Lincoln Electric : Q2 2022 Lincoln Electric Holdings Inc Earnings Conference Call Transcript

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LECO.OQ - Q2 2022 Lincoln Electric Holdings Inc Earnings Call

EVENT DATE/TIME: JULY 28, 2022 / 2:00PM GMT

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JULY 28, 2022 / 2:00PM, LECO.OQ - Q2 2022 Lincoln Electric Holdings Inc Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Amanda H. Butler Lincoln Electric Holdings, Inc. - VP of IR & Communications

Christopher L. Mapes Lincoln Electric Holdings, Inc. - Chairman, President & CEO

Gabriel Bruno Lincoln Electric Holdings, Inc. - Executive VP, CFO & Treasurer

Steven B. Hedlund Lincoln Electric Holdings, Inc. - Executive VP & COO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Adam Michael Farley Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

Bryan Francis Blair Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst

Christopher M. Dankert Loop Capital Markets LLC, Research Division - SVP

Joseph Michael Grabowski Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate Robert Stephen Barger KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst Saree Emily Boroditsky Jefferies LLC, Research Division - Equity Analyst

P R E S E N T A T I O N

Operator

Greetings, and welcome to the Lincoln Electric 2022 Second Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. And this call is being recorded. It is my pleasure to introduce your host, Amanda Butler, Vice President of Investor Relations and Communications. Thank you. You may begin.

Amanda H. Butler - Lincoln Electric Holdings, Inc. - VP of IR & Communications

Thank you, Dylan, and good morning, everyone. Welcome to Lincoln Electric's Second Quarter 2022 Conference Call. We released our financial results earlier today, and you can find our release as an attachment to this call's slide presentation as well as on the Lincoln Electric website at lincolnelectric.com in the Investor Relations section. Joining on the call today is Chris Mapes, Lincoln's Chairman, President and Chief Executive Officer; Gabe Bruno, our Chief Financial Officer; and Steve Hedlund, our Chief Operating Officer. Chris and Steve will begin with a discussion and overview of our results and business trends. Gabe will cover our quarterly financial performance in more detail. And finally, Chris will conclude with a review of updated assumptions for the year. And following our prepared remarks, we're happy to take your questions.

Before we start our discussion, please note that certain statements made during this call may be forward-looking, and actual results may differ materially from our expectations due to a number of risk factors. A discussion of some of the risks and uncertainties that may affect our results are provided in our press release and in our SEC filings on Forms 10-K and 10-Q. In addition, we discussed financial measures that do not conform to U.S. GAAP, and a reconciliation of non-GAAP measures to the most comparable GAAP measure is found in the financial tables in our earnings release, which again is available in the Investor Relations section of our website at lincolnelectric.com. And with that, I'll pass the call over to Chris Mapes. Chris?

Christopher L. Mapes - Lincoln Electric Holdings, Inc. - Chairman, President & CEO

Thank you, Amanda. Good morning, everyone. Turning to Slide 3. We I'm pleased to report another quarter of record sales, profitability, earnings and returns. The organization did an excellent job capitalizing on growth and effectively manage the challenging operating environment. Demonstrating the success of our customer-first approach and the strong execution of our commercial and operational Higher Standard 2025 Strategy initiatives. We achieved record sales of $970 million, led by 21% organic growth on 17% higher price and a 3% increase in volumes,

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JULY 28, 2022 / 2:00PM, LECO.OQ - Q2 2022 Lincoln Electric Holdings Inc Earnings Call

including a solid 10% increase in volumes in our Americas Welding segment. We benefited 3% from acquisitions which partially offset a 6% unfavorable impact from foreign exchange.

We achieved record second quarter profitability with a 17.3% adjusted operating margin and a 30% incremental margin. We are maintaining strong operating leverage from the team's effective management of inflation, supply chain constraints, and the improved operational execution in automation and Europe. These factors helped to offset higher employee costs and unfavorable foreign exchange. Adjusted earnings per share increased 31% to $2.18, a record performance. Additionally, we achieved a record 26.3% return on our invested capital and generated solid cash flows in the quarter. We returned approximately $58 million to shareholders in the quarter through dividends and share repurchases bringing our year-to-date returns to $196 million, which includes $130 million of share repurchases. And now I'm going to pass the call to Steve Hedlund, our Chief Operating Officer, to cover organic sales trends.

Steven B. Hedlund - Lincoln Electric Holdings, Inc. - Executive VP & COO

Thank you, Chris, and good morning, everyone. Looking at second quarter demand on Slide 4, we had solid momentum across most of our business with growth in all reportable segments in all 3 of our main product categories and in every region except for Asia Pacific. A key driver of the momentum has been the acceleration in demand across all of our end markets in the second quarter, led by nonresidential construction and infrastructure, which increased mid-40% and the automotive transportation and energy sectors, which both increased high 20%. Heavy Industries remained strong at mid-20% and General Industries achieved mid-teens organic sales growth. This level of activity reflects the near-term need for our customers in many segments to increase capacity and improve productivity to satisfy current demand, reduce their record backlogs and rebuild their depleted inventories.

In addition, we continue to see several long-term growth catalysts, including the chronic shorter -- of scale bolters globally, the reshoring and nearshoring of supply chains in North America and significant government support in many regions for investments in infrastructure, energy and electric vehicles. These factors suggest that underlying demand in the industrial sector should continue to remain strong even with a slowing consumer sector. And now I'll pass the call to Gabe to cover second quarter financials in more detail.

Gabriel Bruno - Lincoln Electric Holdings, Inc. - Executive VP, CFO & Treasurer

Thank you, Steve. Moving to Slide 5. Our consolidated second quarter sales increased approximately 17% to $970 million. The increase reflected a 17% increase in price 3% higher volumes and a 3% benefit from our Kestra and FTP acquisitions, which was partially offset by a 6% unfavorable foreign exchange translation, primarily from the Turkish lira and the euro. Our gross profit margin increased 120 basis points to 34.4% as benefits from volumes cost management and improved operational execution and automation in Europe offset broad raw material and freight inflation across the business, including an approximate $10 million LIFO charge in our Americas Welding segment. Due to persistent inflation in key raw materials, we will continue to take actions to mitigate inflation as necessary.

Our SG&A expense increased 10% or $15 million primarily due to $9 million of higher incentive compensation and employee costs. as well as higher discretionary spending. SG&A as a percent of sales decreased 110 basis points to 17.2%. We continue to expect our upcoming quarterly 2022 SG&A expense on a dollar basis to be in line with the current run rate. Reported operating income increased 38% and to $168 million, and we achieved a record reported and adjusted operating margin of 17.3% of sales, a 220 basis point improvement versus the prior year's adjusted operating income margin. Our margin performance reflects volumes, favorable geographic mix, diligent price and cost management and structural savings, which generated a 30% incremental margin. We incurred an other income expense of $1.1 million in the quarter from nonrecurring items.

Our second quarter effective tax rate was approximately 20% due to our mix of earnings and discrete items. We continue to expect our full year 2022 effective tax rate to be in the low 20% range, subject to the mix of earnings and anticipated extent of discrete tax items. Second quarter diluted earnings per share increased 36% to $2.18. Excluding special items, adjusted diluted earnings per share increased 31% to a record $2.18. We incurred a $0.07 unfavorable impact to earnings per share from foreign exchange translation.

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JULY 28, 2022 / 2:00PM, LECO.OQ - Q2 2022 Lincoln Electric Holdings Inc Earnings Call

Moving to our reportable segments on Slide 6. Americas Welding segment second quarter adjusted EBIT increased approximately 40% to $118 million. The adjusted EBIT margin increased 200 basis points to 18.9% from solid volume growth, effective cost management and operational improvements in automation, which maintained low double-digit percent EBIT margin performance in that product area. Americas Welding organic sales increased 30% as all end markets in the region accelerated in the quarter. Organic sales growth was led by an approximate 20% benefit from pricing implemented to mitigate inflation and approximately 10% volume growth.

We achieved volume growth in all product areas in the region, led by automation and equipment. The Kestra acquisition contributed approximately 120 basis points to sales growth. Moving to Slide 7. The International Welding segment's adjusted EBIT increased approximately 17% to $35 million. The adjusted EBIT margin increased 260 basis points to a record 14.2% primarily from cost management, geographic mix and benefits of operational improvement initiatives. Organic sales increased approximately 12% due to price actions taken to offset broad inflation in the region and to mitigate unfavorable foreign exchange translation. Volumes declined by approximately 7% due to continued slow industrial activity in Asia Pacific associated with China's COVID shutdowns that persisted through May.

In Europe, volumes were relatively steady versus the prior year. Excluding the impact of our Russian business, Europe volumes would have increased modestly on improved demand trends in the automotive heavy industry and energy sectors in the quarter. Moving to the Harris Products Group on Slide 8. Second quarter adjusted EBIT decreased approximately 2% and to $18 million, and the adjusted EBIT margin decreased 250 basis points to 12.8% and as the organization continued to incur higher expenses associated with acquisition integration initiatives, unfavorable mix and declining commodity pricing in certain metals offerings. We expect these factors to persist into the third quarter. Harris organic sales increased approximately 4% on 4% higher price to recover rising raw material costs and a 50 basis point reduction in volumes as strength in industrial applications and specialty gas was offset by weakness in the retail channel, which is expected to persist through year-end on weakening consumer trends.

The segment also benefited from a 16% increase in sales from the FTP acquisition serving the HVAC market, which will anniversary in August. Moving to Slide 9. We generated $98 million in cash flows from operations due to higher uses of cash and working capital to support higher sales as well as investments and inventories to mitigate supply chain constraints and service customers. We expect cash generation to accelerate in the second half at or above a 90% cash conversion rate, reflecting seasonality in our initial actions to normalize inventory levels.

Moving to Slide 10. We invested $16 million in CapEx spending and returned $58 million to shareholders through a higher dividend payout and approximately $25 million of share repurchases. We achieved a record 26.3% return on invested capital in the quarter, reflecting strong operational execution, but continue to target an 18% to 20% ROIC range to accommodate our active M&A program. And now I will pass the call back over to Chris to discuss our updated assumptions for the balance of the year.

Christopher L. Mapes - Lincoln Electric Holdings, Inc. - Chairman, President & CEO

Thank you, Gabe. Turning to Slide 11. We are performing exceptionally well under extremely dynamic conditions. As we enter the third quarter, we are raising our consolidated full year organic sales growth rate and our incremental operating income margin assumptions. We now expect organic sales growth to be in the mid- to high teens percent as compared to our prior mid-teens percent range, with volume growth still anticipated to be in the mid-single-digit percent range. The increase reflects our strong first half performance and solid momentum in our Americas Welding segment as end market demand accelerates, and we work through record backlogs in that region.

We are incrementally more cautious on Europe as the Ukraine invasion raises concerns around regional energy inflation and availability and its potential impact on industrial activity. We also expect third quarter headwinds in our Harris business in retail and within some areas of their supply chain. We do expect that the net impact will be typical seasonality in sales in the back half of the year for all of our segments. We've also raised our incremental operating income margin assumption for the full year to mid- to high 20% range as we continue to execute in this positive industrial cycle. Our team continues to do an outstanding job servicing our customers while effectively managing these dynamic operational conditions. I'm proud of our team and confident in our ability to continue to drive improved earnings cash generation and returns through this positive industrial cycle. And now I'd like to turn the call over for questions.

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JULY 28, 2022 / 2:00PM, LECO.OQ - Q2 2022 Lincoln Electric Holdings Inc Earnings Call

Q U E S T I O N S A N D A N S W E R S

Operator

(Operator Instructions)I show our first question comes from the line of (inaudible) from Jefferies.

Saree Emily Boroditsky - Jefferies LLC, Research Division - Equity Analyst

This is Saree Boroditsky from Jefferies. You talked about the ability for industrial markets to decouple with the weak consumer. Could you just talk about where you are in the cycle for some of these end markets such as energy, infrastructure and autos that gives you this confidence? And what are you hearing in the channel from some of the secular trends such as reshoring?

Christopher L. Mapes - Lincoln Electric Holdings, Inc. - Chairman, President & CEO

Yes, I just got to tell you, this is Chris. Look, I think that's one of the real positive elements that I see across the portfolio today, not only the regional strength associated with the business, but also the multitude of segments that are migrating towards a positive momentum. And it really continued positive momentum. Think about where we're at in the energy cycle, still very early.

I still believe we're very early in the heavy industry cycle, whether that's mining and the things that we're hearing out from ag. So I think early in the cycle. And as you know, we believe we're still in the earlier portions of a positive industrial cycle when we see the breadth of this type of demand across our portfolio. I do also believe that Linc Electrics probably seeing the better portion of that demand. I believe many of the solutions that we brought forward into these segments over the last couple of years and the ones we've entered recently are positioning themselves and positioning us in those marketplaces as the solutions leader. So we are also receiving the benefit of positive underlying demand as well as solutions that are being adopted into the marketplace.

Saree Emily Boroditsky - Jefferies LLC, Research Division - Equity Analyst

And then international margins maintained at strong levels even as you had some volume decline. So I guess, what are you seeing from a demand perspective today, how are you thinking about that going forward, given you're more cautious kind of outlook? And as volumes kind of continue to see a decline in 2023, how should we think about margins?

Christopher L. Mapes - Lincoln Electric Holdings, Inc. - Chairman, President & CEO

Well, Saree, first, look, you've followed us for a long time. I think the performance in our international operations considering the dynamics that they had in the quarter were exceptional. I mean, between the industrial shutdowns that were experienced in the Asia Pac region and then the challenges associated in the European market because of the invasion of the Ukraine. The team is performing exceptionally well. We've always shared that for that business long term to be operating at the range that we want to see it at on an operating profit perspective that there was a level of volume that was required for us to be able to accomplish that.

I do think that the August time frame this year is interesting in the European market. I think that because of that and the uncertainty associated with the energy position, that's why we've highlighted it as an area of more risk. But quite frankly, the impact of that, I think we'll just have to continue to manage through the rest of the year and see exactly what impacts will have from those 2 variables. But very confident in the structural improvements we've made in our international business over the last few years and confident that we'll be able to meet our expectations as it relates to having them within the ranges we've identified in our higher standard 2025 strategy for the performance of that business.

Saree Emily Boroditsky - Jefferies LLC, Research Division - Equity Analyst

And look forward to seeing you guys in early August.

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