Lincoln Electric Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Financial statements are unaudited. Amounts below are in U.S. dollars; figures are rounded to millions unless stated otherwise.
Business context and key financial metrics
Lincoln Electric designs and manufactures welding, cutting, brazing and soldering products. Its segments are Americas Welding, International Welding and The Harris Products Group.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $737.1m | $669.5m | $2,284.8m | $1,877.2m |
| Gross profit / margin | $251.6m / 34.1% | $217.9m / 32.5% | $778.2m / 34.1% | $636.9m / 33.9% |
| Operating income | $100.8m | $135.6m | $280.6m | $300.6m |
| Net income | $70.5m | $106.1m | $200.2m | $223.3m |
| Diluted EPS | $1.07 | $1.59 | $3.03 | $3.35 |
| Adjusted diluted EPS, non-GAAP | $1.21 | $0.93 | $3.53 | $2.78 |
Q3 net sales rose 10.1%; nine-month sales rose 21.7%. Management attributed the increases to acquisitions, stronger organic sales and pricing. On a consolidated basis, Q3 sales changes reflected volume +0.4%, acquisitions +4.4%, price +7.1% and foreign exchange −1.7%; nine-month changes were +3.2%, +12.6%, +5.5% and +0.5%, respectively.
- Profitability: Gross margin improved, which management attributed to pricing and segment mix. Adjusted EBIT, a non-GAAP measure, increased 13.8% to $107.6m in Q3 and 16.6% to $320.4m for nine months. Adjusted EBIT margin was 14.6% in Q3 and 14.0% year to date.
- Cash flow: Nine-month cash from operations was $229.8m, versus $245.4m in 2017. Capital expenditures were $48.7m; reported investing cash flow was positive $48.3m, substantially reflecting net proceeds from marketable securities. Cash and cash equivalents were $398.2m at quarter-end, up from $326.7m at December 31, 2017.
- Debt and liquidity: Short- and long-term debt totaled approximately $699.3m. Cash plus marketable securities was approximately $497.5m. The company reported no borrowings under its $400m revolving credit facility and compliance with debt covenants. Total debt to total invested capital was 43.0%, versus 43.1% at year-end 2017.
- Shareholder returns: Nine-month treasury-share purchases were $121.5m and dividends paid were $76.7m. Dividends declared were $1.17 per share for the first nine months, compared with $1.05 in 2017.
Material changes versus the prior comparable period
Reported Q3 net income fell 33.5% and nine-month net income fell 10.3%, but the comparison is substantially affected by the $51.6m bargain purchase gain recorded in 2017 for the Air Liquide Welding acquisition. Reported 2018 results also included rationalization charges of $2.6m in Q3 and $24.4m year to date; 2017 included acquisition-related inventory step-up expense and integration costs. Adjusted diluted EPS increased in both periods as shown above.
Americas Welding benefited from stronger demand and pricing. International Welding sales included Air Liquide Welding, but organic volume was weaker; management cited European channel-strategy repositioning and restructuring. In Q3, International Welding volume declined 10.5% while acquisition contribution was 14.3%. The Harris Products Group had broadly flat Q3 sales.
The nine-month effective tax rate increased to 27.0% from 23.7% (Q3: 26.3% from 18.8%). The filing attributes the increase principally to the prior-year nontaxable bargain gain, 2018 rationalization charges in jurisdictions with limited tax benefits, and U.S. Tax Act adjustments, partly offset by the lower U.S. corporate tax rate.
Outlook, management commentary, risks and unusual items
- Management expected 2018 capital expenditures of $60m–$70m, primarily for maintenance and operational-effectiveness investments. The filing provides no specific revenue or earnings guidance.
- Management said operating cash flow, existing cash, available credit facilities and potential debt-market access were expected to fund ongoing cash needs for the foreseeable future. Significant acquisitions could require additional capital-market financing.
- 2018 International Welding rationalization plans include headcount restructuring and manufacturing consolidation. The company recorded $24.4m of nine-month net charges and had $9.3m of related liabilities in other current liabilities; management expected the actions to benefit future results. Further rationalization charges remain possible.
- U.S. Tax Act accounting remained provisional within the measurement period. The company was still evaluating GILTI, BEAT and the interest-expense limitation; it recorded an additional $2.4m tax adjustment in Q3. Unrecognized tax benefits were $15.7m.
- Risks identified include economic and market conditions, acquisition integration, commodity and energy costs, currency movements, tariffs and regulatory complexity, tax-law changes, litigation, and political or other disruptions. The company reported approximately 3,469 plaintiffs in asbestos-related cases; it believes resolution will not materially affect its financial statements, but outcomes and loss ranges can be uncertain.
- The company reported effective disclosure controls as of September 30, 2018, and no material change in internal control over financial reporting during the quarter. Adoption of the new revenue standard did not have a material financial impact. The company expected the new lease standard to result in recognition of right-of-use assets and liabilities for substantially all operating leases.
Most important facts for investors to verify
- How much of sales and adjusted earnings growth is sustainable organic growth, particularly given acquisition contributions and weaker International Welding volume?
- How reported-to-adjusted earnings reconcile, including the 2017 bargain gain, 2018 rationalization and pension charges, and acquisition-related costs.
- Whether working-capital demands and capital expenditures affect operating cash generation; inventory increased to $377.4m from $348.7m at year-end.
- Final U.S. Tax Act accounting and the effect of tax provisions, audits and unrecognized tax benefits on the effective tax rate.
- Execution and cash costs of International Welding restructuring, Air Liquide Welding integration, and any future rationalization actions.
- Potential outcomes of asbestos and other litigation, and the company’s ability to maintain debt covenants and fund future acquisitions or shareholder returns.