Lincoln Electric Holdings, Inc. (NASDAQ:LECO) Q3 2023 Earnings Call Transcript

Lincoln Electric Holdings, Inc. (NASDAQ:LECO) Q3 2023 Earnings Call Transcript October 27, 2023

Lincoln Electric Holdings, Inc. misses on earnings expectations. Reported EPS is $2.22 EPS, expectations were $2.27.

Operator: Greetings and welcome to the Lincoln Electric’s 2023 Third Quarter Financial Results Conference Call. [Operator Instructions] 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 Butler: Thank you, Liz and good morning everyone. Welcome to Lincoln Electric’s third quarter 2023 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 me on the call today is Chris Mapes, Lincoln’s Chairman, President and Chief Executive Officer; Gabe Bruno, our Chief Financial Officer; and Steve Hedlund, Chief Operating Officer. Chris will begin with quarterly highlights, Steve will provide a discussion of end market trends and Gabe will cover quarterly financial performance in more detail as well as comments on our full year 2023 assumptions.

Following our prepared remarks, we are happy to take your questions. Before we start our discussion, please note that certain statements made during this call maybe 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. A reconciliation of non-GAAP measures to the most comparable GAAP measures 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 turn the call over to Chris Mapes.

Chris?

Chris Mapes: Thank you, Amanda. Good morning, everyone. Turning to Slide 3, we maintained strong performance in the third quarter and continued to generate record sales, profitability, earnings and cash flow performance. We also maintained top decile returns and are positioned to continue to fund long-term growth and drive higher shareholder returns with our solid balance sheet profile. We remain well positioned in the market. What is unique in the quarter is the mix and drivers of our 10.5% sales growth. Our automation acquisitions led by Fori Automation accelerated in the quarter and generated approximately 9% sales growth or $83 million. This increased our global automation portfolio sales to $238 million in the quarter as we work to exceed our $1 billion Automation 2025 sales target.

The balance of our business delivered 40 basis points of organic growth. Volumes compressed slightly at 70 basis points. And we achieved 110 points of higher price. Volume performance reflected a challenging prior year comparison in our Harris Products Group segment and fewer shipping days across our segments, which Steve and Gabe will comment on in more detail. In addition, Automation’s volume performance was relatively steady in the quarter, ahead of a strong delivery schedule in the fourth quarter. We generated superior value in the quarter with a high-teens to low 20% increase in gross profit and adjusted operating income respectively. This yielded a record 17.7% adjusted operating profit margin with a 31% incremental margin. Two of our three reportable segments generated EBIT profit margins that exceed their 2025 higher standard strategy EBIT margin targets.

In addition, our automation portfolio continued to advance its margin profile year-over-year. We also delivered an approximate 18% increase in our adjusted earnings per share achieving a record $2.40 in the quarter. These significant improvements in performance demonstrate our track record of effective price cost management through the cycle and our ability to successfully mitigate higher employee costs through continuous improvement programs and Lincoln business system initiatives. This also translated into record cash generation in the quarter with 141% cash conversion. Our team remains focused on growth and executing our strategic initiatives to continue to deliver compounding long-term value through the cycle. Now, I will pass the call to Steve Hedlund to share more details on the third quarter sales performance.

Steve Hedlund: Thank you, Chris and good morning everyone. Turning to Slide 4, as Chris discussed, our reported 40 basis point organic sales growth rate does not fully reflect the more resilient welding end market trends we are seeing due to fewer shipping days in the quarter, which had a 230 basis point unfavorable impact to our organic sales growth rate. Normalizing for this effect, our two welding segments would have reported low to mid-single-digit organic sales growth in the quarter driven by growth in both consumables and equipment with relatively steady organic sales performance in automation due to project timing. Harris Products Group had unseasonably strong HVAC sales in the prior year which was the primary driver of our consolidated 70 basis point volume decline.

Geographically, we saw the greatest growth in the non-European portions of our International Welding segment, particularly in India, Turkey and the Middle East. In the Americas, demand remained strong, while demand in Europe continued to be soft. From an end market perspective, 3 of our 5 end markets energy, heavy industries and general industries, which represent approximately two-thirds of our revenue continued to grow in the quarter. Energy-related demand was up globally led by strong midstream project activity. Looking at consumable demand as a barometer of factory activity, 4 of our 5 end markets were up, representing approximately 85% of our revenue. Organic sales and construction infrastructure remained soft due to challenging prior year comparisons and weak market conditions as reflected in benchmarks such as the Architectural Billings Index.

Excluding Fori’s strong growth in automotive sales in the quarter, organic sales in the automotive transportation sector were down due to timing of deliveries in our automation businesses. We continue to see growth in automotive consumable volumes globally as the OEMs and their suppliers maintain production activity to restore inventory levels. The labor disruptions in the U.S. automotive sector did not have a significant impact on consumable demand in the third quarter, and we continue to see solid demand in this sector for our standard equipment and automation solutions. Looking ahead, we expect a strong finish to the year despite increasingly dynamic environment. We are seeing solid momentum in Americas Welding October order rates given the resilience in many of our end markets and continued strength in capital spending.

In fact, we were pleased to see strong orders for our new equipment and automation solutions showcased at the recent FABTECH trade show with record orders for our new Cooper Cobot solution. We will also see an acceleration of scheduled automation deliveries in the fourth quarter that will lift automation’s organic sales performance compared to the third quarter, and we continue to maintain high backlog levels. This positions us for mid-single-digit percent organic sales growth in the fourth quarter. Fourth quarter will also be a milestone for our newest growth initiative as we will officially start up production and launch our new Velion DC fast charger at a national EV charging testing festival, which we are proudly hosting at our Cleveland headquarters in late November.

And now I will pass the call to Gabe Bruno to cover third quarter financial results in more detail.

Gabe Bruno: Thank you, Steve. Moving to Slide 5. Our consolidated third quarter sales increased 10.5% to $1.033 billion. The increase reflected an 8.8% benefit from acquisitions, 1.1% higher price and a 70 basis point decline in volumes. Foreign exchange translation was favorable by 1.2% versus the prior year. Gross profit dollars increased approximately 18% or $56 million versus the prior year on price cost management and acquisitions. We also recognized a $1.3 million LIFO benefit in the quarter. Our third quarter gross profit margin increased 230 basis points to 35.4% on operational improvements and effective price cost management, which is now slightly positive for the first 9 months of the year. Our SG&A expense increased approximately 18% or $28 million primarily due to higher incentive compensation and employee-related costs and acquisitions.

SG&A as a percent of sales increased 110 basis points to 18.1%. Reported operating income increased approximately 21% to $171 million. Excluding approximately $12 million of special items from rationalization charges and the amortization of step-up of acquired inventories, our adjusted operating income increased 20% to $183 million. Diligent price cost management and contributions from acquisitions drove profit dollar growth. Our adjusted operating income margin increased 130 basis points to 17.7%, generating a 31% incremental margin. Our incremental margin reflects solid performance from operational improvements and easier prior year comparisons in International Welding and the Harris Products Group segment. Moving to earnings. Our third quarter diluted earnings per share increased 19% to $2.22.

Excluding special items, adjusted diluted earnings per share increased 18% and $2.40. Favorable foreign exchange translation provided a $0.04 benefit to EPS. Moving to our reportable segments on Slide 6. Americas Welding segment’s third quarter adjusted EBIT increased approximately 15% to $136.5 million. Their adjusted EBIT margin increased 60 basis points to 19.7% on effective price cost management in a LIFO benefit, which was partially offset by higher employee costs and acquisitions. Americas Welding sales increased 14% in the quarter, driven by an approximate 12% benefit from our automation acquisitions and a 1% increase in organic sales. Organic sales incurred a 280 basis point impact from fewer shipping days in key areas of the segment.

Excluding this impact, Americas Welding organic sales growth would have increased approximately 3.8%, with consumables up low single-digit percent and standard equipment up low double-digit percent. This demand reflects strength in factory activity and industrial capital spending in the region. These increases were partially offset by a slight decline in automation due to project timing. Moving to Slide 7. The International Welding segment’s adjusted EBIT increased approximately 20% to $30 million. Their adjusted EBIT margin increased 110 basis points to 12.2% on higher volumes, effective price cost management and productivity improvements in the region. Organic sales increased approximately 3% despite a 160 basis point impact from 1 less day, led by 3% volume growth and 20 basis points of price.

Consumable automation and standard equipment organic sales increased in the quarter led by strong equipment demand. Moving to the Harris Products Group on Slide 8. Third quarter adjusted EBIT increased approximately 41% to $20 million. Their adjusted EBIT margin increased 530 basis points to 15.9% reflecting effective price cost management mix and operational efficiencies in the business as well as a favorable prior year comparison. Harris’ organic sales declined approximately 6.5% and on approximately 11% lower volumes and 5% higher price performance. Soft volume performance reflected a challenging prior year comparison with moderating demand in several end markets. Retail channel sales inflected positively in the quarter on improving prior year comparisons and some select restocking activity.

We remain cautious on retail channel performance through year-end. Harris’ price performance reflects higher metal costs, primarily from Silver and Copper. Given current metal commodity pricing trends, we expect Harris to report relatively steady price performance on a year-over-year basis in the fourth quarter. Moving to Slide 9. Cash flows from operations increased 71% to a record $223 million in the quarter resulting in 141% cash conversion ratio on free cash flow to adjusted net income. Our average operating working capital to sales ratio continued to improve to 18.3% as inventory levels moderated. Moving to Slide 10. We invested $26 million in CapEx in the quarter and returned $82 million to shareholders through approximately $45 million of share repurchases and our higher dividend payout.

We maintained a solid return on invested capital of 23.6%. And given the strength of cash generation and confidence in the business, our Board recently announced an 11% increase in the 2024 dividend payout rate. Turning to Slide 11 in our full year assumptions. Given 9 months of strong performance, solid order rates into the fourth quarter and better insight to the interim impact of labor disruptions in the U.S. auto industry, we expect full year sales growth to be at the low double-digit percent range with a mid-single-digit percent increase in organic sales, driven largely by volume in Americas Welding. We estimate a $5 million to $10 million sales impact in the fourth quarter from the current list of impacted auto plants. This estimate could change as labor negotiations progress.

These assumptions reflect an expected mid-single-digit percent increase in organic sales in the fourth quarter. We are outperforming operationally on a year-over-year basis and expect incremental margin assumptions in the high-teens percent range on a consolidated basis. Excluding the Fori acquisition, we expect to generate high 20% to low 30% incrementals on mix and improved execution in the business. We expect to be at the lower end of both our interest expense and tax rate ranges. The outperformance in cash conversion year-to-date at 118% gives us confidence in achieving greater than 100% cash conversion this year, which aligns with our long-term track record and strategic targets. And now I would like to turn the call over for questions.

Operator: [Operator Instructions] Our first question will come from the line of Bryan Blair with Oppenheimer.

Chris Mapes: Good morning, Bryan.

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Q&A Session

Bryan Blair: Good morning. Very solid quarter.

Chris Mapes: Thank you.

Bryan Blair: Appreciate all the color on UAW impact being negligible in Q3 that is understandable just given the timing of the start of the strike. With Q4 $5 million to $10 million top line headwind. Just to clarify on that. I assume that’s all consumables. So we wouldn’t expect much of an impact, if any, on the equipment side. And exactly what is factored in, in terms of the timing of resolution so we can try to calibrate whatever [indiscernible].

Gabe Bruno: Yes, Brian. So as we’ve talked in the past, short-cycle type activities what we would expect to be impacted by the labor disruption, and that’s primarily consumables. So as the quarter progresses and we monitor hopefully, resolution to what we’ve just seen, but that’s driven by consumables, and that’s a full quarter type of view.

Bryan Blair: Okay. Appreciate that. And I appreciate you giving us a figure just in general. That’s very helpful. And aside for automation, I believe you said $238 million in contribution for the quarter. That will step up into Q4. Based on that run rate and jumping off point, the backlog that you now have in place and just overall visibility. Is it reasonable to expect that your 2025 target of $1 billion plus, you’re going to hit that in 2024?

Chris Mapes: Well, we’re certainly excited about the execution we’ve had on that strategy and certainly, the trending that we see, obviously, that would look like we would be able to achieve that milestone for the business. I think one of the things that you said there that Brian, I’d like to provide maybe a little bit more context on is that, look, the backlog in the business is very solid. But when we think about the business, we think our backlogs have really normalized. And what I mean by that is that over the last several quarters, we, like many individuals have been working through supply chain challenges. And most of those have eliminated or they are very de minimis within the business. As we think about the company, the company is really running at more of a normalized backlog level now.

And that backlog level is significant, and we’re not seeing that backlog as the mechanism that’s driving those mid-single-digit organic that we’re talking about in Q4. We really have a normalized backlog level that is really coming in within 10%, 15% of the peak backlogs that we experienced a few quarters ago. So we like the backlog position, but it’s kind of a normalized backlog position. We did have a very strong FABTECH show here in North America. We had record orders in right after FABTECH for our cobot technologies that we launched out in the marketplace as well as several other very nice orders across our product portfolio. But when I look at our backlog today, it’s pretty normalized as it relates to the way we think about the business.

Gabe Bruno: So just to add, so as we’ve talked, our run rate currently is $900 million in automation, in our long-term organic assumption into that – are into that mid to high single digits. So we’re very much on pace to our 2025 target of $1 billion in revenue.

Bryan Blair: Yes, understood. I appreciate all the color. Encouraging trends. Thanks, again.

Operator: Thank you. Our next question will come from the line of Saree Boroditsky with Jefferies.

Saree Boroditsky: Thanks, good morning. So you referenced strong capital spending environment a couple of times in the remarks. Are you seeing any impact from higher interest rates and the macro uncertainty on spending plans? I know we’ve seen a few announcements from auto companies pushing out investments. So just what are you hearing from customers? And how do you think about the investment cycle going forward?