Lincoln Electric Holdings, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are with Q1 2013. Lincoln Electric designs and manufactures welding, cutting, brazing and soldering products. Unless noted otherwise, financial amounts below are in U.S. dollars; figures converted from the filing’s thousands are rounded to millions.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $685.1m | $718.6m | Down 4.7% |
| Gross profit / margin | $226.3m / 33.0% | $226.6m / 31.5% | Profit nearly flat; margin up 1.5 points |
| Operating income / margin | $80.4m / 11.7% | $88.6m / 12.3% | Down 9.2% |
| Net income | $56.5m | $66.8m | Down 15.5% |
| Diluted EPS | $0.69 | $0.80 | Down $0.11 |
| Operating cash flow | $13.6m | $(20.1)m | Improved $33.8m |
| Capital expenditures | $14.5m | $15.1m | Down $0.6m |
Gross margin improved because of geographic mix, stable pricing and lower year-over-year input costs; the prior-year comparison also included $1.6m of Venezuela-related inventory costs. SG&A rose 6.6% to $145.9m, or 21.3% of sales versus 19.1%, primarily reflecting higher foreign-exchange transaction losses, including a $17.7m Venezuela remeasurement charge, along with higher compensation and acquisition costs. The effective tax rate rose to 31.5% from 26.3%, contributing to lower net income.
Management’s non-GAAP adjusted diluted EPS was $0.91 versus $0.92, excluding special items, principally Venezuela foreign-exchange losses. Adjusted measures are supplementary and are not a substitute for GAAP results.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $205.4m at March 31, down $94.4m from year-end. Current assets were $1,084.9m and current liabilities $431.9m; the resulting current ratio was approximately 2.5.
- Total debt was $10.0m, down from $19.1m at December 31, 2013. The company had no borrowings under its $300m revolving credit agreement and was in compliance with its covenants.
- Operating cash flow improved from the prior-year use of cash, largely because pension contributions and payments were $33.2m lower. Cash flow less capital expenditures was approximately negative $0.9m.
- Financing cash outflows included $51.0m of treasury-share purchases and $18.6m of dividends paid. The quarterly dividend declared was $0.23 per share; a further $18.5m dividend was paid in April.
- Management expected 2014 capital expenditures of $60m–$80m and said ongoing cash needs could be met through operating cash flow, existing cash and, if needed, available credit facilities.
Business trends and material changes
- Sales volume fell 5.0% amid soft demand in domestic and international markets. Acquisitions added 1.1%, price added 0.4%, and foreign exchange reduced sales 1.2%.
- North America sales fell 4.2%; Europe fell 4.6%; Asia Pacific fell 12.5%; and Harris Products Group fell 11.7%. South America sales rose 20.9%, largely reflecting inflation-driven pricing. Asia Pacific adjusted EBIT turned negative, at $(0.6)m versus $2.3m a year earlier.
- Adjusted EBIT decreased in North America, Europe, Asia Pacific and Harris, due principally to lower volumes, higher expenses, weak China demand or lower commodity-related margins. South America adjusted EBIT increased to $11.8m, primarily from pricing increases in Venezuela.
- Robolution and Burlington, acquired in November 2013, broadened the automation offering; their combined 2013 revenue was approximately $35m. The company acquired the remaining interest in its Harris Soldas Especiais joint venture during Q1 2014 for an immaterial price.
Outlook, risks and contingencies
- Venezuela: The company used the SICAD I exchange rate of 10.7 bolivars per U.S. dollar at quarter-end, recording a $17.7m remeasurement loss. It expected another $3.5m of cost of goods sold in Q2 from liquidation of inventory valued at the historical exchange rate. Management noted uncertainty about future exchange mechanisms and rates, government controls and the effects on margins and operations. A hypothetical move to the SICAD II rate of 49.8 at March 31 could, based on current positions, cause approximately $6m of additional cost of goods sold and $20m of additional SG&A charges. Venezuela contributed $24.2m in sales and a $6.5m net loss in Q1.
- Canadian tax dispute: The CRA reassessment for 2004–2011 could increase Canadian tax by $56.6m plus approximately $15.4m interest. The company disputes the assessment, has deposited $81.0m, and recorded no tax accrual for the uncertain position. It believes it will prevail but says an unfavorable resolution could materially affect results in the period decided.
- Other exposures: The company reported approximately 14,543 asbestos-related plaintiff claims, generally alongside many other defendants, and accrued $2.6m for contingent liabilities. Management believed the proceedings would not materially affect consolidated financial statements, while noting some losses cannot be estimated reliably. It also cited general economic conditions, currency movements, commodity and energy prices, litigation, acquisitions and political events as risks.
- Management stated that operating cash flow can be cyclical. No specific full-year earnings or sales guidance was provided in the supplied filing text.
Most important facts for investors to verify
- Whether weaker demand and lower volumes persist, particularly in Asia Pacific and other international markets.
- How Venezuela’s exchange-rate rules, inventory costs, remittance restrictions and price controls affect earnings and cash access.
- The outcome and timing of the CRA tax litigation and the recoverability or use of the $81.0m deposit.
- Whether the planned $60m–$80m capital expenditure range, dividend and share repurchases remain consistent with cash generation.
- Progress in improving segment profitability, especially Asia Pacific, and the returns from the automation acquisitions.