Lincoln Electric Holdings, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011; comparisons are with the corresponding 2010 periods. The company designs and manufactures welding and cutting products and brazing and soldering alloys. Financial amounts below are in millions of dollars unless stated otherwise. Per-share amounts reflect the two-for-one stock split effective May 31, 2011.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $701.6 | $519.3 | $2,000.1 | $1,505.9 |
| Gross profit | $185.5 | $144.1 | $542.4 | $416.0 |
| Gross margin | 26.4% | 27.7% | 27.1% | 27.6% |
| Operating income | $74.8 | $48.2 | $214.3 | $134.1 |
| Operating margin | 10.7% | 9.3% | 10.7% | 8.9% |
| Net income | $55.5 | $32.5 | $159.5 | $88.7 |
| Diluted EPS | $0.66 | $0.38 | $1.88 | $1.04 |
Q3 sales rose 35.1%; nine-month sales rose 32.8%. Q3 net income increased 71.0%, and nine-month net income increased 79.7%. Nine-month adjusted diluted EPS, a non-GAAP measure excluding special items, was $1.83 versus $1.07.
Cash flow, liquidity and debt
- For the first nine months, operating cash flow was $130.4, up from $103.7. Investing used $112.1, including $62.3 for acquisitions and $50.8 of capital expenditures. Financing used $60.0; cash declined $44.7 to $321.5.
- At September 30, current assets were $1,244.6 and current liabilities were $549.1. Current liabilities included $81.9 of current debt, principally reflecting the $80.0 note due March 2012.
- Total debt was $94.5, down from $97.7 at year-end 2010; debt to total invested capital was 7.1%, versus 7.8%. The company reported compliance with credit covenants and $149.9 of available credit capacity, with no borrowings under its $150.0 credit line.
- Management said ongoing cash needs are expected to be met by operating cash flow, existing cash and, if needed, credit facilities. The company expects to repay the March 2012 note using those sources.
Material changes and management commentary
- Sales increased across all operating segments, attributed to improved demand and modest market-share gains. Nine-month sales growth also reflected acquisitions, pricing and favorable currency translation; consolidated growth contributors were volume $252.1, acquisitions $74.9, price $109.6 and foreign exchange $57.7.
- Gross margin declined in both comparison periods, which management attributed to rising material costs and lower margins from recent acquisitions. Q3 included $1.8 of charges related to initial acquisition accounting.
- SG&A rose in dollars but declined as a share of sales: 15.8% versus 18.4% in Q3 and 16.4% versus 18.9% for nine months. Higher bonus expense was a principal driver, partly offset by lower legal expenses.
- Recent acquisitions included Techalloy and Torchmate in July, Severstal in March, and Arc Products in January. The company reported approximately $62.3 of acquisition cash outflow in the first nine months. Techalloy and Torchmate purchase accounting remained preliminary; Arc Products includes contingent consideration tied to sales through 2015.
- Capital expenditures were expected to be $60–$70 for 2011. No specific earnings or revenue guidance was provided.
- The effective tax rate for the first nine months was 26.9%, including a $4.8 benefit from tax audit settlements; the prior-year rate was 32.9%. The filing notes that the full-year rate depends on earnings mix and tax deductions.
- Currency translation reduced Q3 comprehensive income substantially: the quarter’s currency translation adjustment was negative $59.0. Management also identified Venezuela’s highly inflationary accounting and exchange-rate movements as potential sources of future earnings variability.
Risks, contingencies and unusual items
- Pending product-liability and health, safety and environmental matters include asbestos claims involving approximately 16,897 plaintiffs and manganese claims involving approximately 858 plaintiffs. The company intends to contest claims and believes their resolution, excluding defense costs, will not materially affect its financial statements; outcomes remain uncertain.
- Other stated risks include economic and market conditions, commodity and energy prices, foreign exchange and interest rates, litigation, acquisitions, regulatory complexity and geopolitical or other events. The company reported no material change in market-risk exposure since December 31, 2010.
- The $80.0 Series C note matures in March 2012. The company had no outstanding interest-rate swaps at quarter-end.
- Nine-month rationalization charges were $0.3; management expected no further material costs in 2011. The filing also reports unrecognized tax benefits of $28.8 and says a reduction of $7.1 may be possible by the end of Q3 2012.
- Management concluded disclosure controls were effective at September 30, 2011 and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether sales growth and improved operating margins persist, particularly given lower gross margins and rising material costs.
- Working-capital demands: inventories increased to $421.3 from $291.7 at year-end, and operating cash flow benefited from higher earnings while funding higher working capital.
- The company’s plan and funding source for the $80.0 note due March 2012, and continued access to its credit facility.
- Acquisition integration, preliminary purchase accounting, and the performance assumptions underlying Arc Products’ contingent consideration.
- Exposure to foreign exchange, Venezuela-related uncertainty, commodity costs, and the outcome and insurance coverage of asbestos, manganese and other litigation.