Lincoln Electric Holdings, Inc. — FY2016 Form 10-K
Reporting period: Year ended December 31, 2016; the filing also reports fourth-quarter results. Lincoln Electric manufactures welding, cutting and brazing products. Its three segments are Americas Welding, International Welding and The Harris Products Group. Unless noted, amounts below are in millions of dollars.
Financial performance
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Net sales | $2,274.6 | $2,535.8 | -10.3% |
| Gross profit / margin | $789.3 / 34.7% | $841.1 / 33.2% | Margin +1.5 percentage points |
| Operating income / margin | $288.3 / 12.7% | $181.7 / 7.2% | +58.7% |
| Net income | $198.4 | $127.5 | +55.6% |
| Diluted EPS | $2.91 | $1.70 | +$1.21 |
| Adjusted diluted EPS | $3.29 | $3.48 | -$0.19 |
| Operating cash flow | $303.4 | $310.9 | -$7.5 |
- Sales drivers: Lower volume reduced sales by $247.7 million; acquisitions added $51.5 million and foreign exchange reduced sales by $324.7 million. Excluding Venezuela, sales declined 7.6%. Management cited softer demand, weakness in oil and gas and U.S. export markets, and a stronger U.S. dollar.
- Profitability: Gross margin improved on lower material costs, cost controls and price management. Reported operating income and net income rose largely because 2015 included $142.7 million of pension settlement charges, Venezuelan remeasurement losses and rationalization/impairment charges. Adjusted EBIT fell 13.2% to $328.7 million; adjusted EBIT margin declined to 14.5% from 14.9%.
- Segments: Americas Welding sales fell 14.1% and adjusted EBIT fell 15.8%; International Welding sales fell 4.4% and adjusted EBIT fell 15.5%. Harris Products Group sales rose 3.2% and adjusted EBIT rose 16.1%, supported by retail-market sales mix.
- Fourth quarter: Sales were $563.8 million versus $568.0 million in Q4 2015; net income was $53.4 million versus $48.7 million. The filing does not provide a standalone adjusted Q4 comparison.
- Cash and investment: Cash and equivalents ended at $379.2 million, up $75.0 million. Capital expenditures were $49.9 million and acquisitions, net of cash acquired, used $71.6 million. Cash flow less capital expenditures implies free cash flow of approximately $253.5 million.
- Debt and liquidity: Total debt was $705.6 million versus $354.6 million; debt to total invested capital increased to 49.8% from 27.6%. The company issued $350 million of long-term notes in 2016, with a 3.1% weighted-average effective rate and 18-year initial average tenure. A $400 million revolving facility had no outstanding borrowings; the company reported compliance with covenants. Of cash, $261.5 million was held by international subsidiaries and may incur tax if repatriated.
- Shareholder returns: FY2016 dividends declared were $1.31 per share; cash dividends paid were $87.3 million. The company repurchased 5.9 million shares for $342.0 million, with 8.9 million shares remaining authorized for repurchase.
Material changes and unusual items
- Effective June 30, 2016, the company deconsolidated its Venezuelan subsidiary after exchange controls and operating restrictions impaired its ability to control operations. It recorded a $34.3 million pretax ($33.3 million after-tax) loss and no longer included the subsidiary’s results after June 30. FY2016 Venezuelan sales were $10.8 million, versus $84.7 million in 2015.
- A $7.2 million tax valuation-allowance reversal partially offset the Venezuela loss. The effective tax rate was 28.5%, compared with 25.0% in 2015.
- The company froze benefit accruals under its principal U.S. retirement annuity program and domestic supplemental executive plan, effective December 31 and November 30, 2016, respectively. It expects U.S. defined-benefit plan contributions to be zero in 2017.
- No rationalization or asset impairment charges were recorded in 2016; $20.0 million was recorded in 2015. Goodwill fair value exceeded carrying value by at least 10% for each reporting unit at the 2016 annual test date.
Outlook, risks and contingencies
- Management expected 2017 capital expenditures of $65 million to $75 million, principally for maintenance and operational effectiveness. The filing gives no quantified revenue or earnings guidance.
- Management said operating cash flow, existing cash, credit facilities and debt markets should meet ongoing cash requirements. Significant acquisitions could require additional capital-market financing.
- Key risks include cyclical industrial demand, raw-material and energy price volatility, foreign currency movements, international political and regulatory conditions, competition, product liability and warranty costs, workforce availability, pension assumptions, cybersecurity and environmental regulation.
- At year-end the company was a co-defendant in asbestos-related cases involving approximately 5,954 plaintiffs. It intends to contest claims and believes, based on its defenses and insurance, resolution will not materially affect the consolidated financial statements; ultimate losses and timing remain difficult to estimate. Other ordinary-course product, regulatory, health, safety and environmental proceedings are also disclosed.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls and financial-reporting controls were effective.
Important facts for investors to verify
- Whether sales-volume trends and demand in oil and gas, U.S. exports and industrial markets stabilize, and whether the improved gross margin can be sustained.
- How much of reported earnings growth reflects the absence of 2015 special charges versus underlying operating performance; compare GAAP EPS with adjusted EPS.
- Venezuela’s continuing deconsolidation, residual exposure and the assumptions behind the recorded loss and lack of expected future remittances.
- The effect of increased debt and share repurchases on leverage, liquidity and capital allocation; verify note maturities, interest costs and covenant headroom.
- Potential changes in asbestos/product-liability exposure, pension-plan costs and contributions, and tax-audit outcomes.