Lincoln Electric Holdings Inc (LECO) 2007 Q1 法說會逐字稿

Welcome to the Lincoln Electric Holdings 2007 first-quarter conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Vince Petrella, CFO of Lincoln Electric. Thank you, Mr. Petrella, you may now begin.

Thank you, Jackie. Good morning to all of you joining our 2007 first-quarter earnings call. We issued our financial results for the quarter this morning prior to the market's open. If you don't already have a copy, the release is available through the investor section of the Company's website as well as through a number of financial news sites.

Lincoln's Chairman and CEO, John Stropki, is on the call with me this morning and will provide a view of the quarter in the first part of today's discussion. But before turning the call over to John, 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 here's John Stropki.

Thank you, Vince, and good morning to everyone. Let me quickly cover the numbers in general before getting into the Company overview. Vince will give more financial details in his remarks in just a few minutes.

We had another good quarter with excellent sales and profit results. Most of our businesses reported excellent results reflecting our broad global position and the strength of our product portfolio. Net income in the quarter increased almost 31% to $48 million or $1.11 per diluted share on sales of $549 million, up over 17% from last year's same quarter. Operating income in the quarter was up $68 million, up over 30%. Our North American operation sales were $345.7 million including export sales which were up 55% to $47.5 million. Sales outside of North America were $203 million, up 37%.

Those are the macro numbers and, as I mentioned, Vince will get into more of the details of the financials later in the call. At this point, let me provide some comments on the quarter and activities in the region.

In North America during the quarter results and demand continued to be relatively strong within our U.S.-based operations, yet somewhat softer in our Canadian operations. U.S. industrial activity represented in key measures such as industrial production and capacity utilization continue to reflect growth compared with 2006, although this growth is predicted and is showing some slowing. U.S. industrial production increased 2.3% year-over-year in the month.

During durable goods order production increased 0.9% in March from the prior month and increased 3.5% over the prior year. The purchasing manager's index decreased to 50.9% in March. Many of the key industries that we serve continue to show positive yet slower year-over-year growth. In the U.S. we continue to see order patterns that would suggest that plant activity remains positive, although economic data suggests that overall capital spending levels slowed during the fourth quarter of 2006 and continued into 2007.

Our order trends for the first quarter continue to be favorable versus the prior year. In terms of the economic outlook 2007 will certainly be more challenging when evaluating year-on-year comparison and the economic landscape is relatively uncertain. However, most economists are forecasting a stronger second half for 2007, so we remain optimistic for full-year results. In the Canadian domestic market we have seen softer sales trends due to the decline in manufacturing in central Canada, primarily because of automotive, and the shortage of skilled trades in the Western oil regions.

North American export sales continued to be very strong versus prior year levels, where the key infrastructure development projects have continued to demand our higher technology consumable and equipment products. The weaker U.S. dollar continues to provide good momentum for exports and we expect this trend to continue and possibly to accelerate. As such we are continuing with the key strategic capital programs which are aimed at improving our capacity efficiencies and driving cost reductions throughout our North American operations. Looking forward the economic climate is cautious, but we continue to see strength in many key markets we serve.

Looking at Europe, economic growth continued its robust pace from the previous two quarters. Concerns of a slowdown in Germany after the increase in that tax never materialized while unemployment rates throughout Europe continue to reach low levels not seen since the 1990s. The recent Euro area industrial production showed increases between 3.5 and 4% and, in addition, capacity utilization climbed to 84.4% in the first quarter, the highest level since 2000.

We have fully participated in the upswing, seeing first-quarter sales rise by more than 36% in local currency. The region's sales growth benefited from the inclusion sales of Metrode which we acquired in the fourth quarter of last year. Backing out Metrode, the region still experienced strong double-digit sales growth in most countries throughout Europe.

The drivers of this growth remain largely the same. Europe's industrial companies are very strong participants in the global infrastructure build which is driving very good demand levels for our welding products. This strong industrial growth is pushing unemployment lower which in turn is resulting in better-than-expected consumer spending, particularly sales levels of automobiles.

Eastern Europe remains a particularly strong market with the Q1 launching of our new greenfield sites for [flex] cord and gas apparatus in Poland and the very recent acquisition of SPAWMET, a Polish manufacturer of welding electrodes. We feel very enthusiastic about our prospects for accelerated growth in this strategic and growing market.

Across the European region we are beginning to pay some capacity constraints which are restraining our growth in some important product categories. However, we have several expansion projects underway, including the three Polish projects I mentioned earlier, which should help us maintain good momentum in the coming months. We are also looking to supply Europe from several of our North American facilities where possible and where necessary.

Turning to Latin America -- our Latin America sales were up 20%. Although growth has moderated in Latin America, it continues at a very healthy pace. GDP for the region is expected around 4.5% in 2007; domestic consumption remains strong as well as private and public investment, offsetting the expected negative impact of lower non-oil raw material prices. Oil, near $60 a barrel, continues to provide support for execution of large energy-related projects in the same manner investments in agriculture is expected to benefit from demands for alternate fuels.

Venezuela, Mexico, Brazil and Ecuador continue to benefit from oil related investments; at the same time Brazil and Argentina are expected to greatly benefit from renewed interest in agricultural investment. Mining intensive countries like Chile and Peru are also seeing increased investments in this sector. Unlike most other regions -- excuse me, countries in the region, Mexico's manufacturing sector has experienced a slowdown as it has felt of the weak performance in the manufacturing of metal products and other goods related to the automobile industry suffering as the U.S. economy slows.

Looking at the results for the Middle East and Africa the news remains very positive and the region continues its high-growth pattern with energy, oil derivatives, metal, minerals and mining. Saudi Arabia and the UAE lead the Middle East growth productivity with continued robust pipeline and pipe mill activity. In addition, steel and aluminum production, along with the fabrication, continue to increase activity in the metals and metal infrastructure sectors. High prices for nickel and copper commodities have driven the mining sector in South Africa along with the infrastructure projects stimulated by preparation for the 2010 World Soccer match.

Middle East and Africa sales are up over 50% from Q1 '06 on top of 100% growth in all of '06. And Asia-Pacific, net sales into the Asia-Pacific increased 41% in Q1 '07. Imported product sales into Asia continue to be strong. Q1 sales from the USA to Asia are up over 70% compared with Q1 '06. Overall sales in China in Q1 were up over 50%.

We continue to add consumable manufacturing capacity in our China business. Construction of the new 90,000 square foot building in Shanghai started in December '06 to accommodate more consumable manufacturing expansion and associated warehouse space. This will be completed this year resulting in the doubling of our capacity over the next few years. Economic growth in China continues to be strong with GDP growth of over 11% in Q1.

Although there continues to be some concern that the government will start to push for a mild slowdown to cool things off, commodity prices, especially steal and copper, continue to increase though the rate is stabilizing somewhat. In Southeast Asia overall sales were up approximately 70% in Q1 '07 with business continuing to be driven by strong growth in shipbuilding, retrofit projects as well as offshore platform fabrication and other oil related construction activity.

Higher productivity remains a priority for these fabricators and they are looking to Lincoln for new technology to help them achieve notable gains. This is exemplified by strong sales of our Powerwave ARC equipment throughout the region. Lincoln Australia continues to leverage its market leading position in the domestic market with sales of both domestically produced and imported products increasing over 20% in the quarter. That's a quick overview of the activities in the region. Let me now turn the call over to Vince for details on the financials.

Thank you, John. The first quarter of 2007 represented our 13th consecutive quarter of strong earnings growth. The quarter's consolidated sales were up 17% with North American sales increasing 8% and sales reported outside of North America up 37%. Of these amounts foreign currency effects increased reported sales by 2%; volume increases contributed a robust 10% to sales dollars in the quarter. Pricing year-over-year had a 3% contribution, acquisitions contributed 2%.

On a productline basis machine sales increased 18% and consumable sales increased 17%. Sales by productline were approximately 59% consumables and 41% equipment compared to 60% consumables and 40% equipment in the prior year's same quarter.

The percent of gross profit in the quarter was 28.8% of sales compared with 27.8% in the prior year. The increase in gross margins was primarily attributable to higher volume levels and the associated operating leverage. SG&A expense of $89.5 million, or 16.3% of sales, was down 10 basis points from the prior year's quarter. The lower SG&A as a percentage of sales was primarily driven by our strong volume leverage.

There were incremental selling costs associated with higher sales volumes, higher bonus costs associated with higher profit levels and foreign exchange losses were the primary factors driving the dollar increase. First-quarter operating income at 12.4% of sales was up 120 basis points versus the fourth quarter of 2006. As John noted in his comments, our operating income increased in the quarter over 30%.

The quarter did include approximately $400,000 of charges related to the finalization of a European rationalization effort. The prior year's quarter also included approximately $1 million of like charges. Excluding these rationalization charges, our first-quarter operating profit margins would have been 12.5% of sales compared with 11.4% of sales in the prior year.

The income tax provision for the first quarter reflected an effective tax rate of 30.4% compared to 29.2% in 2006. The higher effective tax rate was due to higher income levels and higher tax rate jurisdictions. The Company invested $15.7 million in capital expenditures in the first quarter compared with $17.5 million in the prior year's same quarter. Our 2007 capital spending plan will continue to focus on our major capacity expansion initiatives as well as improvements in our overall cost base.

Other uses of cash flows in the quarter included the payment of $9.4 million of dividends to our shareholders. Our weighted average diluted shares outstanding increased to 43,349,000 shares for the first quarter compared with 42,718,000 shares for the prior year's first quarter. A 1.5% increase in outstanding shares. At quarter end we had 42,880,000 shares outstanding.

Our return on invested capital rose to 20.2% at March 31, 2007 compared with 19.9% at the end of 2006. This increase in returns is reflective of our higher operating income. Finally, the Company closed the quarter with over $25 million in net debt positions including $95 million in cash. Those are my comments. At this point, Jackie, I would like to open the call for any questions.

(OPERATOR INSTRUCTIONS). Holden Lewis, BB&T Capital Markets.

Good morning, guys. Can you comment first about inventory in the distribution channel right now? Specifically you sort of mentioned that you're trying to shift some of the production that you're putting in North America over to Europe to meet strong demand there. Is that resulting in maybe some availability issues domestically or a buildup in inventory as a result in sort of the channel here?

I would say, Holden, we see zero evidence of any inventory build and we do not have any supply issues of any specific note. Our fill rates are at historical highs and that's driven by the increases in capacity that we have built throughout our North American operations and the improvements in productivity that we're getting throughout our facilities here.

Okay. And then can you comment also -- you had made a comment that you're expanding capacity over into Europe. And is that incremental on top of the capacity adds that you've been talking about all along? And what does that do to your CapEx budget this year if anything? And in terms of expectations about SG&A leverage going forward, does it sort of add additional costs on from what we've been expecting?

Holden, as far as our CapEx plan, we would expect to be in line with what we said in our previous filings of CapEx that are upwards of $65 million to $70 million this year in '07 compared to the prior year. The discussion of capacity expansion in Europe is largely what we have discussed in the past in terms of our new plants in Poland and expanding capacity in some other Western European countries. So from an overall macro standpoint I would say that our plan has not significantly changed from what we have been talking about over the past several quarters.

One follow-up to that, Holden, would be that those facilities are done and the capacity is beginning to ramp up. In the case of the gas apparatus plant that transferred from Ireland is completed, the plant in Poland is fully ramping up and we're ahead of schedule in terms of the cord wire facility in Poland.

Okay. And then lastly, just comments on price and I'll jump back in.

Well, we did have a price increase early in the first quarter. We have announced a price increase on consumables which becomes effective June 1st. And I would say based on some of the steel trends that we're seeing, there's a strong probability of an additional price increase sometime within the late second quarter.

Okay, great. Thanks, guys.

James Bank, Sidoti & Co.

Could you break out the growth or even the absolute dollar for your other countries and Europe?

Well, our growth in Europe is over 30%. Our growth in North America, as I said in my comments, was about 8%. And then other countries was down in the double digits but lower teens.

Okay. What were the -- if you can disclose at this time, what were the operating margins in Europe? I'm just trying to get an idea because it seems as in the fourth quarter last year you really turned it up a notch and you're about 17% there almost. I'm just curious where you were in the first quarter here?

In Europe?

Yes.

Europe's operating profit margins in the quarter were about 11.3%.

Okay. Are you able to comment on what we might presume could be a good run rate for margins this year? Maybe by the end of the year '07 would be equivalent to what you just did in the first quarter here?

James, I don't think I can give you the full year, but what we see in terms of the landscape for the second quarter, based on our order levels, our volumes, the pricing environment, we wouldn't expect there to be a significant change in our gross margin from the first quarter. Our second quarter, as you know, is generally one of our best volume quarters in the year. So barring any changes in volume levels and the overall economic environment in all the regions that we do business, we would expect our gross margins, certainly our operating profit levels, to be somewhere in the range of what we have experienced in the first quarter -- if not slightly ticking up for the higher volumes.

Okay. And moving toward North America, if I could just begin with the export sales given the certainly cheap American dollar. Is this sort of a growth rate we could expect to continue through the year and kind of help offset some of the moderation you might be experiencing in North America?

Well, as far as our experience in North America, as well as our consolidated results, James, you can see in the 2006 year we did have a nice ramping up in the second and third quarters. And so from a comp perspective the second and third quarters are going to be somewhat more difficult than our first-quarter comps. But in terms of looking at what we're seeing right now, we expect growth to continue albeit at perhaps a slowing pace.

Okay, fair enough. And the inventory -- John, I certainly appreciate your comment earlier on it, but it did seem to track up just slightly. Turns came down a bit if I've done this correctly. And I guess my true question here is, is there any backlog in that inventory build?

We would say not any significant level of backlog. If you were to dissect our inventory levels and turns by region and operating unit you would see that our growth outside of the U.S., our non-North American businesses, is so rapid and robust that the inventory requirements there were significant from a trend standpoint. In the North American market where the growth has not been as significant you will see that we've had some improvements in turns as compared with the rest of the world.

So what's affecting our working capital over and above just simple volume increases is the mix of that in these markets that we're growing more rapidly, developing our infrastructure, our distribution channels and that is tending to put some pressure on turns and working capital averages compared to sales levels.

James, the question that I thought I was answering that Holden had asked was relative to do we see an inventory build within the distributor channel? And again, my response to that was I don't see any evidence of that.

Okay, great. And I'm sorry, one last question, then I'll jump back in line here. I don't think in the prepared remarks you mentioned what specific markets were moderating in North America. Could comment on which ones that you're seeing the moderation in?

Well, I think I would say that the automotive sector just stays slow. I don't think that it's moderating any further than where it was, so it's probably plateaued. Clearly construction equipment for the North American market has shown some deterioration, although in other parts of the world it is very strong driven by the heavy infrastructure build. And again, our story remains pretty much the same -- that we're a much different company today than we were years ago.

And we're positioned -- as the large construction equipment manufacturers have built their platforms and other parts of the world, we're now positioned to enjoy the same kinds of relationships with them and those other sites as we do enjoy here in the North American market.

Clearly given your pretty good results this morning I would definitely agree with you on that. Thank you, that's all I have.

Steve Barger, KeyBanc Capital Markets.

It's actually Joe Box on for Steve. Just wanted to dig into the net working capital. As international becomes a larger mix of your business do you guys have an expectation for a peak percentage of sales for net working capital?

I think that would be very difficult to try and predict at this point in time based on our growth in those markets. Clearly you can do the math in terms of our non-U.S. sales growth and the mix of our business shifting from North America to the rest of the world and see that, for example, in receivables I think we lost another day or so in the course of the year-over-year comparisons.

So as you probably know as well, terms outside of the U.S. tend to be a bit longer in Asia, Latin America and Europe and so as our mix changes there will be some additional working capital requirements. However, on the inventory side there are certainly a number of the initiatives and programs that we have in place to become more efficient in the management of inventory. So I would expect from that side of our working capital equation that we would see some improvements over the longer-term even despite the mix changing to more of a non-North America type of business model.

Certainly one of our top priorities in terms of managing our balance sheet is managing our transition into more of a global company and we are optimistic that we can mitigate the structural headwinds that we will face in this transformation of the Company.

And Joe, just one follow-up point on that. With this very strong export environment that we're enjoying, both exports from Europe and from the United States, the transport times do contribute to some longer inventory cycles and obviously that's reflected in the strong sales side of it.

Okay, great. Thanks. Also with respect to your international buildout, how do your contribution margins look in some of our larger international markets? And from an SG&A perspective, how much do you think that you need to actually service these markets?

Well, as far as contribution margins are concerned, those are dictated by where we are in our development process. Obviously in markets and geographies where we're beginning the process of building out our infrastructure, adding the SG&A and the distribution and the manufacturing capacities to satisfy the market needs, our contribution margins will be low.

In markets where we're beginning to mature more, and those would be Latin American markets where we're a little farther along in terms of developing that infrastructure, you will see our operating profit and contribution margins start to approach what we've experienced in more mature and developed markets like North America.

So there's a very distinct correlation between where we are in the development of our businesses by geography and you can view our segment profitability footnote in the Q's and the K's to see sort of where we are by region.

Okay, yes, I'll do that. Can also just comment quickly on the domestic automation business? Trend wise are you seeing this business moderate with overall North America or is it accelerating right now due to welder shortages?

I think we're very bullish on our North American automation business; in fact, we're bullish on our automation business around the world. I think we could comment on the fact that we made a fairly significant investment here in Cleveland to more than double the size of our automation business base based on our bullishness in that area. And we have also begun the process of embedding similar activities into Europe, Asia-Pacific and Latin America.

And you're exactly correct, it's driven by two factors a shortage of welders -- but maybe even more importantly just the tremendous success that people have had in driving productivity and quality gains through the automation activity. And as we've talked a number of times, we have a very commanding position in that portfolio by being a broad line manufacturer that offers turnkey solutions.

Excellent, thanks for the color. Great quarter, guys.

Walt Liptak, Barrington.

Good morning, guys, and congratulations on a nice quarter. If I can just follow up on a couple of things. John, the price increase that you talked about for early 2007, was that both for machines and consumables?

Yes, that's correct. And that was effective I think the first week in February.

Okay. When you say effective, does that mean that that price increase impacted the quarter?

Yes.

Okay. Can you tell me the percentage -- average percentage amount?

Vince can handle that.

It was roughly between 2 and 3%.

Okay, both for the machines and the consumables?

Yes.

We probably didn't get a big impact of that, Walt, because our pricing policy is priced in effect time of shipment with the caveat that we allow customers to place control dated orders up to 30 days. So if the price went into effect the 1st of February that would have meant many of those orders didn't get priced until the 1st of March.

Okay. So going into the next quarter that's where you'd see the bigger impact from it. And I mean if there's going to be an impact in gross margin we'd see more of it then?

Yes, we expect to see some impact on the pricing pre-split. I would also say that the price increase was driven by cost increases on the raw material side, so this was not just driven by a mature margin improvement philosophy.

Of course. We've heard steel costs and other things coming up, energy, etc. I wanted to ask about North America and, Vince, you mentioned the comps getting more difficult in the second and third quarter. Are you seeing some of that sequentially on a month-by-month basis in the first quarter and into April?

No, not really. I would tell you that our order and sales levels in the first quarter, at least from a North American perspective, have been steady and stable and I would tell you that March was as good as January and February from a year-over-year comp perspective.

I guess I've talked to you in the past about tough comps going back over the last couple of years and you always seem to have a tough comp that you tend to beat pretty handily. What's going into your thinking on the tough comp, is it the auto sector or is it some other sector that you're concerned about?

Well, if you look at our numbers quarter-by-quarter, Walk, going back say two years you will see that beginning of 2006 we had growth of the high teens and then coming down 3 or 4% in say the second or third quarter of '06 and another 3 or 4% in the third quarter and the fourth quarter. And so now our volume comps, if you look at the first quarter of 2007 are 10%. And so as you know, we've had three years of very significant volume increases.

And when you layer those on top of one another at 17% on top of another 14 or 15 and now another 10% on top of two or three years of high teens type of volume growth, there are going to be some difficult comps. And so we would expect that continuing to look at our comps year-over-year, although our business continues to be strong, those comps will continue to be more and more difficult as we go forward.

Right, but there's nothing specific? There's no sector that seems to be trending down?

The last thing I would say on comps is if you look at our $1.11 or $1.12 that we made net in the first quarter compared to a comp of $0.88 or so in the prior year's first quarter, that will start to become more difficult as the second, third and fourth quarter of 2006 we're over the $1 mark. And so we had our easiest comp during the course of 2007 during this first quarter.

Okay. Thanks very much.

Seaver Wang, Utendahl Capital Partners.

A couple questions. I was just wondering if you could give a little bit more detail on the export sales in terms of diversification of customers and by maybe region. I'll let you answer that first.

I can start by saying that very strong export growth in Asia, Russia, the Middle East, Africa are all up very significant amounts from the prior year.

And are there any particularly large projects that could kind of drop-off in the next say year and a half, two years or any time that you could foresee?

As far out as we could see, Seaver, the export side looks pretty good. Again, we have a weakening dollar and I think most people feel that that's going to continue if not even further weaken. And if you look at the projects that we're involved in, these are not general fabrication light commercial kind of activities. They're heavily related towards the infrastructure, particularly oil and gas and shipbuilding. And I think if you poll people that are involved in those kinds of projects, they have a backlog that is very long and fairly significant. So outside of some major political disruption in one of those parts of the world, the prospects for those kinds of project works continue to look pretty exciting for us.

Okay. And my second question is about capital investment. Globally you've made quite a bit in the last few years. Are there plans for additional capital investments beyond the basic putting up of plants in say China? Are you looking more into India? Are there certain countries that you'd like to get into that you're not into right now, or are you satisfied in just kind of growing organically what you have?

Well, we're never satisfied, but we think that we've carried a pretty heavy load over the course of the last couple years to put us in the position that we're in to take advantage of some of the opportunities that we have captured. As Vince commented earlier, our capital spend predicted for this year is somewhere between $65 million and $70 million and that's been a hard run rate for the last three years. And again, it's positioned us well to take advantage of some of these growth opportunities that we have experienced.

We are and have committed and have discussed that we're building a plant in India in Chennai that's roughly a 15,000 square meter plant. We'll begin construction on that some time here shortly. We won't get much if any impact of that until the second half, but it shows our commitment to penetrating the growing emerging markets. And in places where we have a good export business but have not have the opportunity to participate in the local market kind of activities and that will surely strengthen our position not only on the local market activities, but also gives us the opportunity to capture more export business because of a broader portfolio.

So Seaver, from today's view, based on what we see from a longer-term capital spending plan, we would expect that we're at a very high watermark in terms of our capital spending and that to put up our additional capacity that we've discussed before in India, in China and Latin America of Eastern European spend is largely behind us.

We would expect that that $70 million number would start to come down in a couple years and migrate more towards a number that's lower than D&A. And that's obviously based on what we see today -- could be changes in the next two or three years that might precipitate us looking at putting more capacity in another part of the world. But the way we see it now we should start bringing that number down in the next couple of years, more traditional levels.

And you've made the comment in the past that you usually need a pretty decent amount of market share to actually see more significant contributions to margins -- or more contributions to profits from these emerging markets. Are there certain countries or regions that are kind of on the cusp of that market share gain?

I wouldn't say there is any cusp, Seaver. It's a gradual and a progressive process that we're chipping away and fighting in the marketplace every day. There isn't a sort of bright line that once we cross 20% our margins jump, but it is certainly a gradual process. We can see this happening in places like Asia and China in particular where we don't necessarily have a market share equivalent to where we stand now in North America, but we do see our margins improving.

They aren't near what we have obviously in North America, but it is a gradual process of gaining market share, gaining operating leverage on the invested capital and infrastructure that we have in place and I would call it more of a gradual process than a cusp that we will pass to achieve a certain level of margin.

Okay, thank you.

(OPERATOR INSTRUCTIONS). There are no further questions in queue. I'd like to hand the floor back over to management for any closing comments.

Thank you, Jackie. We thank all of you for joining us today on our first-quarter call and we very much look forward to reporting our second-quarter results in late July. Thank you very much.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.