Lincoln Electric Holdings Inc (LECO) 2006 Q3 法說會逐字稿

Good morning. My name is Marie, and I will be your Conference operator today.

At this time, I would like to welcome everyone to the Lincoln Electric Holdings 2006 Third Quarter Conference Call. [Operator Instructions]

Mr. Petrella, you may begin your Conference.

Thank you, Marie. And good morning. Welcome to our 2006 third quarter earnings call for Lincoln Electric Holdings.

We filed our 10-Q and released the quarter's financial results prior to market opening this morning. Both are available on Lincoln's website or by contacting our Investor Relations Office at 216-383-4893.

Joining the call this morning is John Stropki, Chairman and Chief Executive Officer. John will comment on the quarter and global market regions in a moment. Following John's review, I will go over the financial details.

But first, let me 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.

Now, for a look at our performance in the quarter, here's John Stropki.

Thank you, Vince. And good morning, everyone. And let me start by thanking you for your continued interest in Lincoln Electric.

We've just completed another strong quarter and delivered excellent sales and profit gains. The sales growth was significant, especially compared with the very strong 2005 baseline. And we are pleased that we continue to see broad-base growth from all of our operations around the globe.

Net income in the quarter increased 15% to $43.9 million, up $0.12 per diluted share on a 20% sales increase to $495 million. Operating income increased 50% to $59.7 million. Net income for the quarter included non-reoccurring items in both 2005 and 2006, as detailed in our Earning Release and our 10-Q. Excluding these non-reoccurring items, third quarter 2006 adjusted net income increased 48% to $44.5 million, or $1.03 per diluted share.

In the quarter, North American domestic sales were up approximately 20% to $330 million, and North American exports grew 70% to $42 million. Sales at Lincoln subsidiaries outside of North America increased to $165 million. This is an increase of approximately $30 million, or 22%, compared with a-year-ago quarter.

Looking at the nine-month period, net income increased 33% to $123.2 million, or $2.87 per diluted share. And operating income for the nine months increased 55% to $173.7 million. Net income for both 2005 and 2006 nine months included non-reoccurring charges, as detailed in our Earnings Release and in our SEC filings. Excluding these non-reoccurring items, adjusted net income increased 51% to $126.2 million, or $2.94 per diluted share, in the 2006 nine-month period.

Sales in the nine months increased 24%, or 20% excluding the April 2005 acquisition of J.W. Harris, to $1.47 billion. North American operations were $986 million in the nine-month, and North American export sales increased 60% in the nine-month period to $113 million. And sales of our operation outside of North America increased 18% to $480 million over the same period.

Those are the top-level numbers. Vince will give you a detailed review in a few minutes.

Next, I would like to briefly review the activities in the regions. First, North America -- industrial activity in the United States and Canada was relatively stable. The operating environment remains healthy when compared to the robust 2005 periods, with key industries that we serve continuing to show positive year-over-year growth. However, those year-over-year comparisons have started to moderate. Capacity utilization in the United States continues to run in the mid 80s. And it looks like interest rates, energy and commodity costs are stabilizing; all good news.

Going into the fourth quarter, we continue to see investments in order patters that would suggest continued positive but slower momentum in the near term.

We did experience strong sales-dollar growth across most product lines and distribution channels. For example, volumes in consumables in the U.S. and Canada reflect strong overall demands in general fabrication, oil and gas, ship-building and construction equipment sectors of our economy. The rental equipment channel remains very strong. However, retail sales are somewhat soft.

In addition, exports from our U.S. and Canadian manufacturing operations were excellent, where global demand continues to be robust in developing countries, as well as energy and transportation-related projects.

We are very pleased with our leverage in profitability, where our operating profit ratios have improved nicely, driven by both volume increases and our continued relentless focus on productivity and cost-control activities.

As I mentioned in our last call, we are continuing with our key strategic capital programs, aimed at increasing capacity, improving efficiencies and driving cost reductions throughout our North American regions. As an example, during the quarter, we approved new expansion plans to support our growing business, with particular attention on robotics, big wire, and aluminum welding consumables.

Looking forward, we believe that the industrial environment in North American markets should continue to provide positive trends in demand when compared to prior years, although it is our expectation that the year-over-year trends will moderate when compared to more recent and very robust growth levels we have experienced this year.

Turning to Latin America -- the Latin America region closed the third quarter and year-to-date with record sales and record operating profit. Overall sales growth in the region was up 30% for the quarter and 31% year-to-date. Operating margins also saw a marked improvement and excellent leverage.

For the quarter, Lincoln Mexicana sales increased 19%, driven by continued strong sales to energy, automotive and equipment-construction sectors. The expansion of our [Torreón] Mexican machine and consumable plants announced last quarter continue on schedule. In addition, the move to an expanded facility in Monterey to house a new automation training center and finished-good warehouse has been completed.

Sales at Lincoln Brazil grew by 50% in the quarter and are up 44% year-to-date. Again, the energy sector played well here, with results driven by strong equipment sales into the oil and gas industry, as well as domestic electro demand and domestic and export volumes for Submerged Arc Flux.

Our new Flux-Cored Wire facility expansion is now producing product for the domestic market. And we are currently developing plants for additional capacity expansion in this product area for Brazil.

Sales were also strong in Venezuela, with growth over 40% for the quarter and approximately 34% year-to-date, and in other parts of Latin America, such as Peru, Ecuador and Columbia, continue to show good growth due to energy-related sales and increased market penetration.

Looking to Europe -- the macroeconomic story in the Euro zone remains positive. Economic sentiment continues to improve [and attract at] five-year highs. GDP forecasts for 2006 have been adjusted upwards to 2.5%. Inflation remains tame at 1.8%, and unemployment relatively positive at 7.9%. Although there are expectations for a slowdown in 2007, the growth rate and immediate outlook is quite positive.

Lincoln Europe continued strong, resulting in a very good quarter. Sales were up approximately 24% over prior-year, with the majority of regions growing at double-digit rates. Demand in the energy sector in Russia continued strong, and we continued to increase our presence in the overall fabrication sector throughout all of Russia.

Sales for the Russian VSTO pipeline project, which we mentioned on our last two calls, now stand at approximately $8 million year-to-date. And the construction will continue through this winter and all of next year.

Turning to Lincoln Middle East and Africa -- the Middle East and the trillion-dollar gulf construction market continues to bolster welding sales. Investments in oil and gas, petrochemicals, aluminum and fertilizer continue to be strong. Local steel production is also being increased to supply these infrastructure projects in the region.

The grand opening of our new Dubai Sales and Training Center in mid-November will provide seminar, demonstration and technology updates to the market for process improvements, increase welding productivity and quality to meet this high demand. In Sub-Sahara Africa, mining and energy continues to play a major role in the increased demand for our welding products.

And lastly, looking to Asia Pacific -- sales in the region were up 12% in the quarter and 27% year-to-date, reflecting overall demand in key market segments which remain strong, particularly in China. This is especially evident at our biannual Asia Distributor Sales Meeting held in Shanghai last month. More than 100 distributors and guests attended from all over Asia. The introduction of our new machine line and consumables from China, combined with strong demand for Lincoln high-tech imported products from around the globe, contributed to a very successful event. We showcased our new plant and welding training centers and generated new orders in excess of $12 million during the three-day event.

Overall, third quarter sales in greater China were 34% ahead of year-ago quarter and 40% year-to-date ahead of the prior year. Imported product sales, from all Lincoln regions into China, are up over 80%, with the order backlog strong heading into the fourth quarter.

We will start construction of our new 90,000-square foot building in Shanghai next month to accommodate Flux-Cored Wire expansion and associated warehouse space. This new facility will enable us to more than double current Flux-Cored Wire output in China. Also, we are opening a third sales branch in Chengdu, Sichuan Province, and additional branches are planned for fourth quarter '06 and first quarter '07.

Down under, Lincoln Australia exports increased 38% on a year-to-date basis.

As previously announced, we have completed purchase of a site in India for the construction of a welding consumable plant. We closed the land purchase in Chennai for the greenfield manufacturing process last month.

On an import basis in India, third quarter sales were up 22% and 34% year-to-date, with sales being driven by healthy orders from the pipe mill and pipeline sector. For example, we recently signed a $4 million contract with a leading pipe mill in India for supply of our flux and wire consumables. We also secured a very significant order for Power Wave machines into the automotive sector.

That's a look at the market regions. I'll turn the call back over to Vince, who will discuss the financial details in the quarter.

Thank you, John.

The third quarter of 2006 represents our 11th consecutive quarter of strong earnings growth. As John mentioned earlier, the quarter's consolidated sales were up 20%. Of this amount, foreign currency increased reported sales by 2%. Volume increases contributed a robust 15% to sales dollars in the quarter. Pricing had a relatively minor impact on sales for the quarter, contributing 3% of the increase in sales dollars year-over-year.

On a product line basis, both machines and consumable sales experienced a strong growth rate, both increasing approximately 20%. 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 28.5% of sales, compared with 27% in the prior year. The improvement in gross margins was primarily attributable to higher volume levels and the related operating leverage achieved. Year-to-date gross profit was also 28.5% of sales, compared to 27.4% of sales in the prior year. Again, the year-over-year improvement in gross profit was primarily due to favorable operating leverage caused by our increased volume levels.

SG&A expense in the quarter of $81 million was 16.4% of sales, down 100 basis points from the prior year. The lower SG&A as a percentage of sales was primarily driven by strong volume leverage. Higher bonus cost accruals and the incremental selling costs associated with higher sales volumes were the primary factors driving the dollar increase.

Year-to-date SG&A of $241 million was 16.4% of sales, down 140 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 last year reduced SG&A as a percentage of sales by 40 basis points. Again, higher bonus costs, the incremental SG&A associated with J.W. Harris and higher selling expenses were the primary factors driving the dollar increase.

Third quarter operating income, at 12% of sales, was up 240 basis points versus the third quarter of 2005. The quarter did include approximately $700,000 of charges related to continuing European rationalization efforts. Excluding these charges, third quarter operating profit margins would have been 12.2% of sales.

Year-to-date, operating income rose to 11.9% of sales from 9.5% in 2005, an increase of 240 basis points. The first nine months included rationalization charges totaling $3 million related to the continuing European rationalization efforts previously mentioned. Excluding these charges, nine-month operating margins would have been 12.1%.

The prior year's nine-month period also included rationalization charges of $1.3 million. Without these charges, prior-year's nine-month operating profit margins would have been 9.6%.

The 2005 prior-year third quarter included $1.4 million pretax, or $900,000 after-tax; $0.02 per share of income related to the settlement of legal disputes.

The income tax provision for the third quarter reflected an effective tax rate of 28.9%, compared to 10.9% in 2005. The 2005 third quarter included a one-time tax benefit of $7.2 million related to the resolution of prior-year tax liabilities. Without this benefit, the 2005 quarterly effective tax rate would have been 27.7%, and the year-to-date rate would have been 27.9%.

The higher year-to-date effective tax rate, without these one-time benefits, is primarily the result of higher income before income taxes. The year-to-date effective tax rate was 30.2%, compared to 20.1% in the prior year. Again, the higher effective tax rate was due to higher income levels and the prior-year's one-time benefits of $9 million.

Third quarter cash flows from operations increased to $47.8 million from $37.6 million in the prior-year's same quarter. Year-to-date cash flow from operations increased to approximately $105 million, compared with $99 million in the prior-year's nine-month period. The increase in cash flows was attributable to higher profitability.

The Company invested approximately $53 million in capital expenditures in the nine-month period, compared with $36 million in the prior year-to-date period.

The 2006 capital spending plan will continue to focus on a capacity expansion, as well as improvements in the overall cost base. We now expect to invest over $65 million on capital projects in 2006, further expanding our global capacity and improving our manufacturing efficiencies. Other uses of cash flows in the nine-month period include the payment of $24 million of dividends to shareholders.

Weighted average diluted shares outstanding increased to 43,119,000 shares for the third quarter, compared with 42,336,000 shares for the 2005 third quarter; a 1.8% increase. Shares outstanding at September 30, 2006 were 42,645,000 shares.

Our return on invested capital rose to 19.5% at September 30, 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 $15 million net-debt position, including $146 million of cash.

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

[Operator Instructions] [James Bank].

Hey, James.

Hi, Vince, hi, John. How are you?

Great.

Good.

Terrific.

So just wanted to clarify a couple things. You seem to lean toward slight moderation in the North American markets, with expected continued robustness in international markets. Looking at the industrial production number that came out September, still grew, at an annual rate, 3.6%; and for September year-over-year, 5.5%.

So I guess, if you could just give us a little bit more color, in terms of what type of moderation you might be looking for in the North American markets.

Well, Jim, just first let me say that what we see today is still a very strong level of business. We're seeing a bouncing of the industrial production numbers more month-to-month than what we have seen in the past several years. But I think it's unrealistic to expect that that can just continue to grow at the very robust levels that we have seen.

Okay.

So, it's very difficult to predict. But we're very confident that what we see now is still very positive.

Okay, terrific.

Then just a couple other quick questions -- in terms of -- this is something that was mentioned on the press release -- in terms of market share gains, I guess with your core strategies international -- could you just give me a little bit more color on that? I understood you spoke about India expansion, and so forth. I was just wondering if you could even put like maybe a number on this market share gain with your global share.

Well, there are a couple other public companies that report welding sales, and you could refer to their numbers. But most of those companies that I've looked at had reported for the second and/or third quarter -- depending on what they've reported -- numbers in the high single digits or low teens, versus our more robust 20-plus percent type of number.

A lot of that is by new product introductions that we've talked about, and our heavy investment in R&D, and what that's been able to capture for us. And the second element of that is just building this global footprint and the capacity that is a result of the capital that Vince spoke of; that we have dramatically increased our capacity at a time that has been very appropriate for us and has given us an opportunity to really benefit, I think, in a way that some of our competitors haven't, either due to lack of capacity or lack of the right products.

Okay, terrific.

And does that sort of stem from maybe what you're doing in Europe? I saw the price increase benefit at 8%; is that really just stemming from not much competition in that area, and you're able to get those price increases over?

Well [inaudible] we talked last call, we still have plenty of competition around the world, and we don't see any real lack of good, solid competition. But I think that again, it's a mixture of our product line and our technical sales approach to the market of offering value-added products versus commodity products. And when people are investing heavily in these very, very expensive oil and gas and infrastructure-type projects, the most important thing to them is technology and high quality, not low-cost consumables.

Right. Terrific.

And last question -- and I apologize if you brought this up in your comments -- the rationalization of the Irish plant, and now moving to Poland -- is that on-line yet?

We are producing product in the Poland plant. We expect to complete the final transfer of all of the equipment and production by the end of the first quarter. So the phase is on schedule; the building is complete. We have people producing in Poland. We've acquired the new equipment that we were going to acquire to start up that production, and now we're transferring the old equipment and phasing down in Poland -- excuse me -- in Ireland.

Okay. So we would see, then maybe, the full margin benefit in the first quarter of '07?

If not the first, it would be clearly into the second. Because the Irish plant will be completely shut down by that period of time.

All right, terrific. That's all I have. Thank you very much.

James, as far as price increases are concerned, I think you referred to Europe as having 8%. Europe actually was relatively flat on a pricing -- from a pricing standpoint. You're referring to other countries. So that would encompass Latin America and Asia, and not Europe.

You're right, Vince, I'm sorry, I did say that. I did mean other countries.

Okay. Thank you.

Okay, thank you.

[Walt Lipitt].

Hi. Thanks, good morning. This is Walt Liptak, with Barrington.

Hi, Walt.

Hi, Walt, how you doing?

Good. Congratulations on a really nice quarter.

My question is on price increases. Now that -- it seems that material costs have moderated somewhat. I wonder if you could comment on your material costs and any planned price increases through the end of this year or the beginning of next year.

Well, I think again, Walt, you have to break that down a little bit by different segments. I mean, clearly, carbon steel wire rod has stabilized. It hasn't gone down, but it's -- the volatility has been eliminated. And we expect in the foreseeable future for that to be pretty much the case.

We still see some volatility in the alloy parts of our consumable business, particularly stainless and nickel kind of products. And if you follow that on a commodity basis, you see that that's regularly bouncing against historic kind of highs. And we have to be responsive, and we have always been, to that. And we do that through surcharges versus price increases, because it's more immediate, and the impact is clearly definable.

On the welding equipment side, we still have some challenges in the copper area, both on the availability and on the cost of copper. But again, we track that very closely on a monthly basis, as far as [PDM] is concerned. And we make any necessary adjustments.

Our strategy at this point is to have a first quarter -- early first quarter 2007 price increase on consumables and equipment for our major markets.

Okay. Thank you.

And then, the tax rate for 2007 -- Vince, I'm not sure if I caught that -- what tax rate should we use?

I didn't say.

Oh.

But that tax rate is dependent upon our level of earnings that we expect in 2007. For 2006, our rate --

-- yes, I meant for 2006.

Okay. For 2006, you should use the rate that we've booked through nine months, which is 30.2%. So that's our expectation for the effective rate for the full year.

Okay. Okay. And your North American growth -- volume growth was impressive, especially considering the tough comps that you were up against with the hurricane-related sales last year. What -- you didn't mention that in this call -- what were the hurricane-related sales last year? And I'd like to try and adjust volumes for that.

Well, last year, I believe we gave a range of between $8 million to $10 million of hurricane sales in the third quarter. And then, in the fourth quarter, we gave a range that was roughly half of that. And we said that some of those hurricane-related sales, from a machine standpoint -- particularly engine-driven type welders -- was cut in half again in the first quarter, and then it diminished from then on. So those are sort of the range of numbers that we gave last year for hurricane-related activity.

Okay. Okay, thank you.

[Evan Steen].

Hey there, guys, nice quarter.

Just on the moderation -- I've followed you guys probably for a long time; well over 10 years. And I know that you're introducing new products, and whatever. But I'm also just trying to be realistic. And I know that mid-high teens volume growth is something that happens usually in a cyclical upswing. But on a long-term basis, that is not something we should be expecting.

So I'm curious if you guys, from a longer-term planning process, have any sense of what you think the organic growth rate of the market is, plus your ability to take market share; some number that -- for the next quarter, whatever. But when I'm looking at the '07, '08, '09, in terms of modeling purposes, I mean, I'm not quite sure exactly what that number sort of settles down to.

Well, Evan --

And I know -- because you tend to go from very high teens for a couple years, then a little bit lower; then you may go flat to slightly negative. And then obviously, early in the cycle, you have some enormous numbers, and then you have to comp against higher numbers. And I'm just trying to get a sense.

From a long-term perspective, the way that we would look at what our sort of steady rate would be is we look at the markets that we participate in now. We look at the welding markets that we're entering and expanding our business. We have a reasonably good idea of longer-term welding and steel-related activities in different regions of the world. And based on the longer-term growth rates of our participation in those regions and what we think those will grow at, we think, from a long-term perspective, sales volume should grow in the mid-single digits.

Okay, that's fair enough.

The only -- I mean, it's probably a non-concern -- but the only issue I have is I saw Cat came out with their numbers, and they sort of took down guidance and talked about the housing. I know you're not really that involved with that. But they did mention on the heavy equipment and stuff like that. Is that what you're referring to when you say “moderation;” just a little bit of things like that? Or is it just more that you're just comping against very tough numbers?

I think it's probably a combination of both, Evan. But I was at Caterpillar in Illinois and in Northern Mexico, three days the week before last. And they are at very, very high levels of production, historically high levels of production. And don't -- I don't see that moderating from what I saw or whom I talked to.

I think that, like you discussed, it's unrealistic to expect that you can get 20% year-on-year sales gains forever. But when you reach a level of business that our customers or we are at, and you can get good growth on top of that, it's going to provide very, very good results and good leverage opportunities. And I think that's what we're focused on.

[inaudible]

But don't lose sight of the fact that this is a $13 billion industry. We think that we're somewhere 15 to 16% of the market share of that industry on a global basis. And that gives us plenty of opportunity to execute our strategies of new product introduction and global expansion to gain shares in important markets around the world.

Right.

And one thing I would add, Evan, that we've been talking about for some time, you would know, is -- I think today, we have a better global footprint than we've ever had; whereas traditionally, 10 years ago, when you started following the Company, it was largely a North American business with a relatively modest footprint in non-U.S. -- or non-North American geographies. Today, we're in a better position than ever before to take advantage of somewhat higher growth trends in Latin America, in Eastern Europe and in Asia Pacific. So our percentage of sales and profitability in North America is now at the lowest level that we've seen in the 10 years that you've been following the Company.

Okay, one --

[inaudible]

No, that answers it.

One last question -- in the past, you guys have obviously made some acquisitions; those have worked out fairly well. Is there anything that you feel you need to fill in? Or it seems like more lately, you've been doing it internally as opposed to making large acquisitions, particularly internationally, to sort of establish a presence.

Well, I would say that there are both some product sectors that we're focusing on, from an acquisition standpoint -- if we come to the conclusion we can't find an attractive opportunity there, we do do an internal R&D effort. But we do have some good opportunities from a product sector.

And then secondly, the geographical expansion in important markets like China -- I think there'll be a continued consolidation of manufacturers in China. There are way too many companies. And I think there'll be some good opportunities. And we're going to continue to focus on those opportunities as they present themselves. But if we can't find again attractive offers that give us that opportunity, we know how to build the capacity in the country and do it organically.

Right, okay. Okay, great. Thank you very much.

[Steve Barber].

Good morning.

Hey, Steve.

Morning, Steve.

Congratulations; very nice quarter.

I'd like to dig into Europe a little bit more. What's the key driver in the volume gains there? Is it a function of just increasing your capacity there? Or how do you see that market?

Well, we've been going through some significant rationalization efforts in Europe for several years, getting a management structure in place, getting an organization that is much more competitive from a cost basis and much more efficient. And that's allowing us to capitalize both on a more robust European economy and to capitalize on some market share growth opportunities. And so I think it's a combination of a number of different things. And we still have not completed that journey. We have two brand new plants under construction in Poland, one which we talked about for the gas apparatus.

But I think more importantly -- from a futuristic point of view in the volume and market share side, is our Flux-Cored plant, which will come on-stream in the first quarter or early second quarter of next year; and then our pretty significant expansion in Turkey of our consumable business there.

So we're focused on where the market is and where it's going to. And we see it moving heavily into Eastern Europe, and we're positioning ourselves to be sure that we're there, from both a capacity and a cost basis, to capitalize on it.

Right.

Just -- sorry if you mentioned this earlier, but how do you think about European growth rates on a kind of sustainable basis?

Well, in the West -- you have to break it up between the West and the East. And the West is going to be in the low single digits. And the East is going to be in the mid to higher single digits from a long-term perspective.

Okay.

And one last -- can you talk a little bit about the automation business? What are your expectations for growth there? I know you just added capacity. But how do you see that market playing out in the nearer term?

Well, we're very bullish on automation. There are a number of issues that we're addressing there. One obviously is productivity and efficiency. But as you go around -- and going back to the conversation about Caterpillar, one of Caterpillar's struggles has been their ability to increase capacity. And some of that's driven by their ability to hire and maintain people. And so people are turning to automation to replace the manual side of welding. And that is very positive for us. And we consider ourselves to be the leader in welding automation solutions. And that's the reason for the increased investment into the expansion.

Okay. Thanks.

[Operator Instructions] At this time, there are no further questions. Are there any closing remarks, Mr. Petrella?

No, just -- I'd like to thank everyone for joining us on our call today. And we look forward to talking to you after our fourth quarter and annual earnings release sometime in February of 2007.

Thank you very much.

This concludes today's Lincoln Electric Holdings 2006 Third Quarter Conference Call. You may now disconnect.