Lincoln Electric Holdings Inc (LECO) 2007 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Lincoln Electric second quarter 2007 financial results conference call. (OPERATOR INSTRUCTIONS.)

It is now my pleasure to introduce your host, Mr. Vince Petrella, Senior Vice President and Chief Financial Officer for Lincoln Electric. Thank you. Mr. Petrella, you may begin.

Thank you, Claudia. Good morning, and thank you for joining the conference call for Lincoln Electric's second quarter. Financial results for the quarter and the first half were released this morning prior to the market's open. If you don't already have a copy you can obtain copies from the Lincoln Electric website or by contacting our Investor Relations office.

John Stropki, Lincoln's Chairman and Chief Executive Officer, will provide commentary on the quarter in a moment. 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, let me turn the call over to John Stropki.

Thank you, Vince, and good morning, everyone. I'll quickly review the high level numbers and then spend a few minutes reviewing the quarter and important activities within the regions. The results for the quarter highlight another quarter of strong sales, profits, and cash flow. Despite softness in several key market segments, we are encouraged by the results and the success of our ongoing strategy.

Net income increased almost 30% to $55.2 million or $1.27 per diluted shares on sales of $587 million, which were up approximately 17% compared with the year ago quarter. Operating income increased 22% to $75.4 million in the quarter. North American sales increased over 8% to $364 million, and our U.S. export sales were up 27% to $50 million. Lincoln's subsidiaries outside of North America had sales of $223 million, a 34% increase from last year's second quarter.

That's a general view of the numbers for the second quarter and, as I mentioned at the top of the call, Vince will cover them in more details in a few minutes. But, first, let me comment on the regions, starting with North America.

Overall results continued to be strong within our North American operations, and we continued to outpace the sales results of our primary competitors. In general, overall industrial activity represented in key measures, such as industrial production and capacity utilization, across the factories in the United States continued to reflect market growth compared with 2006, although the YOY comparisons continue to be more challenging with growth levels reducing during the second quarter of '07 and with some sectors actually reporting negative results.

In Canada industrial production trends continued to contract on a YOY basis. Many industries that we serve continue to tighten with little YOY growth. As an example, the Ontario automotive sector has been particularly hard hit.

Despite some of these challenges, our new order trends in the second quarter continued to be favorable versus the prior year. Overall, our U.S. welding sales growth was driven more by volume than by increases in price. And, as you all remember, we did implement price increases for most consumables in the second quarter in both the U.S. and Canada in order to cover increases in certain metal markets. These prices, increases, affected -- were effective May the 1st, were in the 3 to 6% range but were much higher on nickel based products. These increases should have a greater impact in the third and fourth quarter of '07 than in Q2.

U.S. based export sales growth continues to be very strong compared with prior year levels. This is driven by the energy and key infrastructure development projects around the world, which continued to demand our high technology products which helped drive productivity and improve quality. And we continue to be bullish on these key sectors. Finally, we are continuing with key strategic capital programs aimed at improving capacity, improving our supply chain efficiencies, and driving cost reductions throughout our North American operations.

Looking at Europe, the overall European economic environment remains very strong. Projections of real GDP growth now stand at 2.7% for 2007, and the Euro area unemployment rate has been on a declining trend since the beginning of 2005 and fell to 7% in May. Expectations are that the Euro zone economy will continue to grow at a sustained rate, driven by strong exports, as well as a steady improving domestic demand.

The Lincoln story there continues to be very positive. Lincoln's Europe sales increased 43% to $132 million in the quarter. The excellent sales results were aided by our two most recent acquisitions and exchange rate differences; however, the base sales were up in all regions over prior year as Lincoln is fully participating in the European economic expansion.

We continue to focus on the tremendous growth opportunities in these important markets, and just last week we held our biannual global sales meeting at the site of our two new factories in Poland. Both of these facilities are complete and are providing important new sources of high quality, low cost products for the European market.

The integration of SPAWMET, the Polish stick electrode manufacturer acquired in March, will make meaningful contributions to our commercial growth in the east region and allow for continued expansions of market share in Poland and exports to other important eastern European markets.

Turning to Latin America, economic growth in the region remains strong, driven by continued investments in oil, mining, and agricultural, as well as favorable macroeconomic trends. Domestic consumption remains solid, as well as public investment. The only exception was Mexico, which posted GDP growth of 2.6% in Q1 '07 versus 4.3% in the fourth quarter of '06. Much of this decline is a result of the slowness in the industrial activity. However, most economists expect a recovery in the second half with the target of 3.2% GDP growth for the year.

Despite the softness in Mexico, sales in the Latin American region grew by over 20% in the quarter, led by very strong results in Venezuela, Brazil, and Colombia. Solid domestic consumption and oil related projects continue to benefit base market sales and resale business in these markets. In Mexico, our largest market, results reflected the softness of the industrial market driven by lower activities with the United States, especially in the automotive sector, and the postponement of several major oil related investments.

We continue broadening our product offering throughout the Latin America region. Capital investments continued at a healthy pace in our subsidiaries, and we are expanding geographically and leveraging our commercial infrastructure with positive results on both the base market and large scale projects.

Looking at the results for the Middle East and North Africa, Lincoln sales in the region were up 25% in the quarter. With $70 plus per barrel oil investments in the oil and gas projects, pipelines, pipe mills, offshore structures are ongoing and accelerating, with commitments out for several years. Lincoln is very well positioned to capitalize on these numerous infrastructures related projects.

In sub-Sahara region mining, manufacturing, and energy sectors continue at a solid pace, given strong world demand. South Africa continues to advance on its goal of building out the infrastructure in preparation for hosting the World Cup in 2010.

And, lastly, turning to Asia-Pacific. Overall, economic growth in the region continues to be very positive. China continues at a near 11% growth rate, although there is a growing consensus that the government will take stronger measures to pull things off.

Lincoln's Asia sales increased 29% in the quarter. Our new 90,000 s.f. wire factory in Shanghai will be completed in the third quarter. This will allow us to continue our market penetration into the construction sectors.

We also continued to grow and expand our sales and distribution infrastructure headquartered in Shanghai, and we are utilizing the facilities and technical expertise of our Shanghai staff to boost technical service capabilities and provide in-depth training for our distributors and end users.

The shipbuilding industry is booming, with most yards booked out until 2009, 2010 timeframe, and dozens of large yards are being built or greatly expanded. As an example of the opportunity, China is expanding its oil tanker fleet and will build more than 90 super tankers with the goal of ordering 65 by 2012. The estimates were approximately $7 billion in construction costs, with a very high concentration of welding involved.

And last week we announced the acquisition of Nanjing Kuang Tai, a welding material company, a manufacturer of stick electrode based in Nanjing, China, adding to our existing portfolio of stick electrode products.

Lincoln was previously a minority shareholder owning 35% indirectly through our investment in the JV partner, Quantai. The acquisition of majority ownership will allow Lincoln to fully leverage both the Nanjing manufacturing products and distribution network with a complete complement of Lincoln resources and products.

YOY the best performing markets in the region were Singapore and Malaysia, where sales were up more than 50%, again driven by high levels of activity in the offshore fabrication markets where Lincoln high technology consumables and equipment are in increased demand.

And, finally, in India GDP growth is forecast for 9% for 2007. Foreign investments in the automotive first-moving industries and metal commercial buildings are progressing steadily. Sales in the second quarter to India almost doubled. Increases are due to strong activities in pipe mill, pipeline, and other infrastructure projects. Orders for India have been filled from our U.S., Australia, and European manufacturing operations to meet the strong demand for Lincoln products.

That's the view of the quarter and the regions. Vince will now go through the financial results in detail.

Thank you, John.

The second quarter of 2007 represented our fourteenth 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 34%. Foreign currency effects increased reported sales by 3%. Volume increases contributed a robust 8% to sales dollars in the quarter. Pricing contributed 4% of the increase in sales dollars YOY and, finally, acquisitions contributed about 2%.

On a product line basis machine sales increased 16% and consumable sales increased 17%. Excluding our recent acquisitions of both Metrode and SPAWMET, consumable sales were up 14%.

Sales by product line were approximately 60% consumables and 40% equipment, in line with the prior year's quarter. The percent of gross profit in the quarter was 28.8% of sales compared with 29.1% in the prior year. The decrease in gross margins as a percentage of sales was primarily attributable to a greater mix of sales in lower margined geographies.

The first half gross profit was 28.8% of sales compared to 28.5% of sales in the prior year. This YOY improvement in gross profit percentage was primarily due to favorable operating leverage caused by increased volumes, partially offset by the shift in sales mix to lower margin geographies, previously mentioned.

SG&A expense was $93.3 million or 16% of sales compared to 16.6% of sales in the prior year's quarter, down 60 basis points. The lower SG&A as a percentage of sales was primarily driven by strong volume leverage.

Incremental selling costs associated with higher sales volumes, additional SG&A related to acquisitions and higher bonus costs were the primary factors driving the dollar increase. Foreign currency exchange rates also increased SG&A expenses by $1.7 million.

SG&A expense for the first half was $182.8 million, 16.2% of sales, down 30 basis points from the prior year. Again, the lower SG&A as a percentage of sales was primarily driven by strong volume leverage. Increased selling costs associated with the higher sales volumes, additional SG&A associated with acquisitions, and higher bonus costs were the primary factors driving the dollar increase.

Foreign currency exchange rates increased SG&A expenses by $3.1 million in the half. Second quarter operating income at 12.8% of sales was up 50 basis points versus the second quarter of 2006. Operating income increased 22% in the quarter. The prior year's quarter did include $1.3 million of European rationalization charges. Excluding these charges from the prior year, second quarter operating profit margins would have been 12.8% compared with 12.5% in the prior year's same period.

First half operating income rose to 12.6% of sales from 11.8% in 2006, an increase of 80 basis points. Operating income increased 26% in the first half of 2007. The first half of 2007 included European rationalization charges of approximately $400,000, compared to $2.3 million in the prior year's first half. Excluding these charges from both periods the operating profit margins would have been 12.7% compared with 12% in the prior year.

The income tax provision for the second quarter reflected an effective tax rate of 29.6% compared to 32.4% in 2006. The YTD effective tax rate was 30% compared to 30.9% in the prior year. The lower effective tax rate was due to the utilization of foreign tax credits, lower taxes on non U.S. earnings, and the utilization of foreign tax loss carryforwards, for which valuation allowances have been previously provided.

Cash flows from operations increased to $65 million in the second quarter, from $28 million in the prior year's same quarter. First half cash flows from operations were $107 million compared with $57 million in the prior year's first half.

The company did invest approximately $30 million in CapEx in the first half compared to around $32 million in the prior year's first half. The 2007 capital spending plan will continue to focus on capacity expansions, as well as improvements in the cost base.

Other uses of cash flows in the first half included the payment of $18.8 million of dividends to shareholders. Weighted average diluted shares outstanding increased to 43,461,000 shares for the second quarter compared with 43,008,000 shares for the 2006 second quarter, a 1% increase in outstanding diluted shares. Shares outstanding at June 30th, 2007 were 42,998,000 shares.

Our ROI capital rose to 21.4% at June 30, 2007 compared with 19.9% at December 31, 2006. The increase in these returns is reflective of a higher operating income. The company closed the quarter with $23 million of net cash.

Those are my prepared comments. At this point, I would like to open the call for any questions.

(OPERATOR INSTRUCTIONS.)

Our first question is coming from Walt Liptak with Barrington Research. Please proceed with your question.

Hi. Thanks. Good morning, guys.

Good morning, Walt.

I've got two questions. The first one, Vince, I wonder if you could tell us what the volume numbers looked like for North America, Europe, and, you know, the other regions?

Okay. North America's volumes were up around 3%. Europe's volumes were up around 21%. And other countries were up about 13%.

Okay. And in North America, you know, John, you talked a little bit about what -- I wonder if you can go into a little bit more detail about what you're seeing in North America's, you know, going through the quarter what's strengthening, what's weakening, et cetera?

Well, it's kind a mixed bag, Walt, which I think is what we talked about the last call, that, you know, we expected the YOY comparisons to become more difficult. This is a challenging time from vacation and shutdown kind of a basis, so it's a little more difficult to get a good read on, you know, what sectors are performing well and which aren't.

We're very encouraged, as an example, in the retail sector. That had been one of our soft spots last year and despite some of the reports coming from some of our large retail customers on YOY and store growth we're seeing some very strong numbers in the retail sector and are very encouraged by that.

Okay.

And, clearly, the construction and the energy related sectors around the Gulf Coast or anyplace that's participating, and we see that spreading because of the lack of capacity along the Gulf Coast to address some of the needs that there's kind of a geographical expansion of people participating in those sectors and people who were out of that business for many years, jumping back in to take advantage of some of the growth opportunities that exist in there. So we're seeing some new plants come onboard and some capital equipment being expended as regards to that in that overall energy sector.

Okay. All right. That's sounds positive. But the volumes at 3% are down from 5% YOY in the first quarter.

Yeah, well, one point --

(Inaudible) is that primarily the issue?

-- well, one point I would make on that, and we'll use our brazing business as an example, is from the volume standpoint. When we purchased that business, there was some low margin business that we as the Lincoln Company would traditionally not participate in, and we made a very conscious effort over the last 12 to 18 months to either raise the margin levels at those accounts, which we have to a certain extent, or to shed those accounts. And so we have a bit of an anomaly as it relates to the volume side of that.

What was the -- what's the revenue that would have been impacted in the quarter from that brazing product?

Vince may be able to dig that out in more detail later. I don't have it right at the top of my hand.

It's a --

All right. That's fine. And, John, you mentioned in your commentary about North American manufacturing, the supply chain, and I wonder if you could go into a little bit more detail about that and what we can expect going forward, because the profit performance would look, you know, excellent during the quarter?

Well, I would start by commenting on that, Walt, that John's commentary was really geared towards the impressive improvement in performance in our operating cash flows. We more than doubled our cash flows from operations to $107 million [in the half] and it was a very good quarter, as well, at around $67 million, I believe, from operating cash flows. And what we're doing is we're working very hard at focusing on working capital management and, in particular, more aggressive programs in managing inventory and the supply chain.

And so if you -- when our Q comes out on Monday, you will see that the growth in inventory was far less than our growth in sales, and there's been good improvement in many regions and operating units around the world from an inventory management and supply chain standpoint. And we're looking forward to continuing that process and, hopefully, continue to drive more cash out of the working capital and the balance sheet.

And, Walt, I would just comment, you know, I think that we're entering a period of time where we're going to be able to shift some of our focus to really dig into the efficiencies of the supply chain basis. If you recall, we were engaged in some major constructions and/or moves of manufacturing facilities that were occupying a lot of our resources and energies. And a number of those plants, as example the two that I talked about in Poland, those transitions are done now and, you know, we can go back to really taking a look at driving the cost elements of these new plants and the additional capacity that we filled in places, like Turkey and China and [Delco] in Canada, because the construction phases are done now.

Okay. Got it. Okay. Thanks, guys.

Our next question is coming from James Bank with Sidoti & Co. Please state your question.

Good morning.

Hi, James.

Good morning, James.

John, I was wondering if I could just get -- I'd like a bit more elaboration on North America? It seems as though it's still chugging along, and industrial production is still tracking pretty well here. You know, I think you mentioned automotive, but I didn't know you guys were really exposed to that area, if you will, maybe about 5% of your business, and it seems as though none of those sectors are doing well for you, but can you just maybe elaborate a little bit further on some of the other sectors that might be underperforming for you?

Well, I talked specifically about automotive as a result of Canada. The Ontario Province of Canada is very heavily concentrated with automotive production. And, clearly, you know, that region and area has suffered the consequences of some of the challenges that the automotive industry has endured over the course of the last 12 to 18 months.

That being said, we're looking at the capacity utilization numbers trending up over the last three to four months. We're looking at the purchasing managers' index trending up quite nicely over the last three to four months. We're seeing some positive trends in the number of hours and the overtime hours that are worked. So, you know, the expectation that most economists have had of a stronger second half U.S. economy seemed to be getting some traction as far as the forward-looking indicators are concerned.

Great. Terrific. And the price increase, do you think that'll affect your back half here?

Well, as I said, I mean the way our price increase program works is that that program was announced on May the 1st. Its price can effect time of shipment but we do allow customers both distributors and end users to put orders in with a 30-day control date basis, to give them some buffer. So they would have had, quite frankly, till June the 1st to purchase at the old price, so if you look at the quarter we didn't get the full impact of that, and we think that we will some more positive impact of that in the third and fourth quarter as that's finalized and just normal course of business.

Okay. Great. And, Vince, if you could just help me with the cost of goods sold as a percent of sales in SG&A, it seems like gross margin came off a bit, but I know you've referenced higher gross and lower margin geographies, but if there's anything more to that, please let me know? And then the second part to that question is what really drove the increase in op margin there?

Okay. From a gross margin standpoint, from a regional perspective we lost some margin in our Asia-Pacific region, as well as some parts of Latin America, and those losses are also affected by a higher growth rate of sales in proportion to the growth rate of sales in North America. So we had higher growth rates in the lower margin geographies of Latin America and Asia, and we also lost some gross margin, in particular, in Asia and more specifically in China.

Okay. And the op margin improvement?

Well, the operating margin improvement is really a function of the leverage that we have on the SG&A line. As you can see, YOY in the quarter we leveraged that line by roughly 60 basis points and, as I've been saying for a long time, there's a great deal of our SG&A that is largely fixed in nature, it doesn't necessarily move with the top line. And so we're relatively happy with the leverage we showed in the quarter and as long as our sales volumes and top line continue to grow like we've seen in recent history we should continue to see that leverage moving forward.

So, hopefully, that would be, I guess more or less an offset to the higher growth you're seeing in those lower margin regions?

Yes. And, you know what -- one headwind in terms of the leverage that we're gaining on the SG&A line is that in those regions we are adding SG&A as rapidly, if not more rapidly than the sales growth, and, you know, Asia-Pacific and China, in particular, are an example of where we're building our infrastructure, we're adding sales branches, salespeople, and building our business. And so we're really in largely a startup mode in Asia and particularly, again, in China.

And as we move through the development of our business into a more mature business we should see a bit more stability in the delivery of margins and operating profit, as well as growth in that operating income line from a percentage of sales standpoint.

Okay. And, lastly, I think I heard European sales were $120 million, but what was that number again?

$132 million.

$132 million.

Yes.

Okay.

And roughly, John mentioned in his comments that we're up around 40 -- over 40% in the aggregate, 10 percentage -- roughly 10 percentage points of that was foreign exchange.

Uh-huh.

Because of the strong Euro. And roughly another 10 percentage points were the important acquisitions of Metrode that we had towards the tail end of last year. So on a base business, from a base business standpoint, Europe was up roughly 25%, which is leading the way as far as our regions are concerned, along the lines of what we're experiencing in Asia and Latin America.

Okay. And, last question, can you break out the op income for your three segments?

Yes. EBIT, which will be disclosed in our segment footnote, we expect to file in our 10-Q on Monday is for the quarter $55 million for North America.

Okay.

$18.5 million for Europe, and roughly $7.5 million for the other geography segment.

Okay.

That's roughly margin speaking 14.2% for North America, 13.5% for Europe, and roughly 8% for our other geographical segment.

Okay. Great. Very helpful. Thank you, Vince.

Our next question is coming from Steve Barger with KeyBanc Capital Markets. Please state your question.

Hi. Good morning, guys. This is actually Joe Box on for Steve.

How are you doing, Joe?

Not too bad. Thanks. I'm just curious, as you talk to some of your distributors I was wondering if you could give us some color on what their expectations are for the back half of 2007 and into 2008 for both construction and general engineering end markets?

Well, as I said, Joe, we're very bullish on both the construction and the energy sectors. We don't see any slowdown. In fact, our people in Canada are expecting a nice acceleration in the second half of the year. Part of the challenges to some of these construction projects we're facing were material and manpower shortages, and I think they slowed down the pace until they could get some of that rationalized, but again with the strong price of oil, in particular, these projects continue to move forward and I think we'll see some acceleration of that.

Almost every day I see an article in either the Wall Street Journal or the Financial Times, that talks about the energy sector and the big buildout -- you may have seen the article on GE and the large order that they've talked about for the Middle East. We're still seeing the shipyards expanding quite rapidly, and it's our expectation that that's going to continue for well into the future.

And, as we talked at the last call, I think it really kind of changes the dynamic of what used to be a very cyclical business from a Lincoln perspective, that if we were in a situation where some of these industrial sectors that were very important and are important to us, we're showing the kind of declines or softness that we're seeing in some of these markets, it would have been dramatically reflected in our results. And as you see, it was not, and that is a result of our strong and growing participation in the overall construction and energy sector. It's driven by a very strong consumable offering into that market, but also a lot of new equipment that's captivating the attention of some of our competitors' traditional customers, and I think, again, if you look at our sales results in the quarter versus some of our traditional competitors, you'd see how we distance ourselves from them.

Excellent. Thank you. One last question for you. Can you give us an idea of maybe capacity utilization by the three different regions that you break out?

Oh, you know, I'd rather, you know, Joe, that maybe you have an offline conversation with Vince. That takes a little bit of work to do to really kind of drill that out.

Yes. I would say that it's also very difficult to generalize in terms of capacity utilization. As you know, we have a consumables business and a machine business, and literally between those two and product categories there's a variety of different capacity utilization, if you will. So it's a difficult number to give in any kind of precise terms.

Fair enough. Thank you.

(OPERATOR INSTRUCTIONS.)

Mr. Petrella, there are no further questions. I'd like to turn the floor back over to you for any closing comments.

Thank you, Claudia. And thank you, all, for joining us on the second quarter call. We very much look forward to talking to you at the end of the third quarter. 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.