Lincoln Electric Holdings Inc (LECO) 2006 Q2 法說會逐字稿

Good morning. My name is Meredith, and I will be your conference operator today. At this time, I would like to welcome everyone to Lincoln Electric Holdings, Inc.'s second quarter conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question press star then the number two on your telephone keypad. Thank you.

I would now like to turn the conference over to Vince Petrella, Chief Financial Officer. Please go ahead, sir.

Thank you, Meredith. Good morning, and welcome to the 2006 second quarter earnings call for Lincoln Electric Holdings. We released financial results for the quarter and filed our 10-Q prior to market opening this morning. Copies are available on Lincoln's web site or by contacting our Investor Relations office at 216-383-4893.

John Stropki, Chairman and Chief Executive Officer, is also on the call this morning and will provide commentary on the quarter, as well as global market activity. Following John's remarks, I'll cover the financial details later in the call.

However, before we get into the discussion, I would remind you that certain statements made during this call and discussion may be forward-looking and 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 10-K and 10-Q.

At this time, I'll turn over the call to John Stropki.

Thank you, Vince. And good morning to all joining the call.

We are very pleased with the great results for the quarter. Second quarter traditionally has been our strongest, and this quarter was no exception. Net income increased 33% to 42.6 million or $0.99 per diluted share on record sales of 502.5 million, an increase of 24% or 20% excluding the April 29th, 2005 acquisition of J.W. Harris.

Net income for the 2006 second quarter includes charges of 1.3 million after tax or $0.03 per diluted share related to European rationalization actions. North American operation sales were up 27% in the quarter to 335.7 million or up 22% excluding J.W. Harris.

Export sales increased 62% to 39.6 million in the quarter. Sales at our Lincoln subsidiaries outside North America increased to 166.8 million from 140.5 million a year ago. In local currencies sales at our international subsidiaries increased 17%.

Looking at the half, net income increased 46% to 79.4 million or $1.85 per diluted share. First half net income includes charges of 2.3 million after-tax or $0.06 per diluted shares related to European rationalization actions. Sales in the half increased 26% or 20% excluding the J.W. Harris acquisition to 971 million.

North American operations had sales of 656 million in the first half, an increase of 32%, 23% excluding J.W. Harris. Export sales increased 50% to 70 million.

Operations outside North America had sales of 315 million, a 16% increase over sales in the year ago half. In local currencies non-U.S. operation sales increased 17%.

That's a quick look at the financials. Vince will give a more detailed view of the numbers in a few minutes, but first I want to cover the activities in our region.

Our solid performance and record sales and profitability reflects a strong business global environment as well as effective execution of our strategy by our strong management team and dedicated employees, keeping our focus on our core strategies of new product introduction, geographical market expansion, customer service excellence, and ongoing cost control.

Two of the key measures we track the economic environment with, industrial production and capacity utilization, highlighted a healthy operating environment during the first half of 2006.

Turning back to our own business environment in the quarter we saw strong sales dollars results in volume growth over 2005 levels and we continue to maintain healthy order levels. We did increase sales prices in selected product sectors during the quarter to counter cost increases in certain commodities, and these increases will carry-forward for the remainder of the year.

We are also continuing with our key strategic capital investment program aimed at improving capacities, efficiencies, and driving cost reductions throughout our North American operations. These investments have had significant impact on improving quality and operating margins.

As we look ahead, we believe the industrial environment in the North American market should continue to provide good demand. However, YOY comparisons will probably temper as business activities in the prior third and fourth quarter were very strong, driven in part by significant demand resulting from the hurricane activity.

Turning to Latin America, in Latin America we continue to see very positive activity and completed the second quarter and first half with record sales and operating profit in the region. Overall sales growth in the quarter was 22% and 32% for the half.

Lincoln Mexicana sales increased 18% in the quarter, driven by continued strong sales to the energy, automotive, and equipment sectors. In Mexico we broke ground during the quarter on our [Otorio] machine plant expansion and expect the new facility to be ready for occupancy by the end of the year. In addition, we will be increasing capacity at our current wire facility in Otorio this quarter, and will also be opening expanded facilities in Montreal to house our new automation, our new training center, and finished goods warehouse.

Lincoln [del Brazil] sales grew by 43% in the quarter and 41% in the half. Results were driven by strong equipment sales into the oil and gas industry, domestic electrodes demand, and domestic and export volumes of new submerged arc products. The expansion of our flex cord wire operation at our Brazil facility, mentioned during our last call, has been completed, and we are in the final stages of the startup this quarter.

Venezuela continued strong with sales up 20% for the quarter, driven by energy sector demand and market share expansion in the country. Sales grew a strong 30% in the half. Oil related and infrastructure investments are driving consumables and equipment sales. We expect strong sales to continue for the balance of the year despite the potential disruptions from the upcoming presidential election in December.

YTD growth continues to be very strong in several other parts of the region, including Peru and Equador. From our perspective, the outlook for Latin America, the balance of the year is positive in light of the continuing demand for our products in energy, automotive, mining, and retail sectors, and the increased contributions to investments being made in that region.

In Europe, the economic outlook is more positive with the industrial confidence indicator improving by a point in June, representing the seventh consecutive month of improvement. Export growth spurred by a global infrastructure build underway remains the story. As a result, the European Commission has slightly increased the forecast for Q2 and 3 and full year GDP to 2.2%.

Our European sales increased 17% in the quarter to 92.3 million. In local currencies net sales were strong across all regions, growing 14% over prior year. Growth was positive in all European regions, exceeding double digits in several important markets.

YTD net sales increased 10% to 174.7 million with strong growth in exports in several key regions or operations, including our [Irhan] and [Twill] unit, which grew by more than 28% in the first half.

The energy sector in Russia continues to generate strong demand for our welding product and consumables. Other infrastructure development in hard goods manufacturing are also growing based upon the strong value represented by Russian oil and gas resources.

The 4,000 kilometer pipeline project, mentioned in our last call, continued to grow, generating more than $4 million in orders thus far this year. We believe Russia's economy will continue to grow and demonstrate great potential for Lincoln's manufactured product.

Turning to the market covering the Middle East and Africa, once again, energy continues to drive the robust business in the region. One of our new technology sub-arc processes using power wave AC/DC has been chosen to manufacture large steel filters [cans], which are used in oil and gas pipe, offshore drilling jackets, and large braces for shipbuilding. This new technology has demonstrated increased productivity up to 30% and improved quality at the same time.

Pipeline, power plant, aluminum smelters, and mining construction has also created robust demand for Lincoln engine driven welders and our specialty pipeline consumables.

The Lincoln Sales and Training Facility in [Dubuis] opened in May, which will help us to better serve the Middle Eastern countries and will help distributors and end users transfer new technology to the shop floor and construction site for increased throughput.

Looking to Asia-Pacific, in the quarter the Asia-Pacific Region posted a 44% YOY sales growth, with particularly strong growth in China. Total product sales in China were up 78% in the quarter, with strong momentum heading into the second half of the year. Compared with prior years Shanghai Lincoln Electric sales were up 48% primarily driven by volume, as well as material costs and price increases.

This past week, our Board of Directors approved a capital plan to double our flex cord wire capacity by yearend and to start construction on a new 90,000 s.f. building in Shanghai to accommodate more flex cord wire expansion and associated warehouse space.

In India we are moving forward with our plan to start producing consumable products. We have selected a site in South India, with construction expected to begin this year and production commencing in 2007.

Sales activity increased in most other parts of Asia-Pacific. Sales to Singapore improved by 47% with YTD sales up 55%. YTD Indonesia total sales increased 31%, driven primarily by electro export sales to Asia and the Middle East. We are also expanding our capacity at our Indonesia consumable plant and expect that new capacity operational by the end of year.

The South Korea market is showing strong growth with all major shipyards booked full until 2009. Korean shipbuilders are focusing on productivity and quality improvement, and we believe Lincoln is well positioned to take advantage of this with our high technology power wave machines and specialty consumables.

Down under, Lincoln Australia sales increased 15% in local currency and export sales increased 110% in the quarter, driven by sales of Indian driven welders and submerged arc consumables to Southeast Asia, the Middle East, and Africa.

That's a look at the market regions. A high level of activity and good results in all regions. We continued to execute on our strategy, and we currently have five plants being either expanded, under new construction, or nearing completion. These expansions will positively impact every market region.

Next, Vince will provide financial details on the quarter.

Thank you, John.

The second quarter of 2006 represents our tenth consecutive quarter of strong earnings growth. As John mentioned earlier, the quarter's consolidated sales were up 24%, with North American sales increasing 27%, and sales reported outside of North America up 19%.

Foreign currency increased reported sales by approximately 2%. In addition, about 3% of the Company's overall sales increase was attributable to our acquisition of J.W. Harris. Volume increases contributed a robust 17% of sales dollars in the quarter. Pricing had a minor impact on sales for the quarter, contributing 2% of the increase in sales dollars YOY.

On a product line basis, machine sales experienced a strong growth rate, increasing over 22%. Consumable sales were up 25% or 19% without the acquisition of J.W. Harris. Sales by product line were approximately 60% consumables and 40% equipment, approximating the prior year's same quarter.

The percent of gross profit in the quarter was 29.1% of sales compared with 28.1% in the prior year. The improvement in gross margin was primarily attributable to higher volume levels and the related operating leverage. Higher product liability defense costs reduced second quarter gross margins by approximately 50 basis points.

First half gross profit was 28.5% of sales compared to 27.6% of sales in the prior year. Again, the YOY improvement in gross profit was primarily due to favorable operating leverage caused by our increased volumes. Higher product liability defense costs reduced gross margins for the half year by 40 basis points.

SG&A expense in the quarter of $83.4 million was 16.6% of sales, down 110 basis points from the prior year. The lower SG&A as a percentage of sales was primarily driven by strong volume leverage. In addition, recent acquisitions reduced SG&A as a percentage of sales by 30 basis points. Higher bonus costs and the incremental selling costs associated with higher sales volumes were the primary factors driving the dollar increase.

SG&A for the first half of $160 million was 16.5% of sales, down 150 basis points from the prior year. Again, the lower SG&A as a percentage of sales was primarily driven by volume leverage and a predominantly fixed SG&A cost structure. In addition, the acquisition of J.W. Harris reduced SG&A as a percentage of sales by 50 basis points. Higher bonus costs, the incremental SG&A associated with J.W. Harris, and higher selling expenses were the primary factors driving the dollar increase.

Second quarter operating income at 12.3% of sales was up 190 basis points versus the second quarter of 2005. Operating income increased 47% in the quarter. The quarter did include $1.3 million of pretax charges related to continuing European rationalization efforts. Excluding these charges, second quarter operating profit margins would have been 12.5%.

First half operating income rose to 11.8% of sales from 9.4% in 2005, an increase of 240 basis points. Operating income increased 58% in the first half of 2006. The first half included rationalization charges totaling $2.3 million, again, related to the continuing European rationalization effort. Excluding these charges, first half operating margins would have been 12%. The prior year's first half also included rationalization charges of 1.3 million. Without these charges the prior year's first half operating profit would have been 9.5% of sales.

The income tax provision for the second quarter reflected an effective tax rate of 32.4%, compared to 24.9% in 2005. The higher effective tax rate is primarily the result of higher income before income taxes and higher tax rate jurisdiction, the related catch-up adjustment required to arrive at the expected annual 2006 effective tax rate, and a onetime tax benefit of $1.8 million reported in the prior year related to an adjustment of state deferred income taxes.

The YTD effective tax rate was 30.9% compared to 25.5% in the prior year. Again, the higher effective tax rate was due to higher income levels and the prior year's onetime tax benefit of $1.8 million.

Depending on the level of full year earnings as well as estimated tax deductions in 2006 we expect our effective tax rate to approximate between 30 and 32% this year.

Now, to review the balance sheet. Working capital turnover efficiency remained flat with average operating working capital for sales of 31.3%, the same as the prior year's end.

YTD cash flow from operations decreased to approximately $57 million compared with $62 million in the prior year's first half. The decrease in cash flows was caused by a higher working capital needs generated from higher sales volumes.

The Company invested approximately $32million in capital expenditures in the first half, compared with $21 million in the prior year's first half. The 2006 capital spending plan will continue to focus on capacity expansion as well as improvements in the overall cost base. We now expect to invest over $60 million on capital projects in 2006, further expanding our global capacity and improving our manufacturing efficiencies.

Other uses of cash flows in the first half included the payment of $16 million of dividends to shareholders. In addition, the Company contributed $16 million to its pension plans for the first half compared with $21 million in the prior year.

Our weighted average diluted shares outstanding increased to 43,008,000 shares for the second quarter compared with 41,845,000 shares for the 2005 second quarter, a 2.8% increase in outstanding shares. Shares outstanding at June 30, 2006 were 42,581,000 shares.

Our return on invested capital rose to 19.3% at June 30th, 2006 compared with 17.7% at December 31st, 2005. The increase in returns is reflective of our higher operating income. The Company closed the quarter with $32 million of net debt, including 125 million in cash. Our overall business levels remain solid, and we are optimistic that strong earnings growth will continue through the remainder of 2006.

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

[OPERATOR INSTRUCTIONS.]

Your first question is from the line of Gary Mcmanus with JP Morgan.

Hi, good morning, John and Vince.

Good morning, Gary.

Hi, Gary.

Hey, you know, I was reading through the 10-Q, and it looks like in the second quarter on the taxes you had a charge for valuation allowance of about a little more than $1 million. Can you explain what that is? And can I assume that's a nonrecurring item?

Well, that relates to, Gary, some NOLs that we have in Europe that prior to this quarter we believe had a likelihood of more likely than not that we would realize those NOLs. And the operating performance of this particular subsidiary hasn't been up to our original expectations, and so we took an additional valuation allowance against the deferred assets associated with the NOLs in Europe.

As far as considering it to be a nonrecurring item, these type of adjustments can occur from time to time, and I wouldn't necessarily consider it to be nonrecurring because we're adjusting valuation allowances based on judgments from quarter to quarter.

But the degree that you do, that you did this in the second quarter is a lot higher than normally is the case, is that right?

Yes, and that's why we disclosed that it was a couple cents per share additional charges to the income tax provision.

Right.

That's the disclosure.

But you didn't talk about, when you were talking about your commentary on the higher tax rate, you know, in your prepared remarks, so I just wanted to verify that.

It was one of the smaller items affecting it. The bigger impact on the effective tax rate, was really last year's rate being lower because of the $1.8 million.

Yes.

Benefit. And then a bigger impact to the quarter, this quarter, was much higher earnings than we had initially anticipated.

Okay, I hear you. Looking at, you know, you had 2% pricing in the quarter, you know, company wide. I think that's the lowest growth we've seen in more than two years, so can you comment on the overall pricing trends? Is it becoming more competitive out there? I mean certainly you're still seeing very strong volume growth. You know, why are the pricing gains starting to diminish? And is there kind of greater competitive dynamics out there than in the recent past?

I would say, Gary, the biggest driver has really been the consumable material cost issue that we faced. It's very significant magnitudes over the course of the last 18 to 24 months.

As we commented, as we were going through that, we priced our products to capture all of the costs and try to recapture some of the margins, but we weren't always able to do that. As prices have stabilized we've focused more on trying to rebuild the margins. And I think if you look at our margin improvement you can see some of that.

The material side of the consumable business has been much more stable through the first half of this year, although we're seeing a little bit of upward pressure on that. And in the area of equipment where we saw a pretty significant commodity increases in the consumable, or excuse me, on the commodity side, the things like copper and aluminum, we've moved pretty effectively I think and have been kind of ahead of the pace of some of our competitors in that area.

So our strategy stays the course that, you know, we think our products demand a premium in the marketplace and we're continuing to price according to that.

Okay. The last question is kind of, you know, two kind of related things. You know, what is Lincoln's exposure to the energy markets generic, generally speaking? And kind of where are we on the welding equipment cycle? It looks like that's where we got another 20% organic growth, at least through the first half of the year. You know, we've had like 20% gains the third year in a row. So kind of where are we in the cycle and how much – how important is the energy sector to Lincoln?

Well, you know, Gary, that's – it's almost impossible to identify it as just the energy cycle because so much of this energy cycle is contributing to people, like in the construction equipment and related infrastructure type of work that's been driven by that.

Obviously, the energy sector under today's economic cycle would, say automotive a little bit softer is taking a bigger focus, but it's a global expansion and one of which I don't see any slowing to under the current view that we have of what's taking place in these kind of products, sectors around the world.

So a big part of the equipment strength that we've had, and if you look at the export numbers has been the demand for our high tech technology product in these sectors and other sectors around the world, like shipbuilding, that are driving very, very hard to complete projects in accelerated fashions and looking for productivity improvements. And we've got products that others don't have that's capturing a lot of attention into those marketplaces.

The final point would be is that the hurricane activity in the third quarter of last year really started a big trend in engine price. That trend has maintained a very good pace but it's not likely to accelerate and have the kind of bump that we got last year unless there's another big episode of that, and we're all hopeful that doesn't happen.

Okay, thanks.

Your next question is from the line of [Walt Lipnek] with [Behrington Research].

Hi, thanks. Good morning, guys.

Good morning.

Hi, Walt.

The – obviously, your volumes are going along well. You know, in general industrial there's been some concern about slowing, and I wonder if you look at your month's sequentially, you know, if the trend continued to be strong throughout the quarter? And wondering if there are any sectors that you're seeing turning down, at all?

First, I would say that our order book continues to look very strong, Walt. And I wouldn't say at this point in time even in late July that we're seeing any weakening. And that's true across most all geographies in the world.

In the prepared statements I think we've noted that Middle East and Asia and Latin America are all very strong, even growing at higher rates of YOY performance, the North American business. And so we're seeing a continuing good growth across most all geographies and product categories.

But if there is one area that is not as strong, it's in the retail segment which we've seen some softening over the past quarter or so. And that segment, of course, is less than 10% of our total sales, but it's not as strong as what we've seen in the past or as strong as some of our industrial business in the last quarter or two.

Okay, good. And then the hurricane related sales in the second half of '06, I wonder if you've quantified those or if you can give us an order of magnitude?

We gave some rough estimates in the prior year. We're not, we don't have exact quantification of those because there's obviously a lot of knock-on activity from that. But I think we said in the third quarter of last year it was roughly 8 to 10 million, and then in the fourth quarter we cut that in half to roughly 4 to 6 million. And then it even trickled into the first half of this year and roughly got cut in half again I the first quarter of '06. So those were our rough estimates of the third and fourth quarter of last year.

Okay, all right, thanks for that. And the price increase, when did that go into effect, and how much did you raise for machinery and consumable?

The increase, it was primarily in equipment, although there were specialty consumables that had very high value, like aluminum and nickel, stainless kind of materials. The price increase went into effect June the 15th, Walt, I think, I have to go pull the date of it. And I think the impact of that was 3 to 5% depending on the product category.

That will start showing up in sales for this quarter, for July?

Yes, some minor impact last quarter, but stronger impact in the second half of the year.

Okay, good. All right, thank you.

Your next question is from the line of [Steve Barger] with Citibank Capital Markets.

Good morning, gentlemen.

Good morning, Steve.

Yes, just to follow-up on the prior energy question, can you tell us how much of the progress that you're seeing is the result of end market demand versus actual market share gains there? Can you quantify that?

Well, I think it's both. That's a sector, quite frankly, that we have always been very, very traditionally strong in. So as that sector has taken on a greater significance in the global economy we're obviously benefiting.

But as I mentioned, you know, our new technology, particularly in submerged arc equipment is capturing a very large share of sales on the equipment side of that, more so even than our traditional kind of position because it is so much further advanced than any competitive equipment in that product category.

And, again, that's happening all around the world where traditionally we would have benefited in that from North America, but today that equipment is equipment of choice even in the emerging markets, so we're seeing very strong gains there.

I think I commented at the last conference call that we know of confirmed construction projects in the Middle East that are on the books of over a trillion dollars.

Right.

And those are significant kind of numbers and they're going to be in place for quite some time.

Earlier this month I visited Northern Alberta to visit the oil sands activity that is going up there, and a very similar story. I mean people are rushing to buy equipment to try and get production equipment into the ground. And hundreds of billions of dollars of construction equipment, projects committed there. And, again, you know, a pretty long timeline associated with it.

And you can go right around the world and see the same kind of a story as people try to capitalize on both the demand aspects of oil and gas but, more importantly, on the price aspects of it. And, again, we could be surprised, but, you know, there doesn't appear to be any end in sight in that kind of activity in any place that we're focused on, at least.

Okay. So, to follow-up on that, how should we think about your local capacity in those markets, in the higher growth markets internationally? And are you having to ship significant amounts of machinery and consumables? Or are you capacitized to serve those high growth markets right now?

Well, you know, as I mentioned, we have five plants that are either brand-new plants that are being built or plants that are being significantly upgraded. Obviously, we're doing that because we're at capacity utilization numbers that are very, very high. And in certain areas we'd like to have more immediate capacity and we're accelerating the plants or the infrastructures to accommodate that.

Cleveland is an example, we're adding significant capacity for our large engine drives because we see a good future there. Canada the same kind of a situation. We're adding flex capacity in France and Brazil. That's, again, energy related kind of activity. Cord wire activity, we're adding capacity in the U.S., Brazil, China, and a brand-new and pretty significant plant in Poland.

So, you know, we're at levels of capacity that we're strained with but we think we've got a strategy that will completely alleviate that in short order and give us the opportunity to take advantage of, you know, the growth that we see coming.

And, Steve, those comments are generally directed at consumable capacity that is at higher levels of utilization rates than say our overall machine capacity. There are areas, as John mentioned, engine drives, where we're expanding in the U.S. and Canada, but most of the plant expansion is really related to the consumable capacity increases.

Right. Okay, thanks. And along those lines, how should we think about employee headcount as you increase capacity from consumables and machines, and what do you think that will look like relative to direct labor and SG&A going forward?

Well, from a headcount perspective, for the most part the increases in headcount are associated with adding the necessary direct labor to build the products.

From an SG&A and a general overhead standpoint we do have a continuing leverage that can be achieved. When you look at headcount additions historically over the past year or so they predominantly have been in the area of direct labor. So to the extent that we are adding capacity in large part this capacity addition or the headcount requirements are direct labor.

Okay. And just one final one, for your sales driven working capital needs, do you see more of an impact in inventories or receivables? And is what we saw this quarter kind of what we should expect on a run rate going forward, given strong growth?

Well, we have – the quarter growth in receivables and inventory was similar, both using approximately between $20 and $25 million of additional working capital.

As far as moving forward, I think we hope that working capital needs will not grow as rapidly as what we've seen this the past quarter. And the first quarter was a better result from a working capital usage standpoint, so we're hopeful that moving into the third and fourth quarters of this year we will harvest a bit of this working capital growth.

The other element of that, Steve, is the rapid rise on commodities, particularly in the equipment side. And, as you know and I'm sure you do, what happened to copper and aluminum prices in the last six months. The same volume of those raw materials are now worth double the price, so.

Right.

That has mitigated and that should have some impact, and, you know, we're focusing on the opportunities in inventories to close out the year.

All right, gentlemen, I appreciate it. Nice quarter.

Thank you.

Your next question is from the line of [Fred Stahl] with UBS.

Good morning or good afternoon, gentlemen. Just a question on the five plants you mentioned earlier. How much capacity are you adding to the group in percentage terms? And could you also comment on the general state of the industry when it comes to capacity? And I have a feeling that many of your competitors are adding capacity, as well?

Well, I would say some of our competitors are adding capacity, I wouldn't say many, at least from what I've been able to see or to read. I think that Lincoln has always taken a very long-term view towards our market, and we've been fortunate enough to be able to continually invest in the growth opportunities that we see down the road and to be well-positioned to take advantage of that. Quite frankly, I don't see that on the part of many of our major competitors, although there are one or two that are.

This has been a globally driven growth, and I think it takes a big player to be able to participate in it. The smaller niche players are not really focused on trying to take advantage of some of the global growth opportunities that exist there.

In terms of what our overall capacity percentages are, I don't think that we want to talk too much about that other than to say that we think it positions us very well to take advantage of the growth in the strategic markets that we think we want and need to play in.

Okay. Thank you.

[OPERATOR INSTRUCTIONS.]

Your next question is from the line of Holden Lewis with BB&T.

Thank you. Good morning.

Good morning.

On the gross margin side, I know you're talking about sort of volumes and absorption on that, but what was the role not only of price but raw materials. I mean you've been trying to stay ahead, obviously, of pricing increases but what did your raw materials do? Did that sort of wind-up sparking any of the improvement in the gross margins? Are you seeing a little bit of price and a little bit less pressure on materials, anything like that, that dynamic?

Now, Holden, our raw material prices did increase, depending upon the line of business in the low to mid single digits. Price increases that we have implemented in the half year were required to cover those commodity and other cost increases. We don't believe that we achieved any additional margin expansion because of the price increases, but were used to offset some of these higher raw material costs.

But in comparison to where we have the rapidly accelerating raw material costs we were able to preserve our margins not necessarily increase it.

Okay. I mean it just seems like this quarter you really saw a big step-off. And you've been having very strong growth over the past, you know, call it five or six quarters. And it just seems like a switch got flipped here this quarter that did not occur in the last few quarters to really drive the margin up. And I'm just sort of curious really what was the delta, what really was the catalyst of seeing a big step-up this quarter where you haven't, despite volumes in prior quarters?

Well, there's a lot of – there isn't one particular catalyst, Holden. There are a number of smaller factors that continue to drive-up our margins. We're improving our margins in other geographies outside of North America that were challenged somewhat, including Asia and China where pricing has moved up nicely and costs have stabilized. Our Latin American businesses are continuing to realize margin expansion.

And I wouldn't say there's any particular one reason why we had a good bump-up, but I will also point out that we had, again, a 17% volume increase on top of high double-digit 20% + volume increases in the prior year.

So we're just continuing to see the opportunity that the organization has to achieve greater and greater operating leverage. And so that's, the key, if there's one key to the overall significant margin expansion it's a much higher volume level that's giving us this kind of operating leverage.

And then on the SG&A side, even though you had improvements YOY, it looks like your SG&A kicked up a little bit sequentially as a percentage of sales. Besides the fact that this is a very strong volume, very strong revenue, I thought there might have been more of an absorption impact. Are we seeing accelerating sort of costs rolling through that line, or what's the dynamic there?

There really aren't any particular items that are affecting that. In our view the SG&A is relatively stable quarter over quarter. It's not going to perfectly continue to move down every quarter, so we're still in line with what our expectations are.

We are accruing more bonus in the second quarter versus the first quarter to account for the much higher operating earnings than what we might have expected at the end of the first quarter. And really that's the biggest variable component of our SG&A dollars in the first two quarters and, particularly, the second quarter were bonus dollars.

Can you give a sense of how much higher that accrual was in dollar terms? What was sort of the…

Yes, it was $11 million for the half.

Right. And how much of that did you put in the second quarter?

It was about 5 in the first quarter.

5 in the first quarter, okay. Okay, thanks.

[OPERATOR INSTRUCTIONS.]

Your next question is from the line of Seaver Wang with Utendahl.

Hi, good morning. I just had a quick question on litigation costs. I guess you had in the past couple of quarters said that you thought it had kind of flattened out, but it seems like maybe they've ratcheted up a little bit, again. Can you kind of give a sense of where that's headed? You've had some, I guess, positive results in certain cases?

Yes, we have, Seaver. We did have a higher level of activity in the first and second quarter of this year than we had predicted originally. We had a [stefus] case that came to trial in the second quarter that added to costs, as well as a higher level of activity in the MDL in Cleveland, Ohio.

So we're hopeful that moving forward that we're at a peak level of spend, and hope to see further increases in legal costs to be perhaps smaller than what we saw in the first two quarters of this year.

Do you break-out how much you spend on an annual basis on the litigation?

We don't break-out the total. What we've done heretofore is just talk about how much the costs have increased from quarter to quarter and year to year. And for the half year the costs are up about $4 million.

Okay.

And for the quarter they're up approximately 2, 2.5 million, between 2 and 2.5 million.

Okay.

YOY.

At this time, there are no further questions. I will now turn the call back over to Vince Petrella for closing remarks.

Thank you, Meredith. And thank you, all, for joining us and for your continuing interest in Lincoln. We're looking forward to having another good quarter in the third quarter, and we'll be talking to you in late October. Thank you very much.

Thank you. This concludes today's conference call. You may now disconnect.