Lincoln Electric Holdings Inc (LECO) 2007 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Lincoln Electric third quarter 2007 financial results. 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, Mr. Vince Petrella, Senior Vice President and Chief Financial Officer. Thank you, Mr. Petrella, you may begin.

Thank you, Everett. Good morning and thank you for joining Lincoln Electrics' third quarter financial results conference call. Results for the quarter and nine-month period were released this morning prior to the market's open. If you don't have a copy of the results you can obtain one from Lincoln Electrics web site or by calling 216-383-4893.

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.

We closed out another strong quarter of higher sales, profit and cash flow. All of these results were achieved despite some unique challenges in several key markets and geographic segments. Even with those challenges, we continue to focus on strategically strengthening our broad global manufacturing platform and overall product line. That focus and the impact of ongoing supply chain improvements help achieve record levels of operating cash flow.

Net income increased 14% to $50 million or $1.15 per diluted share. Sales were $565 million which were also up approximately 14%, compared with the year ago quarter. Operating income increased 13% to $68 million in the quarter. North American entity sales increased 5% to $347 million and U.S. export sales were up 20% to $51 million, reflecting our growing presence in the robust international markets. Europe sales increased 36% to $122 million. Excluding currency, changes and acquisitions, the base sales of Europe grew 15% in the quarter.

Sales at other Lincoln Electrics subsidiaries outside of North America and Europe were up $96 million, a 28% increase from last year's third quarter. Excluding currency and acquisitions, the base sales recorded by other subsidiaries grew 19% in the quarter.

Vince will return in a moment to provide more detail on the numbers. But let me spend a few minutes updating you on the quarter in the regions.

In North America, during the past third quarter overall results and demand continue to be good within our North American operations while certain market segments strained some areas in our business. Industrial activity represented in key measures such as industrial production and capacity utilization across the factories in the United States continue to show modest growth compared with 2006. Although the comparisons to prior year continued to be more challenging during the third quarter of 2007.

Key industries that we serve showed mixed results as there was a clear slowing in housing, construction equipment and the retail sector offset by growth in infrastructure projects, commercial construction and the energy sector. Total manufacturing industrial production excluding the high tech sector was trending at .7% ahead of 2007, as of September of 2007, while capacity utilization was running at approximately 80%.

In Canada, overall economic trends show positive results in growth, led by a 30-year low in unemployment and solid GDP results. However, the strong Canadian dollar has had a dampening effect on manufacturing in Ontario and Quebec, the largest industrial sectors of the country. The softness in these regions has been somewhat offset by the growth in Alberta and British Columbia, related to the energy sector. The Canadian dollar has appreciated 19% against the U.S. dollar during 2007 which obviously impacts the competitiveness of Canadian manufactured products.

Quarter trends in our traditional U.S. welding market remained good in the third quarter, suggesting that despite the softness we discussed earlier there is a continued growth opportunity in certain key sectors in the U.S. Also U.S. export activity continued to represent very strong growth. This U.S. export sales growth continues to be driven by key infrastructure development projects in the energy sector and in the shipbuilding industry, which have demanded our high-technology products from our U.S. manufacturing facilities.

In Cleveland, we are continuing with key strategic capital programs to expand our capacity to serve the growing demand for welding automation solutions. The refurbishment of a recently purchased 118,000 square foot facility is well underway and will serve as our headquarters for the North American automation business and additionally will provide global support as demand for this product offering continues to grow around the world.

Looking at Europe, I'm very pleased with our progress in Europe and more importantly what that represents related to our Global International Expansion program. Our European operations are largely self-sufficient and have structured the combination of their manufacturing footprint and commercial networks to realize profit levels similar to our more mature North American operations. I am optimistic that the continued execution of our European strategy will produce additional topline growth and operation leverage moving forward.

In the quarter, our European results reflected double-digit growth rates in Western Europe, Eastern Europe and the European export markets as our extensive local infrastructure has enabled Lincoln Electric full participation in the European economic growth.

[The] overall European economic environment remained very solid but the momentum has slowed in several countries and the sentiment is beginning to change in some important areas, due to the global worries and euro exchange rate concerns. Second quarter GDP rose just 3/10 of 1% and was the first quarter in the last five that did not show quarter on quarter growth.

Full year GDP projections now stand in the range of 2.3% to 2.9%, while the 2008 projections have been adjusted downward to 2%. Manufacturing activities remained very strong by historical standards, driven by the European -- particularly German -- companies' active participation in the global infrastructure build. The Lincoln Electrics subsidiary [Erhan and Schwill] is a perfect example of this global infrastructure build, driving European entity sales.

The global demand for energy has driven the pipe mill industry to expand their capacity. Pipe mill capacity expansions are long-term capital-intensive projects which require specialized automated welding solutions. Erhan and Schwill is the global leader in providing these solutions to the pipe mill industry and subsequently has recently signed contracts totaling over $20 million for projects in Russia, India and China. The industry demand for automated pipe welding solutions has resulted in contracts being signed in the third quarter of 2007 for delivery during 2008 and '09.

This industry expansion will also drive significant growth for our submerged Ark Wire and Flux products.

The two new Polish factories continue to ramp up their production levels and provide needed incremental capacity, both regionally and globally. The Polish apparatus factory reached record levels of production during the third quarter which exceed the historical production levels achieved by our Ireland plant and at a much lower cost base. Two of our most recent acquisitions, Metro and SPAWMET contributed nicely to the quarterly performance of the region as their products and distribution network are integrated and leveraged with the Lincoln Electric organization.

Our focus on market consolidation opportunities through acquisitions should continue to bolster the region's results.

Last week, Vince and I attended the grand opening ceremony of our new state-of-the-art Turkish welding consumable factory. The new factory will provide additional capacity and improved efficiency to serve the rapidly growing Turkish market and exports throughout the region.

As an example, the Turkish shipbuilding industry has doubled in size the past several years and continues to drive a large portion of the welding sector growth. The international maritime organization as well as other government bodies continue to expedite the mandatory transition from single hole tankers to double hole tankers. These regulatory changes combined with increased base demand will drive the growth in expansion of the global shipbuilding industry for many years to come.

Turning to the other subsidiaries outside North America and Europe, the sales growth of 28% and other subsidiaries was driven largely by Asia and South America, which recorded quarterly sales gross levels in excess of 40% excluding currency impact. Mexico and Australia contributed high single digit sales growth results in the quarter.

Mexico continues to be affected by the softness in the industrial sector. This is driven in part by the lower activity in the U.S. especially in the automotive sector. as well as the slow slowness of execution of oil-related investments by the Mexican government. Additionally our Mexican operations and many key customers in the region were negatively impacted as a result of a local terrorist attack on an important national gas pipeline.

This attack resulted in the loss of power and interrupted both our production and sales activities for us and key customers for approximately one week.

The South America economic activities continues to record positive GDP growth, despite currency and political volatility in some key countries. The drivers behind the economic growth fell to welding sector in general as the mining and oil industries continued to experience very strong demand. Brazil's GDP growth estimates of 4.7% per 2007 combined with our recent manufacturing capacity expansions have enabled Lincoln Electric Brazil domestic sales growth in the high teens, excluding currency impacts. Venezuela's sales growth continue to lead the South American region as our strong local market manufacturing and distribution presence has provided the opportunity to capitalize on the oil industry and infrastructure-related growth in this country.

Finally in Latin America, Colombia and Argentina generated sales growth in local currencies in excess of 50% as leveraging of the complete Lincoln Electric product line offering has resulted in expanded market share.

Turning to Asia-Pacific, Lincoln Electric Australia experienced single digit sales growth as decreased demand was offset by increases in export sales to Asia. The decreasing value of the U.S. dollar combined with the growth in Australia exports into Asia placed significant pressure on profit margins, as sales are typically denominated in U.S. dollars. Asia reported sales growth of 35% excluding currency and acquisitions driven largely by China.

Economic growth in China continues at near 11% rates, despite the government's effort to take measures to cool things off. So far there has been a reduction of bad export rebates which has added up to 8% of our consumable export costs and also negatively impacted our third quarter margins in China. We obviously have adjusted prices moving forward to correct this.

The shipbuilding industry in Asia is still investing in capacity with most yards booked through 2010. Dozens of large yards are being built or expanded, primarily in the Guangdong Province, the Shanghai area, Ningbo and Dalian. There's also a huge expansion in offshore investment in the Bohai Bay area of northeast China.

Capacity expansion in the welding industry is still living at a fast pace and the overall market is extremely competitive. Scale is the key to moving forward and we are working quickly to build the scale required to develop purchasing sales and pricing leverage. This will be along the very successful journey.

As announced earlier in the quarter, Lincoln acquired 100% of Nanjing Kuang Tai, which will enable us to consolidate our stick electrode sales, distribution, sourcing, formulation and other important synergies in China. Integration plans are on track and progressing well as the manufacturing operations are being located to a new facility which provides opportunity for efficiency improvement and significant future capacity expansions. We expect this acquisition to positively impact our first half 2008 results.

Construction of our Shanghai Flux-Cored wire plant is nearly complete and we'll open production in fourth quarter. This facility will provide Lincoln Electric Shanghai with the infrastructure to double cord wire production and to consolidate warehousing.

Export sales into India continue to double year-over-year and have reached levels in excess of $25 million to date. The Indian market represents a significant consumer of our high-tech infrastructure, equipment and consumables. This growing sales base will provide critical brand and volume support for our new manufacturing facility being built in Chennai, India.

Finally turning to the Middle East and Africa. This region continues its bullish cycle led with the oil and gas sector. We continue to expand our presence with additional sales and technical people to support both the distribution channel and the end-user. The steel sector also continues to ramp up in this region with emphasis on building infrastructure and facilities to produce hydrocarbon derivatives.

The welding sector in the Sub-Sahara region is also growing at percentages above GDP growth. Energy mining and infrastructure continue to lead other sectors, which are positive for welding [new] fabrications. Also we are increasing our presence by adding to our distribution network while providing welding process solutions in advanced welding processes.

The welding market has limited local capacity and represents a strong market, for not only our high-tech U.S. exports, but also our lower-cost Chinese consumable exports. That's a view of the quarter in the regions. Next Vince will go over the details of the financial results.

Thank you, John.

The third quarter of 2007 represented our 15th consecutive quarter of strong earnings growth. The quarter's consolidated sales were up 14% with North American sales increasing 5% and sales reported outside of North America up 32%. Foreign currency effects increased reported sales by 3%. Volume increases contributed 4% to sales dollars in the quarter. Pricing contributed 5% of the increase in sales dollars year-over-year and finally acquisitions contributed about 2%.

The percent of gross profit in the quarter was 28.3% of sales, compared with 28.5% of sales in the prior year same quarter. The decrease in gross margins as a percentage of sales was primarily attributable to a greater sales mix in lower margin geographies, the impact of lower-priced realization and the detrimental effect of the weakening U.S. dollar on non U.S. company, U.S. dollar-denominated export sales.

Gross profit for the nine-month period was 28.6% of sales, compared to 28.5% of sales in the prior year. This year-over-year improvement in gross profit was primarily due to favorable operating leverage caused by increased volumes, partially offset by a shift in sales mix to lower margin geographies.

SG&A expense was $92 million in the quarter or 16.3% of sales, down 10 basis points from the prior year. The lower SG&A as a percentage of sales was primarily driven by volume leverage. There were incremental selling costs associated with higher sales volumes, additional SG&A related to acquisitions and higher bonus costs driving the dollar increase.

Foreign currency exchange rates increased SG&A expenses by $2.1 million. In addition, foreign exchange losses increased approximately $1.5 million in the third quarter over the prior year.

SG&A expense for the nine months of $275 million was 16.2% of sales, down 20 basis points from the prior year. Again the lower SG&A as a percentage of sales was primarily driven by volume leverage.

Incremental selling costs associated with the higher sales volume, higher administrative costs, additional SG&A associated with acquisitions, higher bonus costs and foreign exchange losses were the primary factors driving the dollar increase. Foreign currency exchange rates increased SG&A expense by $5.2 million in the quarter.

Now moving to our operating profit. Operating income was 12% of sales which was flat with the prior year's third quarter. On a geographical segment basis, North American EBIT margins grew to 14% of sales in the third quarter compared to 13.2% in the prior year same quarter. Europe's EBIT margin expanded to 12.4% of sales from 11.3% -- that's 11.3% in the prior year, a 110 basis point improvement in Europe.

All other country segments which include Asia and Latin America declined to 3.4% of sales, compared to 9.5% in the prior year's third quarter a decline of approximately 600 basis points. The other countries' decline is primarily attributable to higher costs as we expand our manufacturing, distribution and selling capabilities in those regions; lower margins as our mix shifts towards lower margin products in geographies -- including the effect and the impact of lower-priced realization; and finally the detrimental effect of a weakening U.S. dollar on non U.S. company, U.S. dollar-denominated export sales out of, in particular, Asia.

Year-to-date operating income rose to 12.4% of sales from 11.9% in 2006, an increase of 50 basis points. Year-to-date 2007 did include European rationalization charges of approximately $400,000 compared to $3 million of the same types of charges in the prior year-to-date. Excluding these charges, the operating profit margins would have been 12.4%, compared with 12.1% in the prior year.

The income tax provision for the third quarter reflected an effective tax rate of 28.7%, compared to 28.9% in 2006. The year-to-date effective tax rate was 29.6%, compared to 30.2% in the prior year.

Now to cash flows. Our third quarter cash flows from operations rose $49 million to $96.7 million from $47.8 million in the prior year same quarter, almost a doubling of our cash flows in the quarter. This significant increase in cash flows was driven by higher operating income and a continuing improvement in working capital management, particularly in the inventory area.

For the nine-month period cash flows from operations reached $204 million, a $99 million increase from the prior year same period. Again, solid improvements in income and working capital management drove this increase.

The Company did invest approximately $46 million in capital expenditures in the nine-month period compared with $53 million in the prior year's nine-month period. The 2007 capital spending plan will continue to focus on previously announced capacity expansions as well as improvements in our cost space. Other uses of cash flows in the nine-month period include the payment of approximately $28 million of dividends to our shareholders.

Weighted average diluted shares outstanding increased to 43,467,000 shares for the third quarter compared with 43,119,000 shares for the 2006 third quarter -- an 80 basis point increase. Shares outstanding at September 30, 2007 were 43,119,000 shares.

Our return on invested capital rose to 22.1% at September 30, 2007 compared with 19.9% at December 31, 2006. The increase in returns is reflective of our higher operating income. The Company closed the quarter with a $97 million net cash position on its balance sheet.

That is the end of my prepared comments. At this point, Everett, I would like to open the call for any questions.

(OPERATOR INSTRUCTIONS). James Bank with Sidoti & Company.

So it's kind of just -- given the Stock's reaction this morning, just wondered if you could help investors understand expectations maybe heading into 2008 for both North America and your opportunities there, as well as international?

I think that our story has been pretty consistent over the course of the last 12 to 18 months and that is, we are a global company. We are growing globally and we are in a much different situation than at any time in the history of our Company. I think that our results show that despite the softness in the North American markets -- many of which would have been traditional Lincoln markets -- we continue to perform very well on the sales growth and on the profit growth side.

We think that the global infrastructure build, driven by emerging markets in the energy sector, is going to be a very strong emphasis for us and impetus for strong growth in the long term and many, many years ahead. And that is where we are going to continue to focus our effort and energy on.

Have you seen any improvements in any of those weaker North American markets that you discussed in prior quarters?

I would say some. I think some people feel that the automotive industry has kind of bottomed out and in the last quarter, GM in particular, started to rebound a little bit. Construction equipment, I think it's probably gone through its worst cycle. If it slows anymore it will be slower growth and should start to rebound during the 2008 cycle.

Housing? Your guess is as good as mine and I think that we have never really been a really big player in the housing sector, but our braising business does -- is impacted by that. And obviously we saw some consequence of the continued slowdown in the housing business in our braising business.

And this is probably a little more for Vince. In terms of gross margin seems like we are coming closer and closer to 28% which is down sequentially. But is that something I should maybe be looking at modeling forward?

Well, certainly if you look at our margins by geographical segment, you'll see that in North America and in Europe we have continued to experience expansion in both our gross and operating profit margins. But challenges are coming in what we refer to as our other segments geographically of the world, which are Latin America and Asia. And those challenges are primarily focused on our businesses in China and the rest of Asia.

So we are in a process here where we have some very mature businesses in North America we are continuing to develop our market share and maturity in Europe. But we are in a continuing startup and a development phase in Asia and particularly China.

So we will continue to have growth in our cost space there. We will continue to have pricing challenges and as we ramp up our capacity there there will be volatility in our operating margins, particularly in that region of the world.

We did have a very nice progression during the course of the year in our other countries segment, and have had some more challenges in the third quarter. And I would frankly expect that those challenges will continue in large part into the fourth quarter of this year.

As far as next year is concerned that's a little bit too far out for me to start making predictions. But our people in Asia are working very hard at building the infrastructure, ramping up our manufacturing, penetrating the market. And as our market share grows over the longer term and as we become more mature I would expect, again, those margins would start to migrate upward in a more stable and consistent fashion.

That would be a pretty long-term view though. Right, Vince? I mean, would that be beyond 2009? Wouldn't you expect something like that to happen?

I would like to say that it's linear but as you can see from the results we experienced in the third quarter that there will be volatility. But I fully expect that we will continue to make progress every quarter and every year going forward. But it's not certainly going to be linear as has been experienced in this most recent quarter.

I just have three more questions. I'll move through them quickly. The submerged arc wire products in the pipeline, you guys were discussing the potential there. Is there any way you might be able to quantify that in terms of either the revenue potential to you or at least the market dollar potential?

We have to do a little bit of work on that. I will just tell you that we are planning very significant expansions and submerge our product category during 2008 and 2009.

And Vince, that 600 basis point drop in other countries EBIT, that is what you were just discussing?

Yes (multiple speakers). Yes. Last year, as I mentioned in my prepared comments, the other countries' geographies achieved a 9.5% operating profit margin and this quarter's -- third quarter of '07, that dropped to 3.4%.

Now mind you last year was a particularly good quarter by historical standards in those regions of Latin America, Asia Pacific, but we did have some difficult comps. But the 3.4% is a relatively low water market in that other countries' segment for the last couple of years.

And lastly, could you just break out the absolute dollar for or net sales dollar for Europe and other in the quarter? North America, I have.

Yes. Europe's sales were $127 million and other's was $98 million.

[Jack Hain] with Barrington Research.

I've just got a quick question regarding your cash-flow statement. Indicates a reduction in inventories of about $30 million. And I was just hoping that maybe you could maybe add some color as to what geographies that reduction occurred in?

By far the most significant and the predominance of that number was in the U.S. in North America where we've taken out a significant amount of Day Sales in inventory and absolute dollars.

There has been some more modest progress in some of our other areas, but areas of the world that are growing much more rapidly in line with our close to 30% increase in sales in say, Asia, and to a lesser extent in Europe really didn't have significant inventory improvement. So the bulk of that is really in the U.S.

Steve Barger. KeyBank Capital Markets.

I'd like to talk about the mix of machine versus consumable coming out of your primary facility there in Cleveland. How did those sales growth rates come in relative to the 5% North American production number? And how does that compare year-over-year?

I would start out by saying that the machine business has grown a little bit faster than our consumables business. As John mentioned a little bit earlier, we have been hurt a bit in the housing sector and the consumables part of braising and soldering. And so our export sales as well climbed out of the U.S. by approximately 20% in the quarter and that is largely a machine-laden number as well. So on balance we saw a little bit better growth in machines and than consumables.

And, Steve, you also have a little bit of an apple and orange element to your question there in that when you talk about the primary facility in North America, obviously, that is Cleveland and the U.S. sales number is quite a bit different than the North American sales number that we talked about, particularly when you look at just welding. Traditional welding versus welding and cutting and braising.

I understand. I guess I am trying to get to the idea that should North America end markets slow down? You are going to have lower utilization rates which could forestall new machine sales. And my question would be for the North American market, are you really seeing that yet or has there not been a significant decline in machine?

To the contrary. We've had a significant increase in machines and in both sales and incoming orders and, again, a significant portion of that is export-driven and we don't expect that to slow down. We actually expect that to accelerate with some of the positive things that we talked about going on around the world.

Back to your comment about the relationship going forward for North American operating margins versus European. What do you think the timeframe is, should North America continue to moderate where Europe can match or potentially exceed those margins? How should we think about that, relative to timing?

We commented that it is -- we're very close to that level now and obviously as the scale continues to build there the leverage that we're getting in Europe is quite significant. And I think it is important that we don't miss Vince's earlier comments in the quarter that we had very good leverage in the U.S. and the European operations. And that was mitigated by some of the issues that we discussed in these smaller emerging market areas.

So we are quite optimistic that that trend can continue. And as I commented, we are continuing to look at additional acquisition opportunities that we think will continue to leverage those results in both of those markets too.

[Greg Halter] with Great Lakes Review.

Wondering if you could quantify some of the balance sheet categories such as receivables and inventories?

You mean you want the actual amounts?

Sure, if you've got it available.

Yes. One moment. Accounts receivable net was $353 million. Inventory net was $356 million.

Is there any way to quantify how much the weak dollar impacted your results in the quarter? In terms of either (multiple speakers) or EPS?

Yes. The weak dollar impact on our operating profit out of those non U.S. operating units had a negative impact of approximately $2 million.

That's on operating profit?

Yes, it's pretax.

And you -- John mentioned a little bit about the acquisition opportunities. You are now sitting with close to $100 billion in net cash and wonder what your thoughts are regarding acquisitions and or the share buyback?

Again our primary focus has been on acquisition opportunities. And I would say that we are pleased with the pipeline. And we think that with some of the slowdowns in certain sectors that we thought about that there will be additional opportunities there as people are maybe concerned about the future in the traditional durable goods industry looks like versus the opportunities that we discussed on global expansion energy infrastructure. I would say quite optimistic.

one last one. Do you have a figure for what you believe your capital spending will be in '07 and any sort of early figure for 2008?

Yes we are looking at bringing down our expectations a tad bit in '07 as our capital spend hasn't been up to what we initially thought we would have at the beginning of the year. So we will be looking at something in the range of about $65 million for the full year now.

Then as far as next year is concerned, we would be looking at that number dropping down a bit to perhaps $55 to $65 million as a broad range.

And if you remember I mean we build out a lot of brick and mortar during the course of late 2006, 2007. Most of that brick and mortar in our work is done and we will be populating those plants or are in the process of populating those plants with capital equipment. But that spend isn't nearly what the acquisition of the land and/or the building would be.

The one exception to that would be India, where we still have the plans to undergo that project which is a little bit behind schedule because of some bureaucratic issues. But we are optimistic we will get moving forward with that soon.

Great. I was just going to ask about India, but thank you.

Thank you, gentlemen. There are no further questions at this time.

Thank you very much, Everett. I thank everyone for joining us today. Appreciate your interest and we look very much forward to reporting our fourth quarter results in 2008. Thank you again.

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