Lincoln Electric Holdings, Inc. — Q3 2017 Form 10-Q
Business context and period. The company designs and manufactures welding, cutting, soldering and brazing products. This unaudited report covers the three and nine months ended September 30, 2017, compared with the same 2016 periods. Its segments are Americas Welding, International Welding and The Harris Products Group.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $669.5 million | $567.6 million | $1,877.2 million | $1,710.8 million |
| Gross profit / margin | $219.5 million / 32.8% | $199.8 million / 35.2% | $640.9 million / 34.1% | $591.8 million / 34.6% |
| Operating income | $133.1 million | $81.8 million | $302.2 million | $205.2 million |
| Net income | $106.1 million | $60.0 million | $223.3 million | $145.0 million |
| Diluted EPS | $1.59 | $0.89 | $3.35 | $2.11 |
| Adjusted diluted EPS | $0.93 | $0.89 | $2.78 | $2.49 |
Sales drivers and margins. Q3 sales grew 17.9%, reflecting volume growth of 3.8%, acquisitions of 11.0%, pricing of 1.8% and favorable foreign exchange of 1.4%. For the nine months, sales grew 9.7%; volume, acquisitions, pricing and foreign exchange contributed 3.3%, 3.9%, 2.2% and 0.3%, respectively. Gross margin declined as rising input costs outpaced pricing; higher LIFO charges also weighed on results. Q3 adjusted EBIT was $94.5 million, up 12.9%, while its margin declined to 14.1% from 14.8%. Nine-month adjusted EBIT rose 12.6% to $274.9 million and margin increased to 14.6% from 14.3%.
Cash flow and balance sheet. Nine-month operating cash flow was $245.4 million, versus $240.2 million. Capital expenditures were $39.0 million, making operating cash flow less capital expenditures approximately $206.4 million. Investing activities used $249.8 million, including $140.4 million net purchases of marketable securities and $72.5 million for acquisitions. Financing activities used $93.9 million, including $69.1 million of dividends. Cash declined $79.7 million to $299.5 million; marketable securities were $179.3 million. At September 30, total debt was $706.9 million, including $704.8 million long-term debt; debt to total invested capital was 42.8%, down from 49.8% at year-end 2016. The company had no borrowings under its $400 million revolving credit facility and was in compliance with debt covenants. The facility matures June 30, 2022.
Material changes, unusual items and outlook
- Air Liquide Welding acquisition: Completed July 31, 2017, with a net purchase price of $72.5 million. Its results were included from August 1 and contributed $63 million of Q3 sales; its Q3 net-income impact was described as immaterial. The preliminary purchase accounting generated a $51.6 million bargain purchase gain, which materially increased reported operating income, net income and EPS. Acquisition transaction and integration costs were $11.4 million for the nine months; inventory step-up expense was $2.3 million. Purchase accounting remained preliminary and could change.
- Adjusted results: Excluding special items, Q3 adjusted net income was $61.8 million versus $60.0 million, and adjusted diluted EPS was $0.93 versus $0.89. Nine-month adjusted net income was $185.2 million versus $171.1 million. The reported comparisons also reflect a $34.3 million Venezuelan deconsolidation loss in the 2016 nine-month period, which did not recur in 2017.
- Other costs and taxes: Q3 included $5.3 million of pension settlement charges related to lump-sum payments. The effective tax rate was 18.8% in Q3 versus 25.2%, and 23.7% for the nine months versus 27.2%; the 2017 rates benefited in part from the nontaxable acquisition gain and stock-compensation tax benefits. Interest expense rose with higher borrowings.
- Outlook and liquidity: No specific revenue or earnings guidance is provided. Management said it expects to meet foreseeable cash needs using operating cash flow, cash balances, credit facilities and debt-market access. It anticipated 2017 capital expenditures of $55 million and may make further acquisition-related expenditures. Management noted that operating cash flow can be cyclical and that significant acquisitions could require capital-market funding. Of cash and cash equivalents, $254.3 million was held by international subsidiaries and may incur tax if repatriated.
- Risks and contingencies: Cited risks include economic and market conditions, commodity and energy costs, currency movements, interest rates and credit-market access, litigation, regulation, political or other disruptions, and successful integration of Air Liquide Welding. The company was a co-defendant in asbestos-related cases involving approximately 3,751 plaintiffs; it believes resolution will not materially affect the consolidated financial statements. Management reported effective disclosure controls. Integration of the acquired business’s systems and controls was expected to continue through fiscal 2018.
Most important facts for investors to verify
- How much of sales growth and future profitability is organic versus attributable to the Air Liquide Welding acquisition, and whether integration synergies materialize.
- Whether pricing can offset rising input costs and restore gross margins, given higher LIFO charges.
- The final acquisition purchase-price allocation and any changes to the $51.6 million bargain purchase gain.
- Cash conversion and working-capital trends: operating working capital to sales rose to 20.5% from 15.6% at year-end 2016; inventory and receivable days also increased.
- Debt, liquidity, and the potential tax cost of repatriating overseas cash; confirm continued compliance with credit covenants.
- Developments in asbestos litigation, tax audits and unrecognized tax benefits, and the company’s integration of acquired-business controls.