Lincoln Electric Holdings, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless noted. Amounts are in U.S. dollars; financial statement amounts below are in millions unless specified.
Business context
Lincoln Electric designs and manufactures arc welding and cutting products, consumables, automation systems, and brazing and soldering products. Its operating segments are Americas Welding, International Welding, and The Harris Products Group. The company stopped consolidating its Venezuelan subsidiary in July 2016 and continued accounting for it under the cost method.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $580.9 | $550.7 | +5.5% |
| Gross profit / margin | $203.9 / 35.1% | $189.1 / 34.3% | Margin +0.8 percentage points |
| Operating income / margin | $81.5 / 14.0% | $75.3 / 13.7% | +8.2% |
| Net income | $55.8 | $53.6 | +4.1% |
| Diluted EPS | $0.84 | $0.76 | +10.5% |
| Operating cash flow | $76.2 | $24.7 | +$51.5 |
| Capital expenditures | $12.0 | $8.9 | +$3.2 |
| Free cash flow (operating cash flow less capital expenditures) | $64.2 | $15.8 | +$48.4 |
Cash and cash equivalents were $401.4 million at March 31, 2017, up from $379.2 million at year-end 2016. The company also held $70.0 million of marketable securities. Total debt was approximately $705.5 million, largely long-term; net debt after cash was approximately $304.1 million. Total debt to total invested capital declined to 47.4% from 49.8% at December 31, 2016. The company had no borrowings under its $400 million revolving credit facility and reported compliance with debt covenants.
The board declared a quarterly dividend of $0.35 per share, compared with $0.32 a year earlier. The company paid $23.0 million in dividends during the quarter. Approximately $294.1 million of cash was held by international subsidiaries and could be subject to taxes if repatriated to the U.S.
Material changes and segment results
- Sales growth reflected higher volume, pricing, and acquisitions. Excluding Venezuela’s $5.0 million of Q1 2016 sales, reported sales growth was 6.4%. Consolidated volume contributed 2.9%, pricing 2.1%, acquisitions 0.6%, while currency reduced growth by 0.1%.
- Gross margin improved with higher volume and favorable product mix, partly offset by a $1.7 million LIFO charge. SG&A increased 7.5%, including higher compensation, acquisition-related costs, and acquisition expenses.
- Americas Welding sales rose 6.8% and adjusted EBIT rose 11.9% to $68.7 million. International Welding sales rose 3.7% and adjusted EBIT increased to $9.6 million from $6.2 million. Harris Products Group sales rose 1.9% and adjusted EBIT rose 9.7% to $8.5 million; lower retail-market volume partly offset pricing and mix benefits.
- Interest expense increased to $6.1 million from $3.8 million, reflecting higher borrowings in 2017. The effective tax rate rose to 28.3% from 26.7%, primarily due to changes in tax deductions and the geographic mix of earnings.
- Q1 included $3.6 million of transaction costs related to the proposed Air Liquide Welding acquisition. Excluding these costs, adjusted diluted EPS was $0.88 versus $0.76; GAAP diluted EPS was $0.84 versus $0.76.
- Operating cash flow improved substantially, principally because of prior-year U.S. pension contributions and improved company performance. Investing cash use increased mainly because the company purchased marketable securities; financing cash use was lower, primarily because of reduced share repurchases.
Outlook, risks, and unusual items
- The company anticipated 2017 capital expenditures of $65–$75 million, mainly for maintenance and operational effectiveness. Management said ongoing cash requirements were expected to be met through operating cash flow, existing cash, credit facilities, and debt-market access. No specific earnings or sales guidance was provided in the supplied filing text.
- On March 2, 2017, the company entered exclusive negotiations under a memorandum of understanding to acquire Air Liquide’s welding business. That business had approximately 2,000 employees and 2016 sales of about $400 million. No definitive agreement had been reached; completion remained subject to employee consultation, competition approvals, and other customary conditions, with no assurance the transaction would proceed.
- Management cited economic and market conditions, execution of operating initiatives, interest rates and credit-market access, currency movements, litigation, commodity and energy prices, and political or other disruptions among risks that could affect results.
- The company was a co-defendant in asbestos-related claims involving approximately 5,120 plaintiffs at quarter-end. Management believed the claims would not materially affect the consolidated financial statements, but noted that possible losses often could not be estimated. The filing also disclosed other ordinary-course product, regulatory, health, safety, and environmental proceedings.
- Q1 pension cost decreased to $5.6 million from $6.3 million, reflecting a defined-benefit plan freeze and lower amortization costs, partly offset by higher defined-contribution expense. The Venezuelan deconsolidation conditions continued; management said it had no remaining financial commitments to that subsidiary and did not expect material future losses.
Important facts for investors to verify
- Whether the Air Liquide Welding negotiations resulted in a definitive agreement, and the transaction’s financing, closing conditions, and expected contribution.
- Whether sales growth, margin gains, and improved operating cash flow are sustained, particularly as working capital increased and inventory days rose to 97.5 from 92.1 at year-end.
- How the planned $65–$75 million of capital spending, dividends, and any future acquisition affect cash, debt, and leverage.
- Potential tax consequences of repatriating overseas cash, the status of tax audits and $13.9 million of unrecognized tax benefits, and developments in asbestos and other litigation.
- The effects of currency, commodity costs, customer demand, and the Venezuela situation on future results; management cautioned that interim results are not necessarily indicative of full-year performance.