Business context and reporting period
Lincoln Electric Holdings, Inc. designs and manufactures arc welding and cutting products, consumables, and brazing and soldering alloys. This Form 10-Q covers the quarter and six months ended June 30, 2011; financial statements are unaudited. Amounts below are in U.S. dollars, with financial figures stated in millions unless noted. Per-share figures reflect the two-for-one stock split distributed May 31, 2011.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $699.3 | $515.6 | $1,298.5 | $986.5 |
| Gross profit / margin | $195.5 / 28.0% | $148.6 / 28.8% | $356.9 / 27.5% | $271.9 / 27.6% |
| Operating income / margin | $80.0 / 11.4% | $51.1 / 9.9% | $139.5 / 10.7% | $85.9 / 8.7% |
| Net income | $57.0 | $32.5 | $103.9 | $56.3 |
| Diluted earnings per share | $0.68 | $0.38 | $1.23 | $0.66 |
| Operating cash flow | Not separately stated | Not separately stated | $45.6 | $47.7 |
- Q2 sales increased 35.6%; management attributed the increase to higher volume across all segments, acquisitions, pricing, and favorable foreign exchange. Six-month sales rose 31.6%.
- Q2 gross margin declined 0.8 percentage points, which management attributed to rising material costs and lower margins at recent acquisitions. Six-month gross margin was nearly unchanged.
- For the six months, investing cash use was $46.4 million, including $29.4 million of capital expenditures and $17.9 million for acquisitions. Financing cash use was $32.6 million. Cash declined $28.3 million to $337.9 million.
- Working-capital requirements rose with sales: receivables increased to $414.2 million and inventory to $424.5 million from $321.9 million and $291.7 million, respectively, at year-end 2010. Management reported operating cash flow was slightly lower year over year, primarily because increased working capital offset higher net income.
- At June 30, 2011, total debt was $97.2 million, compared with $97.7 million at year-end; debt to total invested capital was 7.1%, down from 7.8%. The $80 million Series C Note is due March 2012. The company had no borrowings under its $150 million credit facility, with $149.9 million available after letters of credit, and reported compliance with its covenants.
- Current assets were $1,278.5 million and current liabilities $539.3 million. Cash dividends declared were $0.155 per share for Q2; a $13.0 million dividend was paid in July.
Material changes versus prior comparable periods
- Q2 net income grew 75.2% and diluted EPS increased from $0.38 to $0.68. For the first half, net income rose 84.7% and diluted EPS increased from $0.66 to $1.23.
- Q2 operating income increased 56.5%, with operating margin improving from 9.9% to 11.4%. SG&A rose 14.3% in dollars but fell from 19.6% to 16.5% of sales. Higher bonus expense was a significant contributor to the dollar increase.
- Reported results were affected by special items. First-half 2011 included a $4.8 million tax benefit from tax audit settlements, partly offset by $0.3 million of rationalization charges. First-half 2010 included rationalization gains and Venezuela-related currency and inventory charges. Management’s adjusted diluted EPS was $1.18 for first-half 2011 versus $0.68 in 2010.
- All operating segments reported higher sales. For Q2, Europe Welding sales included acquisition and currency contributions; The Harris Products Group benefited substantially from price increases reflecting higher commodity costs.
Outlook, commentary, risks and unusual items
- Management expects to meet ongoing cash requirements primarily through operating cash flow and existing cash balances, with credit facilities available if needed. It gave no specific earnings or sales guidance in the supplied filing text.
- Expected 2011 capital expenditures are $60 million to $70 million. The company expects to repay the $80 million note due March 2012 using operating cash, existing cash, or credit facilities.
- On July 29, 2011, after quarter-end, the company acquired Techalloy for approximately $38.7 million in cash and assumed debt; Techalloy had annual sales of about $70 million. It also acquired Torchmate for approximately $9 million in cash; annual sales were about $13 million. Earlier in 2011, it acquired Severstal for approximately $16.9 million and Arc Products for approximately $3.3 million plus contingent consideration. Acquisition pro forma results were not presented because the impact was deemed immaterial.
- Management expects no further material costs in 2011 from rationalization actions begun in 2009; the remaining liability was $1.4 million and was expected to be substantially paid by year-end.
- Risks identified include economic and market conditions, operating initiatives, currency and interest-rate movements, commodity and energy prices, litigation, regulatory complexity, acquisitions, and disruptive political or other events. Venezuela is accounted for as a highly inflationary economy; future earnings effects depend on exchange rates and the operation’s monetary position.
- The company faced asbestos claims involving approximately 16,881 plaintiffs and manganese-related claims involving approximately 1,003 plaintiffs at June 30. It reported a $5.8 million accrual for contingent liabilities, primarily product claims, and stated that it believes resolution of claims, excluding defense costs, will not materially affect consolidated financial statements. A patent dispute with Illinois Tool Works remained stayed pending patent reexaminations.
- Foreign exchange and commodity derivatives are used for risk management, not speculation. Management reported no material change in market-risk exposure since year-end 2010. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales growth and improved operating margins persist as input costs rise and acquisition margins remain lower.
- The company’s ability to convert higher earnings into operating cash, given the increase in receivables and inventory.
- Funding and repayment plans for the $80 million note due March 2012, alongside acquisition spending, dividends, and share repurchases.
- Integration, financing, and future performance of the 2011 acquisitions, including the post-quarter Techalloy and Torchmate transactions.
- Effects of currency movements, particularly in Venezuela, and exposure to commodity prices, litigation, and tax audits.
- The extent to which first-half reported earnings benefited from the $4.8 million tax audit settlement benefit; compare GAAP results with management’s adjusted measures.