better focus on, and to serve regions of Asia Pacific market.

Frank Young, formerly head of our Australian subsidiary, was appointed Vice-President of North Asia, which covers Greater China, Japan and Korea.

Leo Landers was named Vice-President of the South and Southeast Region, covering India, Singapore, Malaysia, Thailand, Indonesia, Indochina, and the Philippines.

Both Frank and Leo have extensive international experience in the welding industry.

Sales of our products into Asia from North America, Europe and Australia in the first quarter increased over 20%, led by China and India.

Our imports to China were up approximately 20% over last year’s first quarter.

And imports to India were up triple digits.

Export sales from the region, with products produced from China and Indonesia, were also up significantly.

In China, our Shanghai Lincoln Electric operations increased cord wire manufacturing capacity by approximately 20%, with the commissioning of new capacity in March, with strong orders and backlogs for both domestic and export markets.

Future capacity increases and new product introductions are being planned, and will likely be accelerated.

And again, the energy sector, especially oil, gas, and power generation, continued to offer Lincoln major business opportunities in the region.

I mentioned the sales to India, the second largest market in the region, were up triple digits.

Strong infrastructure work in competitive products being sourced from our China and Indonesia plant are driving sales in India, including strong sales to pipe mills from our Uhrhan and Schwill unit, for our patented Power Wave submerged arc power sources and welding consumables.

Engineering and infrastructure projects also remain strong in India, and continue to represent strong opportunities for our products in the future.

Our Australian subsidiary grew by approximately 20% in the quarter in U.S. dollar terms.

Australian domestic sales remained strong, with a 24% increase, fueled by a strong domestic economy, as well as market shares gained.

Strong infrastructure project activity in Australia is also driving demand for rental equipment there, particularly our domestically produced engine drive welders.

In the market region, comprised of Russia and the former Soviet countries, also Africa and the Middle East, oil and gas related projects continue to fuel business in those markets.

Our sales to Russia increased approximately 25%.

Sales into the Middle East were up approximately 20%.

And in Africa, we continue to add distribution, as we focus on energy related and industrial projects.

Sales in Africa were up over 40% from last year.

To recap, we had good, solid results throughout all of our market regions, and expect to continue the positive steady trends in the quarter up ahead.

Finally, I would like to remind all of you that we will host an institutional investor and analyst day here in Cleveland, on May 10-11.

I would encourage you all to attend, to see in person why we are so excited about our people, our long-term strategies, our product development capabilities, and our production upgrades.

If you need more information, please contact Roy Morrow at Investor Relations.

The phone number is (216) 383-4893.

Next up is Vince Petrella, who will detail the discussions on the financials for the quarter.

Thank you John.

As noted by John, we continue to have higher quarter versus prior year quarter sales across our global operation.

Non-North American markets, including Latin America and Asia, continue to show very good year over year volume growth.

The quarter’s consolidated sales were up 18%, with North American sales increasing 13%, and sales reported outside of North America up over 30%.

Excluding foreign currency effects, non-North American sales increased 25%.

In addition, 3% of the sales increase was attributable to our acquisitions in China.

Pricing had an important impact on sales for the quarter, contributing 12% of the increase in sales dollars year over year.

Volume increases were approximately 5%, including acquisitions.

Looking at purchases by customer location, rather than by our selling units location, North American customers were up by approximately 12%.

Russia, Africa and the Middle East customer sales increased over 20%.

European sales were up approximately 17%.

In local currencies, sales in Europe increased approximately 10%.

Latin American sales increased over 30%.

And Asia Pacific sales were up approximately 90%.

More than half of the Asian sales increase was related to the newly acquired businesses in China.

On a product line basis, machine sales experienced a good growth rate, increasing over 15%.

Sales by product line were approximately 57% consumables, and 43% equipment.

The percent of gross profit in the quarter was 27.1% of sales, compared with 27.4% in the prior year.

The slight decline in gross margins was the result of significantly higher raw material and transportation costs, offset by higher pricing.

Although higher raw material costs were largely offset by product price increases, this factor contributed to the slight compression in gross margin.

In addition, higher product liability defense cost reduced gross margins by approximately one-half of one percent.

SG&A expense in the quarter of $66.9 million was 18.4% of sales, down 1.3 percentage points from the prior year.

Higher bonus costs, stock compensation charges, and the impact of foreign exchange translation, due to the weakened U.S. dollar, were the primary factors driving this increase.

First quarter operating income at 8.3% was up 6/10 of one percent, versus the first quarter of 2004.

Operating income increased approximately 29% in the quarter, 34% excluding rationalization charges.

This increase was primarily attributable to the better leverage created by the higher sales level.

The Company reported $1.25 million, $800,000 after tax, or $0.02 per share, of rationalization charges related to previously announced actions taken in Europe.

The European rationalization actions include the movement of machine manufacturing in France to other Lincoln facilities, and the consolidation of sales and distribution activities in Norway and Sweden.

Without the European rationalization charges in the first quarter, operating profit margins would have been 8.6% of sales, compared with 7.7% of sales in 2004.

The income tax provision for the quarter reflected an effective tax rate of 26.4%, compared to the prior year’s same quarter rate of 22.8%.

The higher effective tax rate in the quarter was primarily the result of higher income before income tax.

Depending on the full year level of earnings, as well as estimated tax deductions, we expect our effective tax rate in 2005 to be in the range of 25% to 30%.

Reviewing the balance sheet, working capital needs remained stable in comparison to the prior year.

Increases in accounts receivable and inventories were necessary to service the higher sales level.

In addition, significantly higher raw material prices, and planned increases in raw material volumes, increased our inventory values.

Working capital turnover efficiency remained constant, with average operating working capital to sales of 32.5%, compared with 32.6% of sales at the prior year’s quarter end.

As a result, cash flow from operations increased to $18 million in the quarter, compared with $12 million in the prior year.

The Company invested approximately $10 million in capital expenditures in the quarter, compared with $9 million in the prior year’s first quarter.

The 2005 capital spending plan will continue to focus on capacity expansion to meet higher demand levels in our global operations, as well as improvements in the cost space.

We expect to invest between $45 million and $50 million on capital projects in 2005, further expanding our capacity capabilities, and improving manufacturing efficiencies.

In addition, the Company paid $7.5 million of dividends to shareholders.

Also, the Company contributed $10 million to its U.S. pension plans in the first quarter, consistent with 2004's first quarter contribution.

We repurchased 135,650 shares in the first quarter, costing $4 million.

Weighted average diluted shares outstanding increased to 42,088,000 at March 31, 2005, compared with 40,880,000 shares at the same time last year, a 3% increase.

The Company closed the year with a $22 million net debt position. $143 million in cash will continue to be available to support our continuing acquisition program, to repurchase shares, pay dividends, and reinvest in our operations.

We expect to experience volume growth in the second quarter of 2005.

These increases will be achieved, despite the significant up-turn in welding industry volumes in 2004, more than 15%.

Year over year sales comparisons experienced during the first quarter of 2005 can continue to moderate, as year over year comparisons become more challenging.

Nevertheless, our overall business levels remain solid.

We are optimistic that earnings growth will continue through 2005.

Finally, we are very pleased with the 22% increase in net income for the first quarter, compared to the prior year.

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

Alison, could you open the call?

[OPERATOR INSTRUCTIONS.] Gary McManus of JP Morgan.

I was looking in your 10Q.

And it looks like North American volumes were down 2.7%, which kind of struck me.

I mean I would think you still should be seeing growth there.

Can you comment about the down turn in North American volumes?

Well, North American volumes were down slightly, because of a decline in consumable sales.

We had very good volume increases on the machine side.

But we did have a softening in first quarter volumes on the consumable side.

Gary, if you remember, in the latter part of the first quarter, and particularly March of last year, both the rapid increases and further projected increases in steel, there was almost a panic buying phenomenon on welding consumables, as people bought forward in search of supplies, and also to mitigate any price increases that were coming on consumables.

So that was an unbelievable month.

And it forced us, in fact, to implement an allocation process on consumables, because we were convinced it wasn’t real demand.

It was more speculative demand.

And, as we saw the allocation process take hold, we normalized the demand.

And I think, to Vince’s comment, the move forward now in the second quarter will be dealing with a year on year comparison that will be much more realistic, versus that unusual phenomenon that we saw in that six weeks period of the first quarter of 2004.

Okay.

My follow-on question is, just looking at pricing compared with raw material costs, I know they’re both up year over year.

But how did they change sequentially?

Did you get further price increases first quarter versus fourth quarter?

And how did raw material costs go sequentially as well?

Well, raw material costs have largely stabilized, first quarter 2005 versus the first quarter.

Steel costs have remained relatively flat, which is the bulk of our cost, particularly on the consumable side.

There are some other underlying inflationary trends of lesser import to the Company.

But from a raw material and cost standpoint, fourth quarter to first is relatively flat.

As far as pricing is concerned, from the fourth quarter to the first, there is not going to be much of a change there either.

We did announce a relatively significant price increase in the fourth quarter, that didn’t get the full benefit for all three months in fourth quarter ‘04.

But that effect is relatively minor in the first quarter of ‘05.

Okay.

Thanks a lot John and Vince.

[Mark Freewell] with Spectrum Advisory Services. [Mark], your line is open.

Please proceed with your question.

And sir, that question was withdrawn. [OPERATOR INSTRUCTIONS.] Walt Liptak with Keybanc Capital Markets.

I guess my question is related to the gross margin.

And you mentioned there was $2 million of product liability defense costs.

And I wonder if you could elaborate on that.

I mean what specifically was that for, I guess the type of product, or what kind of defense?

And is that going to be a continuing expense?

Or is that a full reserve for the year?

That a $2 million increase year over year, Walt, is related to increases in defense costs associated with cases that are moving through the legal system towards trial.

And so the increase in costs is purely the result of more cases that are in advanced states of litigation.

As far as it disappearing, I don’t expect it to be mitigated or declined, as least during the course of 2005, and likely into 2006.

Okay.

Thanks for that.

And was there – ?

Pension expense, which I guess flows through cost of goods sold and SG&A, was there any delta in that year over year?

Yeah.

It declined about $1 million in the first quarter of 2005, compared to the prior year.

Okay.

And is that split evenly between cost of goods sold and SG&A?

No.

It’s closer to two-thirds cost of goods sold, a third SG&A.

Okay.

And then a follow-up on Gary’s question with the North America part of the business down for consumables.

Is there a connection that we can draw between your comments calling out the auto sector as being weak, and net decline for consumables?

Or is it purely the panic buy and tough comps?

I would attribute more of it to the tough comps Walt.

I mean obviously everybody knows what’s happening in the automotive sector.

But the more significant portion was just the huge ramp-up in volumes that existed last year.

And I would just comment that our capacity utilization in our North American plants for consumables is at a very high level.

Okay.

Is it possible to tell us what the volume was for equipment versus consumables in the first quarter in North America?

The split?

Yeah.

Roughly speaking, we had a double digit volume increase, low teens, in welding equipment, and a decline in the high single digits, mid to high single digits, in welding consumables.

Okay.

And that was, just so I understand, that was volumes.

Right?

That we’re talking about?

Yeah.

We’re talking about volumes.

Okay.

In North America.

Okay.

That’s fine.

Okay.

Thank you very much.

[OPERATOR INSTRUCTIONS.] Holden Lewis with BB&T Capital Markets.

I may have missed this number.

But you said that machinery, all told, was up 15% plus for the Company.

But I did not get a consumables number.

Are you able to provide that?

The consumables, again, were down in the mid to high single digits.

Are you talking volumes or dollars?

You’re talking volumes, right Holden?

Well, you gave machinery up 15% plus.

Whatever the comparable number to that is.

I think that’s total sales.

Well, I am talking volumes though.

I am focused on volumes, because on the consumables side, we had a very good increase in sales dollars.

But with sales prices up 20-30%, that has a significant impact, particularly on the consumables side.

So from a pure volume standpoint, excluding the acquisition impact in China of their consumable additions, we’re down on the consumable side in the mid to upper single digits.

Okay.

Thank you.

And at this time there are no further questions.

Mr. Petrella, would you like to proceed with any further remarks?

Well, thank you for joining us on the call.

Again, we’re very pleased with our results in the first quarter of 2005.

And we expect the same kind of results in the second quarter as well.

We look forward to talking to you at the end of the second quarter.

Thank you very much.