Lincoln Electric Holdings, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise noted. The company designs and manufactures welding, cutting, brazing and soldering products.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $645.2 | $715.8 | $1,967.8 | $2,129.4 |
| Gross margin | 30.8% | 33.8% | 32.8% | 33.7% |
| Operating income (loss) | $(84.0) | $76.1 | $103.3 | $268.8 |
| Net income (loss) | $(60.5) | $45.7 | $78.8 | $179.5 |
| Diluted EPS | $(0.82) | $0.57 | $1.04 | $2.22 |
- Q3 sales fell 9.9%: lower volume (10.2%) and unfavorable currency translation (5.9%) outweighed acquisitions (3.0%) and pricing (3.3%). Management cited softer demand, particularly in oil and gas and U.S. export markets.
- Q3 gross profit declined 17.7%. It included a $22.2 million Venezuela inventory valuation adjustment related to the new exchange rate, partly offset by a $4.1 million LIFO credit. Foreign exchange translation reduced Q3 results by $12.8 million.
- The reported Q3 loss primarily reflected a non-cash $136.3 million pension settlement charge, Venezuela-related charges and rationalization/impairment costs. Management’s non-GAAP adjusted diluted EPS was $0.89 for Q3 and $2.72 for the first nine months, compared with $0.94 and $2.86, respectively, in 2014. Adjusted net income was $66.2 million in Q3 and $206.4 million year to date.
- For the first nine months, sales declined 7.6%, operating income fell 61.6%, and net income fell 56.1%. Adjusted operating income was $285.6 million versus $319.9 million in 2014.
- Nine-month operating cash flow was $235.4 million, down from $268.1 million. Capital expenditures were $40.2 million; operating cash flow less capital expenditures was approximately $195.2 million, calculated from reported figures. Cash ended the period at $364.3 million.
- At September 30, current assets were $1,068.9 million and current liabilities $437.4 million (approximately 2.4 current ratio). Debt was $353.4 million, primarily $350 million of new long-term notes; debt to total invested capital was 25.9%, versus 5.2% at year-end 2014. The company had no borrowings on its $400 million credit facility and reported compliance with debt covenants.
- Cash returned to shareholders included $297.8 million of share repurchases and $65.9 million of dividends during the first nine months. The declared dividend was $0.87 per share year to date.
Material changes and management commentary
- Sales declined across most segments amid softer demand and a stronger U.S. dollar. Europe was particularly affected by currency translation; South America’s reported sales growth reflected inflation-driven pricing, while its nine-month adjusted segment EBIT declined.
- North America Welding’s nine-month adjusted EBIT decreased 7.5%; Europe Welding’s declined 32.6%. Asia Pacific Welding improved to positive adjusted EBIT, attributed to lower material costs and operational efficiencies. Harris Products Group adjusted EBIT was nearly flat.
- The company acquired Specialised Welding Products and Rimrock in August 2015; together they had approximately $56 million in annual revenue at acquisition. Rimrock includes Wolf Robotics and Rimrock Corporation; the company said it was reviewing strategic options for Rimrock Corporation.
- A group annuity contract transferred specified U.S. retiree pension obligations to Principal Financial Group. Funded from existing plan assets, it reduced the U.S. pension obligation by $433.2 million, or 48.7%, and generated the $136.3 million non-cash settlement charge. Management expects reduced pension-cost and funding volatility.
Outlook, risks and contingencies
- No specific revenue or earnings guidance was provided. Management anticipated 2015 capital expenditures of $60–$65 million and share repurchases of approximately $400 million.
- Management said ongoing cash needs should be met through operating cash flow, cash balances, existing credit facilities and capital-market access. Significant acquisitions could require additional financing.
- Venezuela presents substantial uncertainty. The company adopted the SIMADI rate of 199.4 bolivars per U.S. dollar at quarter-end, recording a $4.3 million remeasurement loss and the $22.2 million inventory adjustment. It warned that exchange mechanisms, devaluation, price and currency controls, repatriation restrictions, and government actions could cause further losses, disrupt operations or require deconsolidation. Venezuela generated $80.9 million of nine-month sales and a reported net loss of $23.1 million.
- The company was a co-defendant in asbestos-related cases involving approximately 8,901 plaintiffs. It stated that it intends to contest claims and believes resolution of existing proceedings will not materially affect its consolidated financial statements; many claims seek unspecified damages, and a range of possible losses often cannot be estimated.
- Other stated risks include economic conditions, commodity and energy costs, foreign exchange, litigation, rationalization costs, acquisitions and access to credit markets. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Important facts for investors to verify
- How much of the sales and margin decline reflects persistent demand weakness versus currency effects, and whether recent cost actions can offset continued volume pressure.
- The ongoing financial and operational effects of Venezuela’s exchange regime, including access to foreign currency and the potential for further inventory or remeasurement charges.
- The impact of the pension annuity transaction on future pension expense, cash contributions and reported results, apart from the one-time settlement charge.
- Whether planned repurchases and dividends remain sustainable alongside acquisition spending, capital investment and the higher debt level.
- Integration and returns from SWP and Rimrock, including the outcome of the strategic review of Rimrock Corporation.