Lincoln Electric Holdings, Inc. — Q2 2019 Form 10-Q
Business context and period. Unaudited results cover the quarter and six months ended June 30, 2019, compared with the corresponding 2018 periods. Lincoln Electric designs and manufactures welding, cutting, automation, brazing and soldering products. Its segments are Americas Welding, International Welding and The Harris Products Group. Dollar amounts below are in millions unless noted.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $777.0 | $790.1 | $1,536.2 | $1,547.7 |
| Gross profit / margin | $269.9 / 34.7% | $270.1 / 34.2% | $528.3 / 34.4% | $526.7 / 34.0% |
| Operating income / margin | $105.2 / 13.5% | $94.6 / 12.0% | $199.7 / 13.0% | $179.8 / 11.6% |
| Net income | $85.5 | $68.9 | $156.9 | $129.7 |
| Diluted EPS | $1.36 | $1.04 | $2.47 | $1.96 |
| Operating cash flow | — | $152.0 | $123.6 |
Q2 sales declined 1.7%; six-month sales declined 0.7%. For the first half, gross margin improved to 34.4% from 34.0%, while reported operating margin rose to 13.0% from 11.6%. First-half effective tax rate was 20.1%, versus 27.3% in 2018. Management attributed higher net income mainly to the lower tax rate and reduced rationalization and impairment charges. Adjusted diluted EPS, a non-GAAP measure, was $1.28 in Q2 versus $1.22, and $2.46 for the first half versus $2.32.
Material changes and operating trends
- Sales were supported by acquisitions and higher pricing, but offset by lower organic volume and unfavorable foreign exchange. Q2 sales effects included volume of negative 5.2%, acquisitions positive 3.4%, price positive 1.7% and foreign exchange negative 1.7%.
- International Welding was the principal weakness: Q2 sales fell 12.8%, reflecting softer European and Asian demand, integration activity and currency effects. Americas Welding sales rose 3.0%, while Harris Products Group sales rose 4.7%.
- Q2 consolidated Adjusted EBIT was $109.5 million, down 1.7% year over year, with a 14.1% margin in both periods. For the first half it was $212.1 million, down 0.4%, also at a 13.8% margin.
- Q2 reported earnings benefited from rationalization and impairment charges falling to $1.3 million from $11.5 million. First-half charges were $4.8 million versus $21.7 million.
- Gross margin benefited from pricing and segment mix, as well as a LIFO credit of $0.9 million in Q2; the comparable 2018 quarter included a $5.3 million LIFO charge.
Cash, debt and liquidity
- Cash and equivalents were $189.9 million at June 30, down from $358.8 million at year-end. First-half cash flow from operations was $152.0 million; investing used $133.6 million and financing used $190.1 million.
- Investing outflows included $107.8 million for acquisitions and $36.5 million of capital expenditures. Financing outflows included $160.9 million of share repurchases and $60.1 million of dividends paid.
- Total debt was $740.6 million, including $30.1 million of short-term debt, versus $702.7 million at year-end. Debt to total invested capital rose to 46.7% from 44.2%. The company had $30 million drawn on its $400 million revolving credit facility and reported compliance with debt covenants.
- Average operating working capital rose to 18.4% of sales from 16.5% at both December 2018 and June 2018; inventory days increased to 98.4 from 91.0 a year earlier.
Outlook, risks and unusual items
- No full-year revenue or earnings guidance is provided in the supplied filing text. Management expects to fund ongoing requirements with operating cash flow, cash balances and available borrowing capacity. Planned 2019 capital expenditures are $65–$75 million.
- Management cited softer demand in the current economic environment, especially in Europe and Asia, and said rationalization actions are intended to align costs with economic conditions. Additional rationalization charges may occur.
- Acquisitions included Baker Industries in April 2019. In July 2019, after quarter-end, the company acquired a controlling stake in Turkey-based Askaynak; terms and financial impact are not clearly stated in the filing text.
- Material risks identified include economic and market conditions, foreign exchange, interest rates and credit-market access, commodity and energy prices, tariffs and regulation, tax-law changes, litigation, rationalization costs, and the ability to integrate acquisitions.
- The company was a co-defendant in asbestos-related claims involving approximately 3,279 plaintiffs at June 30. Claims generally seek unspecified compensatory and punitive damages; the filing does not provide a clear estimate of potential losses.
- Unrecognized tax benefits were $26.2 million; approximately $22.6 million would affect income tax expense if recognized. Management said up to $5.4 million could be reduced by the end of Q2 2020 as audits proceed or statutes of limitation expire.
Most important facts for investors to verify
- Whether demand and organic volumes, particularly in International Welding, stabilize or continue to weaken.
- How much of reported earnings growth reflects the lower effective tax rate and reduced special charges versus recurring operating improvement.
- Whether cash generation can sustain acquisition spending, elevated repurchases and dividends while cash balances have declined and debt has increased.
- The performance and integration costs of recent acquisitions, including the post-quarter Askaynak transaction.
- Developments in asbestos claims, tax audits and any additional rationalization actions or charges.