Lincoln Electric Holdings, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. The company designs and manufactures welding, cutting, brazing and soldering products. Dollar amounts below are in millions unless stated otherwise.
Financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $728.5 | $727.4 | $1,413.6 | $1,446.0 |
| Gross profit / margin | $250.3 / 34.4% | $240.3 / 33.0% | $476.6 / 33.7% | $466.9 / 32.3% |
| Operating income / margin | $112.3 / 15.4% | $104.3 / 14.3% | $192.7 / 13.6% | $192.9 / 13.3% |
| Net income | $77.3 | $72.6 | $133.8 | $139.4 |
| Diluted EPS | $0.96 | $0.87 | $1.65 | $1.67 |
Q2 sales were nearly flat (+0.2%); volume fell 1.4%, while price and acquisitions contributed 2.3% and 1.2%, respectively, partly offset by 1.9% unfavorable foreign exchange. Six-month sales declined 2.2%, reflecting a 3.2% volume decline and 1.6% unfavorable foreign exchange, partly offset by pricing and acquisitions. Gross margin improved in both periods, attributed to geographic mix and operational improvements; Q2 and first-half results also included a $3.9 million insurance settlement gain.
For the six months, SG&A increased 4.0% to $283.1 million and rose to 20.0% of sales from 18.8%, while operating income was essentially unchanged. Net income fell 4.0%, and diluted EPS fell from $1.67 to $1.65. The six-month effective tax rate increased to 32.2% from 29.3%.
Segments and material developments
- Q2 adjusted segment EBIT improved at North America Welding and Europe Welding; North America benefited partly from operational improvements, lower pension expense and the insurance settlement. Europe benefited from higher equipment volume and mix.
- South America Welding Q2 sales declined 12.3% and adjusted EBIT declined 54.9%, mainly on lower Venezuelan volumes and higher foreign-exchange-related SG&A. For the first half, Asia Pacific adjusted EBIT turned to a $0.3 million loss, attributed to weaker demand in China. Harris Products Group sales declined 10.8% in the first half, reflecting lower volume and lower silver and copper-related pricing.
- Venezuela’s currency regime changed: the company used the SICAD I rate, 10.6 bolivars per U.S. dollar at June 30. First-half Venezuelan remeasurement losses were $17.7 million in SG&A, and the company recorded $3.5 million of higher Q2 cost of goods sold related to inventory valued at the historical rate. Management cited significant uncertainty around exchange mechanisms, controls and future rates.
- Cash from operations was $118.6 million in the first half, up from $87.1 million; the improvement was predominantly due to $57.2 million less in pension contributions and payments. Investing used $34.6 million, including $39.9 million of capital expenditures. Financing used $162.4 million, including $119.3 million of share repurchases and $37.1 million of dividends. Cash declined $95.5 million to $204.3 million.
- At June 30, cash was $204.3 million, total debt was $8.1 million, and the company had no borrowings under its $300 million credit facility and was in covenant compliance. Current assets were $1,105.7 million and current liabilities $464.5 million. Debt to invested capital was 0.5%.
Outlook, risks and contingencies
- No full-year earnings or sales guidance is stated. Management anticipated 2014 capital expenditures of $70–$80 million and share repurchases of approximately $250 million. Management said ongoing cash needs should be met primarily through operating cash flow, cash balances and, if needed, existing credit facilities.
- Management warned that Venezuela’s exchange-rate changes, possible further devaluation, government price and currency controls, and restrictions on foreign-currency distribution could affect earnings, margins, payments and production. At the SICAD II rate cited at June 30, management estimated an additional approximately $6 million COGS charge and $19 million SG&A charge based on then-current exposures.
- The Canada Revenue Agency reassessment for 2004–2011 could increase tax due by $58.7 million plus approximately $16.0 million interest. The company disputes the assessment, has deposited $83.9 million, and recorded no tax accrual for the uncertain positions; an unfavorable resolution could materially affect results in the period of judgment.
- The company faced asbestos-related illness claims involving approximately 14,800 plaintiffs, generally alongside many other defendants. Management believed the claims and proceedings would not materially affect the consolidated financial statements, but noted that possible loss ranges often cannot be estimated.
- Other identified risks include economic and market conditions, currency and commodity prices, execution of operating initiatives and rationalization plans, litigation, acquisitions, and political or other disruptive events. Management stated there were no material changes in market-risk exposure and that disclosure controls were effective.
Important facts for investors to verify
- Whether improved gross margins and operating performance can persist without the $3.9 million insurance settlement gain.
- Developments in Venezuelan exchange rules, trapped currency balances and the resulting earnings and cash impacts.
- Progress and potential outcome of the CRA dispute, including the adequacy and recoverability of the $83.9 million deposit.
- Whether softer international demand, segment pressure and working-capital measures (inventory days rose to 95.8; receivable days to 53.4) improve.
- Whether planned capital spending and share repurchases remain consistent with cash generation, liquidity and the company’s stated outlook.