Lincoln Electric Holdings, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013. Lincoln Electric designs and manufactures welding, cutting, brazing and soldering products. Unless stated otherwise, financial amounts below are in millions of dollars.
Financial performance and liquidity
- Revenue: $718.6, down 1.2% from $727.1 a year earlier. Volume declined 6.0%; acquisitions added 5.5%, pricing added 0.1%, and foreign exchange reduced sales 0.8%.
- Profit and margins: Gross profit rose 5.3% to $226.6; gross margin improved to 31.5% from 29.6%, reflecting lower input costs and pricing stability, partly offset by weaker acquisition margins and Venezuela costs. Operating income declined 3.3% to $88.6, with operating margin at 12.3% versus 12.6%. Net income increased 4.0% to $66.8; diluted EPS was $0.80 versus $0.76. The effective tax rate fell to 26.3% from 31.0%.
- Adjusted results (non-GAAP): Adjusted operating income was $99.3 versus $91.7; adjusted net income was $77.1 and adjusted diluted EPS was $0.92. These exclude special items, including Venezuela devaluation and rationalization charges.
- Cash flow: Operating cash flow was negative $20.1, compared with positive $79.2 a year earlier. The company attributed the decline chiefly to higher working-capital needs and a $50.0 voluntary U.S. pension contribution, $32.0 more than in Q1 2012. Capital expenditures were $15.1, making operating cash flow less capital expenditures negative $35.3.
- Cash, debt and liquidity: Cash was $248.5 at March 31, down $38.0 from year-end. Total debt was $18.5, down from $20.3; debt to total invested capital was 1.3%. The company had no borrowings under its $300.0 five-year credit facility and was in compliance with covenants. Current assets were $1,164.7 and current liabilities $459.0.
- Other: Inventory was $377.3, up from $364.9 at year-end; accounts receivable was $423.8, up from $360.7. The company declared a $0.20 per-share dividend; it paid $16.6 in April. It repurchased $12.8 of shares during the quarter.
Changes versus prior year
- Sales fell despite acquisitions, as softening demand drove lower volumes in every operating segment. North America Welding sales grew 10.0%, primarily from acquisitions; Europe fell 12.2%, Asia Pacific 24.3%, South America 8.7%, and Harris Products Group 6.2%.
- Gross margin improved, but SG&A increased 10.7% to $136.9, including acquisition costs, higher foreign-exchange transaction losses and increased compensation costs. Operating income and pretax income declined, while lower tax expense helped lift net income.
- Operating cash flow deteriorated sharply, mainly from working capital and pension funding. Investing outflows fell to $15.6 from $34.3, primarily because business-acquisition spending was lower; financing outflows were $0.6 versus $107.9.
- Comprehensive income attributable to shareholders decreased to $58.2 from $94.1, principally reflecting a $14.2 currency-translation loss versus a $25.6 gain in the prior-year quarter.
Outlook, commentary and risks
- Management said it expects to fund ongoing operations with operating cash, existing balances and, if needed, available credit. It anticipated 2013 capital expenditures of approximately $60.0. The filing provides no specific revenue or earnings guidance and cautions that quarterly results are not necessarily indicative of full-year results.
- Venezuela: The bolivar devaluation from 4.3 to 6.3 per U.S. dollar caused an $8.1 foreign-exchange transaction loss in SG&A and $1.6 of higher cost of goods sold in Q1. Management expected about $2.5 of additional gross-profit reduction in Q2 from selling inventory valued at the former exchange rate, and expected the subsidiary’s 2013 results to decline. A hypothetical further devaluation to 12.6 could produce approximately $5.5 of additional cost of goods sold and $9.5 of SG&A charges, based on current balances.
- Tax dispute: The Canadian tax authority reassessed 2004–2011 intercompany dividends, asserting $60.5 of additional tax plus approximately $16.7 of interest, net of tax. Lincoln disputes the assessment and deposited $86.9, recorded as a non-current asset, to suspend further interest accrual. No accrual was recorded for the disputed position; an unfavorable resolution could materially affect results when resolved.
- Legal and operational risks: The company reported approximately 15,081 asbestos-related plaintiffs and other ordinary-course claims; it believes the claims will not materially affect its financial statements, but stated that possible loss ranges often cannot be estimated. Risks also include demand and economic conditions, foreign exchange, input costs, acquisitions, rationalization costs, litigation, regulation and political events. New conflict-minerals rules require due diligence for calendar 2013, with initial disclosure due by May 31, 2014.
- Rationalization charges were $1.1 in Q1; additional charges of up to $0.2 in North America and $0.3 in Asia Pacific were expected to complete specified plans. Management said further rationalization actions could result in future charges.
Important facts for investors to verify
- Whether weaker demand and volume trends persist, particularly in Europe and Asia Pacific, and how much reported performance depends on acquisitions.
- Whether gross-margin improvement can continue as input costs and pricing change, and whether elevated SG&A moderates.
- Actual Q2 and full-year impact of Venezuela’s devaluation, including inventory costs, exchange rates and any price or currency controls.
- Working-capital and pension cash requirements, progress against the approximately $60.0 capital-expenditure plan, and cash-generation trends.
- Developments in the Canadian tax litigation, including the timing and outcome of the reassessment and treatment of the $86.9 deposit.
- Completion costs and expected benefits of rationalization plans, and any material developments in asbestos or other litigation.