Lincoln Electric Holdings, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unaudited; financial figures below are in millions except per-share data.
Business context and results
Lincoln Electric designs and manufactures welding, cutting, brazing and soldering products. Its three reporting segments are Americas Welding, International Welding and The Harris Products Group. In Q1 2016, the company realigned its operating structure; prior-period segment results were revised accordingly.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $592.4 | $664.7 | $1,143.1 | $1,322.6 |
| Gross profit / margin | $202.9 / 34.3% | $225.8 / 34.0% | $392.0 / 34.3% | $446.2 / 33.7% |
| Operating income / margin | $48.1 / 8.1% | $96.8 / 14.6% | $123.4 / 10.8% | $187.3 / 14.2% |
| Net income | $31.3 | $70.9 | $85.0 | $139.3 |
| Diluted EPS | $0.45 | $0.94 | $1.22 | $1.82 |
| Operating cash flow | — | $125.4 | $130.1 |
Material changes and drivers
- Sales fell 10.9% in Q2 and 13.6% in the first half. Management attributed the declines primarily to lower volumes amid softer economic conditions, weakness in oil and gas markets and reduced U.S. exports, along with unfavorable currency translation.
- Reported sales movements included substantial Venezuelan price increases and foreign-exchange effects. Excluding Venezuela, sales declined 8.5% in Q2 and 11.3% in the first half; volume was the main pressure, while pricing and currency were also unfavorable.
- Gross margin improved despite lower sales, supported by lower raw-material costs and cost-reduction actions. SG&A fell in dollars but increased as a share of sales, to 20.3% in Q2 and 20.5% for the half-year.
- Adjusted EBIT was $83.9 million in Q2, down 15.6%, and $160.4 million for the first half, down 17.0%. Americas and International Welding declined mainly on lower volumes; Harris Products Group adjusted EBIT increased, aided by mix and volume.
- Reported earnings include a $34.3 million pretax ($33.3 million after-tax) Venezuela deconsolidation loss. Adjusted diluted EPS, which excludes disclosed special items, was $0.83 versus $0.95 in Q2 and $1.60 versus $1.83 for the first half.
Cash, debt and capital allocation
- Cash was $237.0 million at June 30, down $67.2 million from year-end. First-half operating cash flow was $125.4 million; investing used $96.0 million, including $71.6 million for acquisitions, and financing used $99.3 million.
- Total debt rose to $520.8 million from $354.6 million at year-end; debt to total invested capital increased to 39.7% from 27.6%. The company reported $159.9 million of short-term debt, including $135 million drawn under its $400 million revolving credit facility, and $360.9 million of long-term debt. It reported compliance with debt covenants.
- Cash and cash equivalents held by international subsidiaries totaled $227.4 million and may incur U.S. income and foreign withholding taxes if repatriated.
- Share repurchases used $202.9 million in the first half; management anticipated approximately $400 million of repurchases for 2016. The company declared dividends of $0.64 per share for the first half and paid $0.32 per share in July.
Outlook, risks and unusual items
- Management expected to fund ongoing needs with operating cash flow, existing cash, credit facilities and capital markets. Planned 2016 capital expenditures were $55–65 million. No earnings or sales guidance was provided in the filing.
- In July 2016, the company committed to pricing $350 million of private-placement debt, with maturities of 12–25 years and a weighted average effective rate of 3.1%; proceeds were expected in Q4 for general corporate purposes.
- Effective June 30, the company deconsolidated its Venezuelan subsidiary after exchange controls and government restrictions impaired its ability to control operations. It will use cost-method accounting and does not expect dividend or royalty payments in the foreseeable future. It said it had no remaining financial commitments and did not expect future losses to be material; it also halted sales to and inventory purchases from the entity for the time being.
- Management cited general economic conditions, oil and gas weakness, currency movements, commodity and energy prices, credit-market access, litigation, acquisitions and political events as risks. The filing specifically noted potential economic, market and currency effects of the UK vote to leave the EU.
- Asbestos-related claims involved approximately 6,480 plaintiffs at June 30. The company said it intended to contest claims and did not expect their resolution to materially affect consolidated financial statements. Other ordinary-course product liability, regulatory, health, safety and environmental proceedings also remain possible.
- Management reported no material change in market-risk exposure since year-end and concluded disclosure controls were effective; no material change in internal control over financial reporting was reported.
Key facts for investors to verify
- How much of the sales decline reflects underlying demand and volume versus currency, Venezuela’s unusual inflation and pricing effects, and acquisition contributions.
- Whether volume weakness persists in Americas and International Welding, and whether gross-margin improvements from cost actions and raw materials are sustainable.
- The effects of Venezuela deconsolidation, including any future recoveries, obligations or changes in the company’s stated assessment of exposure.
- Debt, liquidity and cash-location developments, including execution and use of the planned $350 million debt financing and the pace of repurchases relative to cash generation.
- Developments in asbestos and other litigation, tax audits and unrecognized tax benefits, and the eventual impact of newly issued accounting standards.