Lincoln Electric Holdings, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Amounts below are in millions of U.S. dollars, except per-share data. The company designs and manufactures welding, cutting, brazing and soldering products and reports Americas Welding, International Welding and The Harris Products Group.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $567.6 | $645.2 | $1,710.8 | $1,967.8 |
| Gross profit | $199.8 | $198.9 | $591.8 | $645.1 |
| Gross margin | 35.2% | 30.8% | 34.6% | 32.8% |
| Operating income (loss) | $81.8 | $(84.0) | $205.2 | $103.3 |
| Net income (loss) | $60.0 | $(60.5) | $145.0 | $78.8 |
| Diluted EPS | $0.89 | $(0.82) | $2.11 | $1.04 |
| Adjusted diluted EPS (non-GAAP) | $0.89 | $0.89 | $2.49 | $2.72 |
- Q3 sales fell 12.0%; management attributed the decline to volume down 12.8% (7.8% excluding Venezuela), lower pricing of 0.7% and unfavorable currency of 0.6%, partly offset by acquisitions adding 2.1%.
- Q3 gross profit increased slightly despite lower sales, and gross margin expanded. The year-earlier quarter included a $22.2 million Venezuelan inventory valuation adjustment; 2016 included a $0.5 million LIFO charge versus a $4.1 million credit in 2015.
- For the first nine months, sales decreased 13.1%; volume was down 12.2% (9.9% excluding Venezuela), foreign exchange reduced sales 16.3%, while reported pricing added 13.2%, largely reflecting hyperinflation in Venezuela. Excluding Venezuela, pricing and currency each reduced sales.
- Q3 adjusted EBIT was $83.8 million, down 14.3%, with adjusted EBIT margin of 14.8% versus 15.1%. Americas Welding and International Welding declined; Harris Products Group increased adjusted EBIT 36.4% on higher volume and favorable mix. Nine-month adjusted EBIT fell 16.1% to $244.2 million.
- Reported earnings comparisons were affected by unusual items. Q3 2015 included pension settlement, rationalization and impairment, and Venezuela remeasurement charges; 2016 nine-month results included a $34.3 million pretax Venezuela deconsolidation loss. Adjusted measures are non-GAAP and exclude specified items.
Cash flow, balance sheet and capital allocation
- Nine-month operating cash flow was $236.8 million, compared with $235.4 million in 2015. Investing used $110.3 million, including $71.6 million for acquisitions; capital expenditures were $39.4 million. Financing used $175.9 million, including $288.6 million of share repurchases and $66.2 million of dividends.
- Cash was $256.9 million at September 30, down from $304.2 million at year-end. The company reported $249.6 million of cash held by international subsidiaries, potentially subject to U.S. income and foreign withholding taxes if repatriated.
- Total debt was $543.7 million, up from $354.6 million at year-end, including $183.8 million short-term debt and $359.8 million long-term debt. Debt to total invested capital rose to 41.9% from 27.6%. The company reported compliance with its debt covenants and had a $400 million revolving credit facility, with $155 million drawn at quarter-end.
- Subsequent to quarter-end, on October 20, 2016, the company issued $350 million of senior unsecured notes for general corporate purposes. The filing gives a combined weighted-average effective rate of 3.3% and weighted-average term of 18 years for the 2015 and 2016 notes.
- Management anticipated 2016 capital expenditures of $55–$60 million and approximately $400 million in share repurchases. In April it authorized a repurchase program of up to 55 million shares; 9.7 million remained available at September 30. The October dividend was $0.32 per share.
- Operating working capital was 17.7% of annualized sales; inventory days were 100.3 and receivable days 48.2. Nine-month ROIC was 18.3%, versus 21.4% a year earlier.
Developments, outlook and risks
- Effective June 30, the company deconsolidated its Venezuelan subsidiary after exchange controls, restricted access to U.S. dollars and operating restrictions impaired its ability to control the business. It recorded a $34.3 million pretax loss and began applying the cost method. It expected the conditions to continue, anticipated no near-term dividends or royalties and reported no remaining financial commitments to the subsidiary.
- Management cited softer economic demand and weakness in oil and gas and U.S. export markets. The filing provides no specific sales or earnings guidance; management stated that cash needs for ongoing operations should be met through operating cash flow, cash balances and available financing.
- Vizient Manufacturing Solutions was acquired in May 2016; the company said the acquisition expands automation capabilities and end-market exposure. Acquisitions contributed to sales, while acquisition spending increased year over year.
- In October, the company announced that benefit accruals under its Retirement Annuity Program would cease effective December 31, 2016, transitioning about 1,500 domestic employees to a defined-contribution plan. It said the changes were not expected to materially affect 2016 or 2017 financial statements.
- Risks identified include economic and market conditions, currency movements and devaluations, credit-market access, commodity and energy prices, litigation, regulatory complexity, rationalization costs, acquisitions and geopolitical or other events. The company said market-risk exposure had not materially changed since year-end.
- Legal proceedings include asbestos-related illness claims involving approximately 6,123 plaintiffs as of September 30. The company said it intends to contest claims and did not expect resolution of the described proceedings to materially affect its consolidated financial statements.
Most important facts for investors to verify
- Whether weak volume, especially in Americas and International Welding, persists and how segment margins respond.
- How much of reported sales and pricing trends reflects Venezuela’s prior hyperinflationary accounting and the subsidiary’s subsequent deconsolidation.
- Post-quarter financing, debt levels, covenant headroom, and the intended pace of share repurchases and capital spending.
- Whether adjusted earnings and ROIC trends remain consistent after considering the company’s non-GAAP definitions and unusual items.
- Developments in Venezuela, pension-plan changes, tax audits and unrecognized tax benefits, and asbestos and other litigation.