Lincoln Electric Holdings Inc (LECO) 2005 Q2 法說會逐字稿

Good afternoon.

My name is Janice, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Lincoln Electric Holdings, Incorporated Second Quarter 2005 Earnings Conference Call. [CALLER INSTRUCTIONS.] Now I will turn today's conference over to Mr. Vince Petrella, CFO of Lincoln Holdings, Incorporated.

Sir, you may begin your conference.

Thank you, Janice.

Good morning, and thank you for joining Lincoln Electric Holdings 2005 Second Quarter Conference Call.

We released financial results for the quarter and the half year prior to market open this morning.

These results are available on our website and on a number of financial news sites as well.

You may also contact our investor relations office if you need copies.

Before we get further into the call, I want to remind you that certain statements made during this 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 Forms 10K and 10Q.

John Stropki, Lincoln's Chairman and CEO, is joining me this morning and will review the general results and add commentary on operations and markets.

I will cover the financials in greater detail later in the call.

John.

Thank you, Vince, and good morning to everyone.

We are pleased to report another good, solid quarter with gains in both net income and sales.

Net income was up 35%, to a record $32.1 million, or $0.77 per diluted earnings per share, on record sales of $406 million, up 22% in the quarter.

The quarter did benefit from a favorable income tax adjustment of $1.8 million, or $0.05 per share, related to a change in the Ohio tax law.

Excluding the adjustment, net income was $30.3 million, or $0.72 diluted earnings per share.

Let me add that Lincoln is an active member of the business community here in Ohio, and we were very supportive of Governor Taft's tax reform program.

Among other changes, the new tax law will eliminate the component of the state property tax which taxes investments in Ohio, and the franchise income tax, which taxes profit.

Given our relatively large fixed capital base in Ohio, the old law penalized us for being here.

The new law will encourage investment in Ohio's manufacturing base.

Our record results in the quarter reflect continued and steady demand across all regions and key industry segments, particularly in the energy related and mining sectors, as well as key infrastructure projects around the world.

Key projects in Asia, the Middle East, and Latin America continue to increase our export business, and our newer acquisitions, including the J.W.

Harris Company, are contributing incrementally to the overall sales and profitability of the Company.

Sales in our North America segment increased approximately 20% to $265.4 million, and export sales were also up over 20% to $24.4 million.

Sales outside of North America increased 30% to $140.5 million.

In local currencies, the sales of our international subsidiaries were up 25%, reflecting the recent increase in the valuation of the U.S. dollar.

Turning to the half, net income increased 30% to $54.4 million or $1.30 diluted earnings per share.

This includes the favorable $1.8 million tax adjustment I referenced earlier regarding the Ohio tax law change, which was partially offset by the previously announced European rationalization charge of $1.25 million pre-tax, or $848,000 after tax.

If you exclude the non-reoccurring items, net income for the half was $53.4 million or $1.27 diluted earnings per share, a 25% increase.

Net sales in the half $768.8 million, an approximate 20% increase over last year.

And sales for the North American operations increased nearly 20% to $497 million.

Exports were up over 25% to $46.7 million.

Outside North America, our international subsidiaries had net sales of $272 million, a 30% increase.

And local sales currencies increased by approximately 25%.

We continue to see growth in important international markets which are contributing to Lincoln's overall profitability.

Our focus continues to be on building our position and market share in those important fast growth economies, especially those in Asia, Eastern Europe, and Latin America.

Taking a closer look at the regions, during the quarter, demand in the North American market was stable and improved across most of our North American operations.

Industrial activity, as represented in key measures such as industrial production and capacity utilization across factories in North America, provided a very steady business environment.

Capacity utilization, excluding HiTech, remained steady at approximately 80% during the past quarter.

Certain industries continued to show healthy year-over-year growth, while month-over-month gains are slowing in some cases.

For example, heavy duty truck manufacturing, mining, and gas field machinery and metal working equipment continues to grow more quickly than the overall industrial market.

The automotive sector continues to be the weakest sector of the market, but this segment appears to be strengthening based on recent domestic sales incentives and reduced inventory levels.

We continue to see strong sales dollar results in our primary industrial product channels.

Unit volumes improved over the first quarter.

However, year-over-year pricing impact was lower than in the first quarter.

This pricing impact will continue to temper as we progress through the year compared with 2004.

In consumable product lines in North America, supply is stable, and we have seen steady material costs, particularly steel.

As a result, we have not introduced any additional price increases for our major consumable products during the second quarter.

We did, however, implement a price increase, effective May 1, for welding machines and for our low alloy solid wires as a result of increased material costs which impact these products.

Let me briefly comment on some of the Company's activities involving North America.

With the completion of J.W.

Harris Company acquisition, integration into the Lincoln organization is going smoothly.

Dave Nangle was appointed president of J.W.

Harris's business.

Dave is also president of Harris Calorific, our cutting and gas apparatus business, as well as WCTA, our retail unit.

Putting these businesses under one umbrella in Dave's leadership is a logical move, and it will help us to achieve the synergies we believe possible.

Already, the J.W.

Harris integration is adding to our other businesses by placing Lincoln's products in J.W.

Harris's sales channels, which was previously resold product produced by other competitive manufacturers.

Looking forward, we believe the industrial environment in North America should provide for steady business levels through the third quarter, and we are encouraged by the recent durable goods report, but year-over-year comparisons will clearly begin to temper.

In Europe, Eurozone manufacturing recession showed positive signs of recovering in June as the Purchasing Manager's Index rose for the first time in five months.

However, the Index remains below 50, indicating a marginal deterioration, but the rate of decline has clearly slowed.

The recent weakening of the Euro has contributed significantly to the improvements of the Eurozone manufacturing sector, as export orders increased at the fastest pace in 4 months.

Domestic European demand continues to be weak, and therefore the overall recovery is forecasted to be modest.

High oil prices and the significant recession in Italy continue to threaten the upturn.

However, the most recent news coming out of both Germany and Italy looked more encouraging.

Despite the slowdown in the markets over the past several months, Lincoln Europe results were strong, with sales up over 10% in the second quarter and in the half, and we continue to make progress in several European regions, in growing our business through increased distribution, new product offerings, and geographical expansion.

Heavy demand for shipbuilding around the world is benefiting Eastern Europe, particularly Croatia, Romania, and Poland.

Lincoln has served the shipbuilding industry for decades, and we are well positioned to take advantage of the opportunities in this segment with new technology equipment and consumables, as well as expanded sales and distribution capabilities.

Our Polish company, Bester, has posted record monthly sales throughout the year.

The Company has to move forward in this important region.

Some strategic investments are being completed at Bester, including a welding technologies center to complement the training facility we open later this year.

These facilities will be an excellent resource for the training and development of our customers and employees.

And we are also expanding our warehousing and sales organization in Poland to better serve the Eastern European markets.

During our last conference call, we announced the restructuring of our French operation.

That project is on schedule, and we will complete the closure of the equipment manufacturing operation during this quarter, with the transfer of productions from France to our Italian, Polish, and U.S. operations.

And the increased flux capacity project in France is proceeding on schedule.

Our outlook for the third quarter in Europe is cautiously optimistic.

We have seen some pickup in the volume demand in July for some of our consumable products, with part coming from export orders.

If the Euro continues to be relatively weak against the U.S. dollar, the slightly positive economic signs should bode well for the region's economic long-term outlook, and the open increasing opportunities in the export markets.

However, the failed vote of the European Constitution does add some uncertainty in the region.

Regarding Europe, we previously announced that David LeBlanc, currently president of our Lincoln Electric Latin American operation, will become president of Lincoln Electric Europe, succeeding Ralph Fernandez, effective September 1st.

Ralph will, in turn, succeed Dave in heading up our Latin American region, at a position that he held prior to being appointed to Europe.

Both are excellent managers with solid international experience, and they have both done a great job in their respective regions.

We look forward to continuing the progress we have demonstrated in both of these important markets.

These moves continue to demonstrate our long-term focus on building international exposure and expertise within our proven management team to ensure continuity of our succession planning process.

Along those lines, let's turn to Latin America.

We had another excellent quarter with very strong growth in Latin America.

All of the region's five subsidiaries enjoyed solid growth, as did exports, both into and out of the region.

The macro economic drivers in the region remain solid.

Specifically, strong commodity prices continue to provide the support for both healthy fiscal positions and growing infrastructure investments in the region.

The results have been that capital goods investment in the mining and oil and gas sectors remain robust, which is driving demand for our industrial and construction welding equipment.

Although regional manufacture activity has dampened some and slowed consumable and base market sales, the infrastructure expansions referenced above have more than compensated for this effect.

We are also pleased that the House has followed the Senate lead in approving CAFTA.

This agreement further opens trade for our products in the region.

In the first 6 months, Latin America sales grew strong.

In addition to the factors behind the region's quarterly performance, higher price levels resulting from last year's surge in steel costs have served to expand the year-on-year growth rates.

Looking at Mexico, year-over-year growth has been very strong in the quarter, demonstrating our continued success in expanding and growing our share in this market region.

Sales remain very strong despite the recent slowdown in industrial sector reaching a record high during the quarter.

Our Torion II plant expansion continues to demonstrate important cost savings and strong operational results.

Sales of locally manufactured product have also pushed good results for the quarter, rebounding from the previous quarter.

In Brazil, sales in the quarter were also very strong, with the exchange rates positively impacting the results, including the translation effects of converting at a much stronger rate, increased sales and substantial foreign gains.

In Venezuela, the economy grew at 7.9% year-over-year, with very high levels of public spending made possible by high oil prices and continues to drive the economy.

Consensus 2005 GDP growth is at 5.7%, with estimates varying from 3 to 7.9%.

Lincoln's Venezuela sales increased strongly in the quarter.

In Asia-Pacific, our sales increased triple digits in the quarter, including acquisitions.

In greater China, sales of our new flux cord wire have continued to grow, and we plan to further expand production capacity at our Baoshan facility, and we will continue to focus on opportunities to grow both domestic and export sales.

While demand for steel in China has tapered off in the first half, the domestic economy continued to expand at 9.5% GDP in the second quarter.

The recent changes in the Chinese RMB present an unknown, but clearly, prospects for continued strong growth look favorable for many years.

In India, the second largest market in Asia, sales continue to increase at very high levels over the same period last year.

Sales are being driven by product demand for energy and pipe mill related projects.

We are, however, starting to see important market share growth in other important segments, such as infrastructure and general fabrication.

In Southeast Asia, business remains strong.

Offshore platform fabrication and shipbuilding was strong in the quarter and expected to remain so through 2006.

Our more advanced welding technology, including power wave AC/DC technology, is providing productivity increases to support growing demand in these yards.

Strong export demand for electrode from our Indonesia plant is requiring us to add a third shift and to evaluate additional capacity at this facility.

Also, sales of engine drive welders from Australia to the region have been very strong.

Business in the rest of the world, the region covering Russia, Africa, and the Middle East, the oil and gas sector continues to be robust.

Sales increased significantly in the quarter.

Pipeline, pipe mills, and energy terminals are all going strong.

Our solid product line of engine driven equipment, stick, and sub-arc consumables, combined with the new technology products I mentioned earlier, for new pipe mill and new pipe mill fluxes, allow for significant penetration into these growth markets.

We are progressing by expanding our presence in the Middle East/North Africa region, as well as the Sahara and Russian markets, to capitalize on the energy sector growth.

And as an example, we are establishing a new sales and demonstrational facility in Dubai.

In summary, anther solid quarter, with strength in most key sectors and regions.

Now let me turn the call back over to Vince, who will discuss the finances in more details.

Thank you, John.

As noted in our release, and in the previous comments by John, we continue to have higher quarter versus prior year quarter sales and profitability across our global operations.

This quarter represents our sixth consecutive quarter of strong earnings growth.

The quarter's consolidated sales are up over 22%, with North American sales increasing 19%, and sales reported outside of North America up 30%.

Latin American and Asia-Pacific continue to show good year-over-year volume growth.

Excluding foreign currency effects, non-North American sales increased 24%.

In addition, 8% of the Company's overall sales increase was attributable to our acquisitions in China and J.W. Harris.

Pricing had an important impact on sales for the quarter, contributing 11% of the increase in sales dollars year-over-year.

Volume increases were approximately 9%, including acquisitions.

Looking at purchases by customer location, rather than our selling unit's location, North American customers were up 18%.

Russia, Africa, and the Middle East customer sales increased over 10%, and Europe sales were up approximately 11%.

In local currencies, sales in Europe increased approximately 8%.

Latin American sales increased over 50%, and Asia-Pacific sales were up approximately 60%.

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 13%.

Consumable sales were up 30%.

Sales by product line were approximately 59% consumables and 41% equipment, compared to 56% consumables and 44% machines in the prior year's quarter.

The percent of gross profit in the quarter was 28.1% of sales, compared with 30.2% of sales in the prior year's quarter.

Part of the decline in gross margins resulted from a shift in sales mix to traditionally lower margin geographies and operating units, including the effect of our recent acquisitions.

Higher product liability defense costs reduced gross margins by approximately 70 basis points.

In addition, prior year's second quarter gross margins were aided by the timing of price increases and related input cost increases.

Gross margins increased 100 basis points from the first quarter of 2005, reflecting improved product mix and an improving cost base.

First half gross profit was 27.6%, compared to 28.9% in the prior year.

Again, the year-over-year decline is related to increased product liability defense costs and geographical sales mix, including the effect of recent acquisitions, as well as the earlier discussed timing of product price increases.

SG&A expense in the quarter of $71.9 million was 17.7% of sales, down 3.1 percentage points from the prior year.

Higher bonus costs, selling costs, and the impact of foreign exchange translation were the primary factors driving the dollar increase.

The substantial decline in SG&A as a percentage of sales is reflected in the Company's operating leverage, as well as the impact of recent acquisitions.

SG&A expense for the 6 month period was $138.8 million, compared to $129.4 million in 2004.

As a percentage of sales, SG&A dropped to 18%, compared with 20.3% in the prior year's first half, a 2.3% decline.

The increase in dollar terms was due to higher selling and bonus costs.

The decrease in SG&A as a percentage of sales was aided by the effect of recent acquisitions.

Second quarter operating profit, at 10.4%, was up 90 basis points versus the second quarter of 2004.

Operating income increased approximately 34% in the quarter.

This increase was primarily attributable to better leverage created by higher sales levels and good cost control.

First half operating profit was 9.4% of sales, compared with 8.6% in the prior year.

The current year includes $1.3 million of rationalization charges recorded in the first quarter.

Excluding rationalization charges, operating profit margins would have been 9.5%.

The income tax provision for the quarter reflected an effective tax rate of 24.9%, bringing the year-to-date rate to 25.5%.

The quarter included a one-time tax benefit of $1.8 million related to an adjustment to state deferred income taxes.

Without this one-time benefit, the quarterly effective tax rate would have been 29.1%, and the half year rate, 28%.

The prior year second quarter rate was 28%, and the half year rate was 25.7%.

The higher effective tax rates, without the one-time benefit, were primarily the result of higher income before income taxes this year.

Depending on the level of full year earnings, as well as estimated tax deductions, we expect our effective tax rate in 2005 to be in the range of 27% to 30%.

Now to the balance sheet.

Working capital needs grew less in comparison to the prior year.

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

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

Working capital turnover efficiency remained constant, with average operating working capital to sales of 32.9%, compared with 32.6% of sales at the prior year's end.

As a result, cash flow from operations increased to $44 million in the quarter, with $32 million in the prior year.

Half year cash flow from operations totaled $62 million, compared to $44 million in 2004.

The Company invested approximately $12 million in capital expenditures in the quarter, compared with $11 million in the prior year's second quarter.

For the half year, Cap Ex was $21 million, compared with $20 million in 2004.

The 2005 capital spending plan will continue to focus on capacity expansion, as well as improvements in the cost base.

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

In addition, the Company paid cash of $71 million and assumed debt of $15 million, to acquire J.W. Harris.

Other uses of cash flows included the payment of $7.5 million of dividends to shareholders in the quarter.

Also, the Company contributed $10 million to its U.S. pension plans in the second quarter, and $20 million for the half year, consistent with 2004 contributions.

The Company repurchased 294,000 shares, costing $8.8 million during the second quarter, bringing our year-to-date purchases to $12.8 million.

Weighted average diluted shares outstanding increased to 41,845,000 shares for the second quarter, compared to 41,477,000 for the 2004 second quarter.

Outstanding shares at June 30, 2005 were 41,582,000 shares.

Our return on investment capital rose to 16.4% at June 30, 2005, compared with 15.6% for the prior year's same period end.

The increase in returns is reflective of much higher operating income.

The Company closed the quarter with an $87 million net debt position and $80 million of cash.

This cash will be used to support our continuing acquisition program, repurchase shares, pay dividends, and invest in our capital expenditure programs.

Looking to the future, we expect to experience steady volume in the third quarter of 2005.

These volumes should be achieved despite difficult comparisons caused by 2004 volume growth of over 20%.

Year-over-year sales comparisons experienced during the second quarter of 2005 should moderate somewhat in the second half of the year, as the year-over-year comparisons become more challenging.

Nevertheless, our overall business levels remain solid, and we are optimistic that earnings growth will continue in 2005.

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

Janice, could you open the call?

Yes sir, thank you. [CALLER INSTRUCTIONS.] Your first question comes from Godfrey Birckhead of SBK Brooks.

Good morning.

Good morning.

Good morning, Godfrey.

Can we talk a little bit about the growth again and what the longer-term objectives are, and do you feel satisfied with where you're at now?

Well, Godfrey, we're never satisfied with where we're at currently.

I think you appreciate the history of our gross margins and operating profit margins.

Since the decline in the industrial sectors, we've been working our margins back up to historical norms.

Last year, significant increase in input costs, particularly steel, have had a dramatic effect on compressing our margins.

We are somewhat gratified that we've been able to break the 28% gross margin barrier and also the 10% of operating profit margin barrier that we've talked about on previous calls, and we certainly have targets and objectives to exceed 30% type margins in the future.

30%?

Yes.

Okay.

So the longer-term objective is 30%?

Absolutely, over 30%.

Were there any unusual factors in the third quarter, like acquisitions and stuff like that, that hurt the margins or -- ?

Yes, there were.

In my formal comments, I mentioned the effect on our margins from the recent acquisitions of J.W.

Harris, and then the new Chinese business that just started to be consolidated mid-year 2004, and that is depressing gross margins by approximately 75 basis points at this time.

And the other formal comment was the effect of product liability, which also drove our gross margins down.

What is that?

Can you spell that out?

What does that mean, product liability?

Well, that's our defense costs associated with our welding fumes litigation, and that defense cost has been increasing beginning with right around mid-year last year, and certainly in the last half of 2004.

So, we expect our defense costs associated with product liability welding cases to increase in 2005 by approximately $5 to $7 million.

$5 to $7 million?

Yes, the quarter had about a $3 million increase, and the half year about $5 million.

Okay.

Those charges run through cost of sales.

So these are an ongoing part of your business then?

Well, we think at least in the near to intermediate term, these are the types of run rates that we will expect.

So we're talking about something like $20 million annually?

Well, we haven't disclosed what we're spending, Godfrey, in terms of our defense costs, but we have talked about the year-over-year increases.

Okay.

Well, that's helpful.

And then, on the SG&A line, what kind of longer-term targets do you have in bringing the SG&A cost down as a percentage of sales?

What's the target there, longer term?

We think we can get down below 17%, or right around 17%, as a good run rate.

Okay.

And then one final question.

What do you think depreciation and amortization will be this year?

It'll run around $40 million to $42 million.

Okay.

Thank you very much.

You're welcome, Godfrey.

[CALLER INSTRUCTIONS.]

Your next question comes from the line of Emeny Venelli of John Hancock Advisors.

Thanks for taking my question.

I think I might have missed some of your comments on the gross margin, especially on the sequential improvement in gross margin, and you might have touched on your -- perhaps on the cost side, not just the price of product side.

How much contribution did you have to the gross margin sequentially on your cost of raw materials side, and what are the trends going forward?

Do you see some of your raw material prices coming down significantly down the road that you might see for the improvement sequentially?

Well, we don't see significant decline in raw materials cost in the near future.

The positive story for the half year is that our major input costs, for the most part, have flattened out and slightly eased.

So our biggest input cost is steel and steel rods, and we had tremendous increases in those costs in 2004, and those costs have now stabilized and flattened out.

However, we don't see, at least into the third quarter, any significant benefits from declines in steel and other input costs.

Okay.

That's very helpful.

The other question, I might also have missed one of your comments on tax rate.

What should we use as a normal tax rate going forward?

I would use what we've booked through the half year, without the one time benefit.

So, about 26.5%?

No, I think it was 28%.

28%.

Yes.

All right.

Appreciate that, thank you very much.

You're welcome.

Gentlemen, there are no further questions at this time.

Do you have any closing remarks?

No, other than to thank you for joining us on the call, and we're very satisfied with our progression through the second quarter and half year, and look forward to talking to you for the third quarter close, which we expect to occur around the end of October.

Thank you very much, Janice.

Thank you, sir.

Ladies and gentlemen, that concludes today's Lincoln Holdings, Incorporated conference call.

You may now disconnect.