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Executives

John Stropki - Chairman, President & Chief Executive Officer

Vincent Petrella - Senior Vice President, Chief Financial Officer & Treasurer

Analysts

Walt Liptak - Barrington Research

Mark Douglass - Longbow Research

Tom Hayes - Piper Jaffray

[Steven Ryan - HST Capital Market]

James Bank - Sidoti & Company

Steve Barger - Keybanc Capital Markets

Greg Halter - Great Lakes Review

Holden Lewis - BB&T Capital Markets

Lincoln Electric Holdings Inc. (LECO) Q3 2009 Earnings Call October 30, 2009 10:00 AM ET

Operator

Greetings and welcome to the Lincoln Electric third quarter 2009 conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.(Operator Instructions).

It is now my pleasure to introduce your host, Mr. Vince Petrella, Senior Vice President and Chief Financial Officer for Lincoln Electric. Thank you, Mr. Petrella you may begin.

Vincent K. Petrella

Thank you Melissa, and good morning and thank you all for joining our Lincoln Electric 2009 third quarter conference call. We issued the financial results press release prior to markets open this morning. Additional copies of the press release are available through our Investor Relations Department at 216-383-4893 or on Lincoln Electric’s website.

Lincoln’s Chairman and Chief Executive Officer, John Stropki will lead the discussion this morning, and provide commentary on the quarter and the regional results. Before we start that discussion though, let me remind you that certain statements made during this call and our discussions may be forward-looking and actual results may differ from our expectation. 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.

Let me now turn this call over to John Stropki.

John Stropki

Thank you, Vince and good morning to everyone. Our financial results for the third quarter shows significant sequential improvement in profitability compared with Q1 and Q2 of 2009. As cost savings initiatives, factory rationalization efforts and other actions aimed at improving operational efficiencies are delivering much improved results. Unfortunately, even though many domestic and international macroeconomic payrolls are indicating improvements.

This is yet to manifest itself a meaningful top line revenue growth for the overall global welding industry. However, we are starting to see signs of recovery in several key geographies and market segments. Our 2009 third quarter sales of $442 million delivered a sequential increase of 7% from the second quarter of 2009, and volume was up slightly sequentially from the previous quarter.

I should also note that our third quarter is historically weaker than the second quarter. So the Q3 volume increase is good news. Excluding non-reoccuring items, net income increased to $27 million or $0.63 per diluted share compared with 2009 second quarter earnings of $15 million or $0.34 per diluted share.

As we continue to focus on improved operating results, we took several important actions in the third quarter to further align our cost structure and improve our overall profitability. We recently announced the closing of a welding consumable manufacturing plant in Spain and the downsizing in our [Flex Cord] operations in the Netherlands. As such, we will be shifting the capacity of these facilities to our plants in Poland.

We’ve also announced plans to move all equipment manufacturing out of Lincoln Australia, to our Shang Hai manufacturing operations and with engine drive production moving back to Cleveland. As a result of these actions taken over the last year, we’ve improved our capacity utilization, eliminated meaningful fixed cost overhead and realigned our work force to current global demand.

We continue to evaluate other structural changes to further improve operational efficiencies, while maintaining our ability to meet the expected return in global demand and simultaneously, maintaining our commitment to world class customer service and product quality. This will give you more specific details about the number for the quarter in just a minute, but first an update on the market conditions we face and the latest developments regarding our strategic initiatives.

First, looking at North America. In the U.S., industrial activities continues to hover at historic low levels. While industrial activity measured by industrial production actually increased in September by seven tenth of a percent, it is still 6.1% below 2008 levels.

Capacity utilization also improved to approximately 68%, but again well below the mid 80s levels, which would be indicative of a robust manufacturing economy. Although, there continues to be uncertainty about the overall business levels moving forward, a majority of the forward-looking metrics that measure overall business expectations, not just the purchasing manager’s index are improving.

As an example, September durable goods reported up 1% with machine re-component up 7.9% in the month. Other metrics such as, steel production and demand are also showing some improvement. After major contraction this year, steel demand is forecasted to rebound nicely in 2010. U.S. steel mill capacity rate continues to climb, and was at 63% at the end of last year, with expectations as high as 70% for Q4.

Global steel productions continue to revamp. With China up 19% year-to-date and the emerging economies are expected to grow over 12% in 2010. In Canada, despite a summer of automotive sector realignment and extended factory shutdowns, industrial production manufacturing is beginning to show positive growth again with a 5% increase over early 2009.

However, a broad recovery is not expected until early 2010, when significant oil and gas related projects come back online. Reflecting the current economic environment in the region, our North American sales of $241 million in the third quarter were essentially flat compared with the second quarter of 2009.

U.S. export sales of $38 million were also flat, with the second quarter results. However, we continue to see some good signs of recovery in Asia, which indicates that the stimulus programs in China and India are driving important infrastructure and construction activity.

We did see order trends in our traditional U.S. welding market begin to pick up as we move through the quarter, with many large manufacturing customers coming off of summer shutdowns or slowdowns. However, we continue to remain cautious about the robustness of the fourth quarter and early 2010 outlook.

The strongest end markets domestically continue to be energy related, namely pipelines, pipe mills and renewable energies, primarily wind towers. For example, the American Wind and Energy Association reported that U.S. wind energy installed 1,600 Megawatts of new power generating capacity in the third quarter. An amount higher than either the second quarter of 2009 or the third quarter of 2008.

Bringing the total capacity added this year-to-date over 5,800 Megawatts. With oil prices rising to approximately $80 per barrel, there’s also renewed interest in new oil exploration and production projects. In the U.S., spending from the government stimulus package is having a trickle effect as best, as many shovel ready projects have been aimed at road resurfacing as opposed to more steel intensive bid ridge restructuring work where Lincoln more fully participates.

The Canadian stimulus package introduced at the beginning of this year was designed to provide stimulus through both infrastructure spending and tax cuts, and we still expect that both stimulus programs will have some impact on demand during 2010.

Turning to Europe, the Euro zone economic activity remains at relatively low levels. Western European economies continue to have large unemployment numbers and the industrial production is at historically low levels.

As a result, Lincoln Europe’s sales were $89 million in the quarter. However, the region did show substantial improvement in profitability, as high cost inventories were liquidated and the region benefited and will continue to benefit from our additional efforts of overhead reduction and factory rationalization initiatives. There were some signs of recovery in the Euro zone. The private sector, powered mainly by France, Germany and Spain appeared to expand this month at the fastest rate in over two years.

According to the purchasing manager index for the region, the Composite index rose from 51.1 in September to 53. The index improved for the third consecutive month and was the largest month we gained since December of 2007.

In Asia pacific, China, the world’s largest economy continued showing improvement during the quarter. China’s economy grew 8.9% in the quarter and is on track to hit its growth target for the year. Sales of Lincoln Electric Asia Pacific excluding Jin Tai were up 7% from the second quarter of 2009.

During the quarter, we completed the Jin Tai acquisition. The company has annualized 2000 revenues of approximately $130 million U.S. dollars. An addition of Jin Tai completes our welding consumable products offering in the region, and enhances our distribution and end market penetration in the key shipbuilding, automotive, heavy transportation and infrastructure sectors.

China has already announced plans to expand its nuclear power generation capacity by more than 30 new nuclear plants over the next 10 years. It will also add more than 30,000 megawatts of new wind power by the end of 2010, and Lincoln’s unique portfolio of products for power generation markets highlights the importance of our expansion strategy in the world’s largest welding market.

As a result, we’ve seen the benefit from China’s stimulus programs, which is focused on infrastructure projects and energy related projects. In a few weeks, we will host an important delegation for one of China’s major nuclear plant contractors, responsible for building portions of the nuclear reactors for China’s government. They will be here in Cleveland attending a technical seminar to learn more about our capabilities and our welding solutions for the important nuclear energy sectors.

Also large construction equipment manufacturers like, Caterpillar and Komatsu are indicating very positive signs towards recovery in China. In addition, the country’s automotive industry is also showing excellent growth. Overall sales were up 78% in September to 1.33 million vehicles, and China now leaves the world in sales with over 9.6 million vehicles sold through September of 2009.

India’s automotive industry weigh much smaller in current production is also rapidly expanding. India’s market conditions remain favorable with solid growth in mining, pipelines and pipe mill end markets. Both our MIG wire factories in India and Jin Tai operations with their leading quality positioned Lincoln well to participate in two of the world’s fastest growing automotive markets.

Turning to Latin America. Our Latin America results reflect the improving economic conditions in the region and indicates that the worst of the recession in the region appears to be over. Lincoln sales in the region were up approximately $9 million, an increase of 17% from the second quarter.

The profitability in the region has also improved since the second quarter as cost savings initiatives and volume increases improved our results. Expectations in the region as we could see continued improvement through the fourth quarter. Latin America countries should be favorably impacted by the recent up tick in commodity prices and fiscal stimulus projects throughout the region.

Brazil, the largest economy of Latin America is clearly growing. Private consumption has been robust throughout the cyclical downturn. Unemployment levels have been down in recent months and Brazil had actually experienced net job gains and now was at pre-recession employment levels.

Other signs, industrial capacity utilization is up at 80.5% in July versus 76% in January and expectations for a 2010 real GDP growth forecast of 3.6% according to one economic report shows that there are lot of infrastructure projects underway or planned.

Economic activity in Mexico, the region’s second largest economy shows that for July, year-over-year growth contracted by 6.9% compared with a 8.1% fall in June. Economic reports expect a slower rate of decline for the rest of the year and returned to real growth in 2010. That’s a broad overview of the region.

Next, I would like to cover some of our market segments and initiatives geared to make our customers more productive. Our focus in technology leadership has been well received around the world. The rollout of our 108 new or improved product introductions in the last nine months is a hit in the market place.

At the most important global trade fair in the welding industry held in mid September in Essen, Germany, the Lincoln booth was clearly the most visited of the show. Among the number of products introduced at the show, two clear standouts, which attracted a lot of attention were Lincoln’s new C300, a revolutionary power source and our new virtual welding source called VRTEX 360. The C300 is a new power wave that supplies automation with a small to midsize manufacturing footprint.

The VRTEX system is a training solution for the growing training centers and school markets and provides a virtual hands on training experience for students. It uses computer generated data with a virtual a welding gun and helmet equipped with internal monitors to practice welding in a virtual environment. The VRTEX 360 can simulate a welding booth training environment as well as field welding applications.

In addition to the virtual welding training system, our new consumable offers streams geared towards pipeline and offshore applications, new and welder welding solutions, plasma cutting products, and our hard and flexible automation solutions gave our distributors and end users plenty to be excited about.

Our new products received a similar success at the Beijing welding show this past summer, and we will conclude our global new product introduction here in North America at November at the FABTECH International and AWS Trade show held in Chicago.

We’ve also developed several new products specifically for the pipeline industry. As an example the new pipeliner 80 Nickel One is a MIG wire designed for automatic welding high strength pipe, with the [Demand Deed] application including artic service temperatures.

In automation, we continue to make improvements in upgrades to our robotic welding packages. Two of the world’s large heavy machinery equipment have placed substantial orders for our robotic and welding equipment for new factories or manufacturing line upgrades. This accelerated large scale global nuke product launch is another of our strategic responses to current market conditions.

Our continued effort in consolidating and streamlining our manufacturing operations and our continued focus on cost management is setting the stage for both top line revenue growth and margin expansion in the upcoming quarters. Combined with our strong balance sheet with little debt and ample cash reserves, we are well positioned to maintain our market leadership in providing welding solutions around the world.

Now, Vince will cover the financial results in detail.

Vincent Petrella

Thank you John. As John pointed out, our third quarter 2009 financial results reflect a meaningful improvement in operating earnings from the second quarter of 2009. Starts with the top line, our quarter’s consolidated sales were down 30%, with North American sales decreasing 35% and sales reported outside of North America down 23%.

Volume declines decreased reported sales by 28% and foreign currency effects decreased sales by about 3% in the quarter. Pricing decreased sales by 4% and acquisitions contributed an increase of about 4% in the quarter. On a product line basis, machine sales decreased 40% and consumable sales decreased 31% excluding acquisitions.

Sales by product line were approximately 68% consumables and 32% equipment, compared with 63% consumables and 37% equipment in the prior year same quarter. The first nine months’ sales were down 35% with North American sales decreasing 36% and sales reported outside of North America down 33%. Volume declines decreased reported sales by 33% in the nine months and foreign currency effects decreased sales by about 5%.

Pricing was flat and acquisitions contributed about 2% in the year-to-date period. The percent of gross profit in the quarter was 28.3% of sales compared with 31.1% in the prior year same quarter.

The decrease in gross margins as a percentage of sales is primarily attributable to unfavorable operating leverage caused by decreased sales volumes. The quarter included a LIFO credit of $7.7 million of which, approximately $3.8 million is related to estimated reductions in inventory levels.

For the nine-month period gross profit was 25.4% of sales compared to 29.6% of sales in the prior year. Again, the year-over-year decline in gross profit was due to unfavorable operating leverage, combined with the impact of liquidating higher cost inventory in the first half of the year.

LIFO credits totaled $13.6 million, of which $6.8 million relate to the estimated reductions in inventory levels for the year-to-date period. SG&A expense for the third quarter was about $85 million, or 19.2% of sales representing a $22 million reduction from the prior year period. The decrease in SG&A expense was primarily driven by lower bonus expense and increased selling costs associated with lower sales volumes.

Foreign currency exchange rates decreased SG&A expenses by $2.6 million in the quarter, pension expense included in SG&A was $2.7 million higher in the quarter. SG&A expense for the nine-month period was $242 million or 19.1% of sales, representing a $77 million reduction in year-over-year SG&A expenses.

Decreased bonus expense of $56 million and the impact of foreign currency translation were the main contributors to the reduction in SG&A cost. Pension expense included in the SG&A line was $8.8 million higher year-over-year. Rationalization charges of $7.1 million were recorded in the third quarter, related to the plant consolidation actions taken in Europe and the other country segment that John mentioned earlier.

On a year-to-date basis, rationalization charges totaled $25.7 million. Our cost savings initiatives resulted in savings totaling, approximately $35 million in the third quarter of 2009. We expect to achieve a similar amount of cost savings in the fourth quarter of the year. Third quarter operating income at 7.5% of sales was down 670 basis points versus the third quarter of 2008. Excluding rationalization charges, operating income was $40.4 million or 9.1% of sales.

On a geographical segment basis, and excluding special items, North America achieved EBIT margins of 12.3% in the third quarter. Europe returned to profitability with an EBIT margin of 2.1% and the other countries geographical segment recorded a 5.1% EBIT margin. Excluding rationalization charges, second quarter 2009 EBIT margins were 9.9% in North America, a negative 3.3% in Europe and 2.9% in the other country segment.

All geographical segments margins improved in the third quarter over the second quarter as a result of lower input costs and our cost cutting measures on a global basis. Our nine months operating income decreased to $53.6 million or 4.2% of sales. The nine-month period of 2009 included rationalization charges of $25.7 million and a pension settlement gain of $1.5 million.

Excluding these special items, operating income was $77.8 million or 6.1% of sales in the first nine months of the year. The income tax provision for the third quarter reflects an effective tax rate of 47.4% compared with 25.5% in 2008.

Excluding the tax effect of the special items in the quarter, the effective tax rate would have been 31.2%. The year-to-date effective tax rate was also 47.4%, compared with 27.8% in the prior year. The higher effective tax rates in 2009 were mainly due to foreign subsidiaries recording pretax losses with no associated current tax benefit.

The company invested $5.5 million and $26.3 million in capital expenditures in the three and nine month periods respectively. Compared with $22.4 million and $53.5 million in the prior years three and nine month periods respectively. Our 2009 capital spending plan will continue to trend substantially below the prior year’s spend.

We do expect to spend approximately $35 million to $40 million on capital expenditures for the full year 2009. Other uses of cash in the first nine months include the pay down of about $30 million of debt, and the payment of approximately $34 million in dividends to our shareholders.

Weighted average diluted shares outstanding decreased to 42,642,000 shares for the third quarter, compared with 43,209,000 shares for the 2008 third quarter, a 1.3% decrease in shares. Shares outstanding at the end of the quarter, September 30, 2009 were 42,528,936 shares.

Even during these most challenging economic times, we continue to demonstrate important improvements in operating results, and our financial position remains very strong. During the quarter and first nine months of the year, we generated $97 million and $231 million respectively and cash flows from operations raising our cash balance to $406 million at the end of the quarter.

This improved our net cash position to $275 million and resulted in a debt to total capital ratio of 11%. The company is very well positioned to take advantage of the opportunities before us as the year unfolds in 2010.

With that, Melissa, I would like to open the call for questions.

Question-And-Answer-Session

Operator

(Operator Instructions) Your first question comes from Walt Liptak - Barrington Research.

Walt Liptak - Barrington Research

I wanted to ask, you mentioned something about a LIFO adjustment in the quarter, Vince?

Vincent Petrella

Yes, so we’ve had LIFO adjustments during the course of the year and the quarter included $7.7 million and the year-to-date adjustments were approximately $13.6 million.

Walt Liptak - Barrington Research

Okay, and was that included in the adjusted numbers?

Vincent Petrella

No.

Walt Liptak - Barrington Research

Okay, so that increased your gross profit by $7.7 million.

Vincent Petrella

Yes, and that’s reflective of declining commodity cost during this the course of the year. So LIFO is a cost flow assumption methodology that matches your most current cost with your most current revenues. And so $13.6 million for the year and $7.7 million for the quarter are estimates of what our most current cost will be at the end of the year. So just one further point Walt is you would have to annualize that year-to-date figure to estimate what our total 2009 credits will be for LIFO accounting.

Walt Liptak - Barrington Research

Okay, does that means that in the fourth quarter we would not see a LIFO adjustment?

Vincent Petrella

No, that means you will see another LIFO adjustment. That annualizes the $13.6 million based on current estimates. So this is subject to LIFO accounting methodologies are subject to estimating what your year-end inventory levels will be and what your year-end cost environment will be.

So, they are adjusted during the course of the year, and currently our best estimate is for the nine months, $13.6 million and so annualizing that for the full year would raise the number somewhere around 18 plus million.

Walt Liptak - Barrington Research

Okay, wanted to ask you about the European profitability that improved, was that related to the cost out action that John talked about earlier?

Vincent Petrella

Yes, certainly cost savings actions have aided Europe significantly during the course of the year. One important factor that has affected us in the third quarter and going forward is, what we have been talking about all year in terms of liquidating high cost inventories in Europe.

So we had a headwind, a drag in the first two quarters, and we have talking it in the first two quarters about putting that behind us by the third quarter, and that is certainly now through the system and clean, and so those headwinds are now behind us and has improved our operating profit in the region.

Walt Liptak - Barrington Research

Did that come to an end during the quarter, during the middle of the quarter or at the beginning of the quarter?

Vincent Petrella

The beginning of the quarter.

Walt Liptak - Barrington Research

Okay, so this is a sort of margin at these volume levels that we would expect like next quarter?

Vincent Petrella

I would say so, and although you understand we do have some seasonality, and the fourth quarter tends to be our weakest quarter of the year. So, I would expect perhaps a tick down in EBIDT margins in the fourth quarter in the light of our normal seasonality.

John Stropki

And there is one other factor too Walt, it’s product mix within, not just in the European business well with all of our business is that, the markets that are softer the traditional lower end general fabrication automotive kind of markets, and the markets that are strong are petrochemical energy related infrastructure, and those are much higher margin products for us, and I think for the industry in general, there is just a lot less competition in those areas. So, we are selling the high-tech products for the specific projects that we are capturing the larger margins there.

Walt Liptak - Barrington Research

Okay, got it, speaking about the motive in North America, what is your percentage of sales with automotive, some of your competitors said that they don’t have a lot of automotive for welding in North America is that because of sales revenue?

Vincent Petrella

Well, the market is really about a mid single digit welding market.

Walt Liptak - Barrington Research

Okay, so 5% of your North America is automotive?

Vincent Petrella

Roughly some place between 5 and 10.

Operator

Your next question comes from Mark Douglass - Longbow Research.

Mark Douglass - Longbow Research

Vince, can you go through the sales mix please by region, for volume price currency?

Vincent Petrella

Sure, for the quarter in North America our volumes were down about 32%, price was down about 3%, and foreign exchange was relatively flat, and moving to Europe, volume was down about 23%, price was down about 7% and foreign exchange had a negative impact of about 7.5%.

Then finally the other countries segment, volumes were down about 24%, price was down about 2%, and acquisitions improved the other country’s segment primarily because of our acquisition in China by 22%, and then foreign exchange had a negative impact of about 4.5%. So, in the aggregate on a consolidated basis, volume was down 28.1%, price was down 3.6%, acquisitions contributed 4.3%, and finally, foreign exchange had a detrimental impact of 2.7%.

Mark Douglass - Longbow Research

Okay, thank you that’s helpful. We can talk about pricing, if I guess, just a lot of the pricing was it relatively flat sequentially down?

Vincent Petrella

If you look at the second quarter Mark, and then look at what it was in the third quarter, you would see that our pricing decreased probably over 200 basis points quarter to quarter, and so, we believe in the fourth quarter that we will continue to see a slight deterioration in pricing as it sequentially comes down to try to better match reductions in input cost.

So I would, I have said in the last call that I thought we would be in the low to mid single digits in pricing decline, that is probably will be in the fourth quarter somewhere in the mid single digits in pricing declines.

Mark Douglass - Longbow Research

Okay, can you talk about the Jin Tai, you are looking at accretion of what, $0.08 to $0.12 after tax?

Vincent Petrella

Yes.

Mark Douglass - Longbow Research

Okay, so I know the other country segment has been pretty volatile as far as margins, but kind of on average or a less couple years ago you say Jin Tai has better than historic margins in that category or about the same?

Vincent Petrella

Well, out of the box, the first two months they have had better margins than the overall other country segments.

Mark Douglass - Longbow Research

Okay, that’s helpful. And then can you repeat again the restructuring savings in the quarter, and what you are looking for in the 4Q?

Vincent Petrella

Yes, I said we estimated cost savings of approximately $35 million in the quarter, and we expect something similar in the fourth quarter.

Mark Douglass - Longbow Research

John you mentioned something about robotic orders, I was intriguing, can you explain a little about where the uptick in orders is coming from and have you seen just a general uptick in capital spending or people are just saying the savings of robotics as they don’t want to replace employees, and then if any estimation on the size robotics sales at this point?

John Stropki

Well, I would say that this is the specific orders that I have talked about were for large construction equipment manufacturers who are either introducing new product lines, building new factories or upgrading existing manufacturing capabilities. As we have talked a number of times, we think that that’s a consistent sustainable trend as people address worker shortage, labor cost and quality improvement initiatives in that area and we have a very key position in that area.

We’ve substantially upgraded the technology associated with the welding hour source and robotic interfaces, and we believe we continue to capture a significant share of that market place. And it is moving globally in our quarter, traditionally that started in the U.S., it moved to North America, now have a strong platform in Mexico, and we are building the same type of capabilities in scale in Asia and Europe.

Mark Douglass - Longbow Research

And relative size?

John Stropki

Relative size of the overall market?

Mark Douglass - Longbow Research

Of your orders?

John Stropki

Well, these were pretty significant orders, but I’m not going to give the absolute detail on it.

Operator

Your next question comes from Tom Hayes - Piper Jaffray.

Tom Hayes - Piper Jaffray

Vince, I was just wondering if you could, I just want to kind of circle back to the LIFO just real quick, make sure I understood. So in the third quarter there was a benefit to the margin line of kind of close to about $7.5 million.

Vincent Petrella

$7.7 million.

Tom Hayes - Piper Jaffray

Okay. So and then for the full year, I mean it’s been an impressive margin performance over the last two quarters, would that be the main driving force that’s pushed that margin back to those levels?

Vincent Petrella

Well, certainly following input cost have had an important impact on our margins. But we also have very important cost savings recognition over the course of second, third and now it’s going into fourth quarter.

So LIFO accounting again is a reflection of matching the most current cost and commodities that you are purchasing against your most current revenue level. So, these are real profit generating gross margins and it’s reflective of declining commodity cost environment.

John Stropki

And it’s also a measure of our ability to continue to capture price even though input cost are reducing.

Tom Hayes - Piper Jaffray

No, I guess, some of the outlook and for the raw material continues to show a little bit of weakness, so would it be kind of a fair expectation that, if that input price were to turn down you would continue to see some future LIFO adjustments?

Vincent Petrella

Yes, that would be the case, but we would say at this point in time, if anything we are seeing indications of higher input cost running into the fourth quarter into 2010. So, you all know we buy a fair amount of steel and other commodities, and those have recently started to trend upward and so there would likely be more pressure and headwinds on margins than anything else compared to the first three quarters of the year.

Tom Hayes - Piper Jaffray

Okay. And then if you could just shift a little bit, John you mentioned the cumulative job you guys have done on the new product, so I was just wondering if you could describe, are you seeing that the sales traction on those new products kind of falling in similar patterns to previous product rollouts?

John Stropki

Well, this is a very broad rollout, Tom as we discussed that we diverted substantial internal resources to really focus on upgrading or introducing new products. We did that in the slow markets, recognizing that we needed to capture share in order to really get maximum value out of the resources that we have in house, and so, we are early in that game, but the early returns are very, very positive.

As I mentioned, the turn out and the enthusiasm that was generated during the course of the Essen welding show, which attendances three or four times that of the North American welding show, was quite refreshing and we are very optimistic. So, we think that the trend will be quite good and because of the number and the scale of the introductions, we think there is a great amount of upside with them particularly, when the markets do return to normal volumes.

Tom Hayes - Piper Jaffray

Well, it looks like a great product offering and I complement you on the core site product. Kind of a derivative question and have you experienced any delays in what will become a normal machine upgrade cycle since a lot of the welders that are already in the field have been relatively underutilized for the last six to nine months?

John Stropki

Well, I would say you really have to kind of break the market into two segments. The low-end commercial business and more of the walk in industrial distributor kind of business is quite slow, and I would suspect that until the markets return it will remain quite slow, but striving our roles in both revenues, where we have them and also in market share is the upgrades that the major end users are going through.

Again, these are driven by the fact that they have had a new product line coming out that they have to build or they have got quality issues or they have productivity issues like all companies have and they are trying to lower their product manufacturing cost and focusing on the productivity increases that we can demonstrate.

Operator

Your next question comes from [Steven Ryan - HST Capital Market].

Steven Ryan - HST Capital Market

I just want to get this right; the facility rationalization that’s mostly done at this point or is there a little bit more to go?

Vincent Petrella

Well, the ones that John talked about are still in progress, not completely done. So, running into the fourth quarter we will still be completing those actions, and then we continue to look at other opportunities to consolidate or reduce our fixed cost structure.

I would say though Steven that the bulk of what we think we need to accomplish has been either announced or accomplished, and there won’t be a significant amount of additional actions either announced or progressing in the fourth quarter in to 2010.

Steven Ryan - HST Capital Market

Then going forward, the tax rate again, can you give us some kind of guidance there?

Vincent Petrella

Well, the tax rate excluding the special items impact was about 31%. So I would tell you that you could use that as a proxy for an ongoing operating type effective tax rate.

Steven Ryan - HST Capital Market

Okay. And then just in general, the kind of M&A pipeline for you guys, if you guys look at smaller or larger because you have a boat load of cash now?

John Stropki

Well, we look at all opportunities, we don’t really classify them by size, we look at them based on the value that we think they could bring to our shareholders. We’ve talked a lot about the fact that what have good relationships with many people in the industry, and we think that our contacts there are important in identifying the good opportunities that exist.

We think that the future looks bright there, that the acquisition targets I think have a better view of what the future looks like for them, the challenges that they face and those aren’t up to the challenges are looking at the alternatives that are on the table and Lincoln presents a very good alternative for people who chose to exit the business.

Steven Ryan - HST Capital Market

Believe me there is greater activity now than a year ago?

John Stropki

I think it’s just easier to get reasonable dialogue going on evaluations as we entered into this tremendous decline in the revenue and the profits of businesses, it was almost impossible to have any reasonable discussions on evaluations.

So again, if people have I think a better view of what their future looks like, those discussions could be much more productive. So, Yes the pipeline is a little better than what it was, but our pipeline is as I would say, is fairly continuous, it’s always a timing issue in terms of execution.

Operator

Your next question comes from James Bank - Sidoti & Company.

James Bank - Sidoti & Company

Your gross margin, it’s roughly where it was back at 2007, I was just wondering with LIFO was slightly having less of a benefit or impact let’s say, in 2010 and pricing of where it is. Do you think you guys could see margin pressure next year at the very least suppression of further expansion?

Vincent Petrella

Well, a lot of it’s going to depend on how the volumes James.

John Stropki

That’s the unknown end of the equation. If the volumes improve with the cost cutting measures that we have implemented, we should be able to capture a significant margins based on what the reductions that we have. If they don’t or they decline yes, will be damages we always are.

Vincent Petrella

Assuming the volume environment that we are in today and facing what we see at least in the near term in terms of increases in input cost however. We would have some pressure on the margin line provided that input cost increased and we do not match that with the requisite increase in the pricing as well as the necessary margin maintenance.

So, we are certainly going to see input cost increase and it will be a managerial challenge to match those increases at the top line and maintain the kind of margins that we have achieved here in the third quarter of 2009.

James Bank - Sidoti & Company

Okay. And the run rate for your structuring now is the $140 million?

Vincent Petrella

Yes, if you were you to annualize what we achieved in the third quarter and the fourth quarter, Yes, $35 million is sort of our run rate at this point in time.

James Bank - Sidoti & Company

And what was the breakdown again between the cogs and the SG&A?

Vincent Petrella

Well, it’s all James, included in a separate line called rationalization charges after gross margin but before operating profit.

James Bank - Sidoti & Company

So you have no, okay, I’m sorry, I thought there was some SG&A reduction as well.

John Stropki

You are looking for the savings?

James Bank - Sidoti & Company

Yes, I’m sorry, the savings.

John Stropki

Yes, the savings number, the bulk of it is in cost of goods sold.

James Bank - Sidoti & Company

Okay. And that annual run rate is a 140.

Vincent Petrella

Roughly.

James Bank - Sidoti & Company

Okay, the Jin Tai, how much did that add to your other countries in the quarter?

Vincent Petrella

In terms of earnings?

James Bank - Sidoti & Company

Absolute dollar?

Vincent Petrella

Or revenues?

James Bank - Sidoti & Company

Revenue?

Vincent Petrella

Revenue was about $22 million, but the total acquisitions in that line because there was another acquisition added about $27 million, because we had an acquisition last year that didn’t affect the third quarter.

James Bank - Sidoti & Company

Okay. Now the equity earnings filling at line, okay, so Jin Tai now being owned what happens to that line going forward?

Vincent Petrella

Well that like will primarily have our 50-50 joint venture in Turkey in that line.

James Bank - Sidoti & Company

And that’s the only one?

Vincent Petrella

Well, we have another smaller one in Latin American, but the bulk of, the sizable joint venture now is in Turkey.

James Bank - Sidoti & Company

Okay, how did that perform this quarter?

Vincent Petrella

It was modestly profitable.

Operator

Your next question comes from Steve Barger - Keybanc Capital Markets.

Steve Barger - Keybanc Capital Markets

If I look back to 2004 and 2005, coming out of the last recession you were running incremental contribution margins in 10% to 20% on really solid revenue growth. So, as I think about all the restructuring you have done now, should you have a structural benefit as revenue comes back versus the last downturn, or what do you think your incremental are going to look like as volume picks up?

Vincent Petrella

Well, I think certainly we are going to have a structural benefit, it’s in rationalizing and consolidating and driving some of a higher cost factories out of our portfolio is going to give us opportunity to achieve both the higher capacity utilization as well as a better unit cost profile in the next upturn and, I would point out in an environment Steve where our sales are down over 30% our North American business put up a 12.3% EBIT margin.

I think we will exceed the previous peak earnings margins if we can get those kind of revenue numbers back again, and certainly some of the other two regions have performed fairly well in terms of progressively improving their EBIT margins during the course of the year in a very difficult volume environment. Now it’s also fair to say on the other side of the ledger that, a fair amount of the cost savings figures are guaranteed employment techniques, and our ability to take wages and hours down to match our productive capacity.

So you can’t simply say that the $35 million is gone forever, because when our volume levels return it will be a fair amount of our cost savings being restored back to the P&L to match current demand levels, but there is still a meaningful amount of fixed cost and overheads that have been removed from the system that should give us a higher peak earnings capability in the next upturn.

Steve Barger - Keybanc Capital Markets

So, when you think about $30 million or $140 million run rate either won what percentage of that is fixed versus variable if you know?

Vincent Petrella

Probably, I give you a rough estimate of two-thirds to three-fourths is probably variable.

Steve Barger - Keybanc Capital Markets

Okay, and do you want to take shot at what the incremental contribution margins could look like, let’s say if you get a 10% revenue growth rate in 2010 or 2011?

Vincent Petrella

No.

Steve Barger - Keybanc Capital Markets

All right. It seems like a lot of companies as we’ve listen to reports over the last week or two, everybody has done about five years of restructuring in the last three quarters. So, cost basis have gotten much smaller, what’s the risk if this becomes a volume game globally at the expense of price as competitors try to take market share if the recovery is a little slower than people wanted to be?

John Stropki

Well, again I think if you go back to remarks about the moves that we made in Europe, we are basically transferring the productive capacities of the facilities that we’ve downsized or closed to lower cost locations.

These are locations where we had build out the infrastructure in preparation for volume increases, since the volume increases did not come because of the recession in those spaces were available, and we are moving the production equipment into those facilities that if the infrastructure is already there, the workforce is already trained, the management is in place, and we can turn on the switch as soon as we move the equipment.

A very good example of that is in our HERUS portfolio where we moved our product like out of Italy into an existing HERUS facility in Poland. In 24 hours we moved 40 truckloads of production equipments into a new facility and in very short order had it installed and operational, and that’s what we have done with these restructuring efforts that we are talking about, and we don’t see that inhibiting in our ability to meet any uptick in the capacity needs that are, that may come.

Steve Barger - Keybanc Capital Markets

Great, and Vince I was kind of surprised to hear you talk about potential input cost increasing going at 2010, steel capacity is being coming back online pretty steadily, but is that kind of looked at some of the steel company results, things like pricing could get softer domestically in the near term. So, was that a global comment, and what’s the right metric for me to think about for consumable read through, should I be looking at fuel capacity or is that in pricing?

Vincent Petrella

It’s pricing, and we use a significant amount of long steel as well as the flat rolled steel, and you can track pricing in all the regions of the world through various steel services, but it’s not only steel, but as other commodities have been rising and price including a copper, aluminum, silver, just about everything, well oil is certainly leading away at over $80 a barrel. So, we are seeing rising commodity prices in our environment.

John Stropki

I think it’s becoming much more difficult to predict in the short term Steve because two things are happening on the field side, I mean capacity is coming back online, when I talked about the capacity utilization numbers going up, and that’s good news, because it relieves some of the stress on the supply chain but also as the metal see that their business is improving obviously, they are going to want to go back to where they were from a profitably and a margin basis.

So, there is shorter term view of that, and I think if you track what happens in the fuel production area, you will get a better view of what we might expect as far as price is concern.

Steve Barger - Keybanc Capital Markets

Okay, one last question John, in your prepared remarks you said China was the worlds largest welding market, did you mean fastest growing or is it actually bigger than the U.S. in terms of dollars?

John Stropki

I think it’s surely bigger by volumes, I mean absolute no question. It’s a little harder to track by dollars, because you don’t have the kind of visibility because of the lack of public companies.

Steve Barger - Keybanc Capital Markets

Right.

John Stropki

But it would be very close, and I will guarantee it will be the biggest, if it is not already the biggest in terms of dollars, but by volume it’s substantially larger.

Operator

Your next question comes from Greg Halter - Great Lakes Review.

Greg Halter - Great Lakes Review

I wonder if you could comment about where your cash is invested and what kind of rates are currently being earned on that?

Vincent Petrella

Above 80% of the cash Greg is in the U.S., and then the reminder is sort of spread around in the bank accounts of our non U.S. operating subsidiaries, and as far as what the rate is that we are achieving, it’s extremely low, you can look at our interest income and divide it by what our total cash balances are and come up with a return that’s in the very low single digits. So we have our cash in very short term highly liquid instruments.

Greg Halter - Great Lakes Review

Okay, and given the fact that you could have greater than $300 million sales and net cash by year end, and obviously I’ve heard the commentary about M&A. So I just wonder how you would prioritize between acquisitions, share repurchase and dividends in terms of that cash.

Vincent Petrella

Well, Greg acquisitions are priority one, two and three and we really think that this is the time and the environment to take advantage of our strong financial position, and the multiples in the pricing environment that we think are appropriate at this point in time, in terms of the other uses of cash this really hasn’t been a shift in our view of how we use our balance sheet.

We are a committed dividend payer and a committed dividend increaser. We have a reasonably modest yield on our dividend payouts and through cycle we have what we believe to be an appropriate payout ratio, one that is a bit higher than normal based on the most recent earnings history of the company.

Then finally, share buybacks are something that we look at not from a systematic viewpoint, but from more of an opportunistic viewpoint, in terms of what our outlook is, for use of cash and what opportunities we have to pursue our top strategies, and from time to time as you know in our history we enter the market and take a few shares out now and again, but that’s not something that we will do on a regular basis, but largely opportunistic profile.

Greg Halter - Great Lakes Review

Okay, and given your debt, where you have it now, is any of that, and I know you reduced it by $30 million, any of that can be paid down or you kind of locked out in the near term here?

Vincent Petrella

Yes, the debt maturity on the remaining outstanding debt has $80 million bullet that’s due in March of 2012, and there are prepayment penalties that are not attractive that we run the calculations periodically from time-to-time and it’s been our view that we won’t pay down that debt at this point of time but wait for its maturity based on the current interest rate curves today until March of 2012.

Greg Halter - Great Lakes Review

Okay, and given that the month of October is almost over, any commentary on how October volumes have shaped up so far?

Vincent Petrella

Well, I think John might have commented on this in his formal comments, but we have seen as the quarter has progressed and into October a continuing slight strengthening of order levels.

Operator

Your next question comes from Holden Lewis - BB&T Capital Markets.

Vincent Petrella

And Melissa this will be our last question.

Holden Lewis - BB&T Capital Markets

On the savings, you have the $140 million run rate, but does that include the savings you are anticipating from these most recent rounds of closures?

Vincent Petrella

There will be little bit more from those most recent rounds; those are not in full maturity yet. So we will likely have maybe a range of another five or six million on top of that.

Holden Lewis - BB&T Capital Markets

Well, VBLA is kind of $145 million in sort of annualized savings that pushed in here, and you kind of feel like that’s where you want to be.

Vincent Petrella

And that’s not a bad estimate, and that’s likely substantially what we would able to achieve through the end of this year.

Holden Lewis - BB&T Capital Markets

And did I hear you right that of that two thirds and three quarter is variable, so you can come back on the P&L as volumes return?

Vincent Petrella

Yes.

Holden Lewis - BB&T Capital Markets

Okay, so one third to one quarter then is how much sort of the fixed cost of the plant and all is?

Vincent Petrella

Right, but Holden I would emphasize, we would be delighted to have those variable cost come back on the P&L, if they come back we are going to have much higher earnings and much higher leverage and therefore much higher peak EBITDA margins.

Holden Lewis - BB&T Capital Markets

Well, I get to raise the question, and are those savings? When they come back, do they naturally come back as the volumes get better because maybe we have to put back or whatever or can you hold those off until your revenues get to X percentage of current levels and what would that sort of be?

Vincent Petrella

Yes, the bulk of what will come back will match productive volume levels, there are some more modest variable cost that will come back as we restore wages for salaried employees and also profit sharing match, but that’s the smallest part of the variable cost savings to-date.

The bulk of it is taking our productive labor cost down, as well as, as you all know Holden our variable compensation structure associated with bonus, so there is a fair amount of variable cost that are associated with just how profitable the firm is, the company is from period to period.

Holden Lewis - BB&T Capital Markets

Yes, instead of looking at what you achieved in other way, can you talk about like how much of your productive capacity now, maybe talk about in terms of the Norham, Europe and rest of the world categories that you tend to think of it, but I mean, where is your production capacity now versus maybe before all of this began? Is it materially different?

John Stropki

Well, it is, I mean, roughly speaking when we were at our peak in 2008 we were running at very high capacity utilization levels, and you also know we had a very high CapEx spend and largely the majority of that CapEx spend was to add new capacity as we were tied in different consumable categories running through ‘06, ‘07, ‘08.

So if your sales are down on a year-over-year basis by 30% or 40%, and if you assume we are 90 plus percent capacity utilization, we are down there roughly 50% to 60% capacity utilization. So there is a tremendous amount of capacity available as proven by our peak volume trends achieved in ‘07 and ‘08.

Holden Lewis - BB&T Capital Markets

I guess, what I’m trying to get at is assuming you get back to peak utilization, given that you shut out a bunch of facilities and moved some stuff around, I mean, peak utilization is North America now like 60% of production where it used to be 80%, I mean, how is that sort of skewed now between Norham, Europe and rest of world?

Vincent Petrella

Again I just emphasize what John said, and let him add to it some more color. But we really aren’t taking out productive capacity, we are consolidating facilities, we are transferring equipment, we are moving the capability to make the same products, and the same volumes but at the lower cost structure, and exiting fixed cost situations to give ourselves a better productive unit cost, but we do not believe that we are actually taking capacity out of the system where we are driving our fixed cost base lower.

John Stropki

Yes, the other part of that Holden is that this is really a tuber in most of these moves, not only as adjusted the direct labor rate that will improve, it’s the productivity that will improve. In our many cases we are moving to new factories that have better layouts and flow and in most cases have a higher level of productivity associated with the workflow.

Holden Lewis - BB&T Capital Markets

When you move capacities it’s been from like Western Europe to Eastern Europe and Australia to Asia?

Vincent Petrella

Right, exactly.

Holden Lewis - BB&T Capital Markets

Then I guess last question about production, inventories in the quarter actually moved up a little bit sequentially, does that mean that we kind of stepped up production a little bit or that utilization rate, the production levels really have not moved at this point?

Vincent Petrella

Generally speaking Holden, we have moved up production levels in the quarter to meet the slight sequential increase in orders and revenues. So that is true that capacity utilization has ticked up a bit enterprise wise.

Holden Lewis - BB&T Capital Markets

Okay, and that looks relatively permanent because you feel like the inventories where you need to have them I guess?

Vincent Petrella

Well, it’s hard to say, whether it’s going to be permanent or not, but I think we have managed our balance sheet very well during the course of this downturn, you will notice that our average operating working capital is actually down year-over-year, inventories have come down significantly during the course of the year to match our volume requirement.

So, we are still ongoing continuous improvement initiatives Holden to try to drive more inventory out of the system, and so those two factors will somewhat offset each other. We will work hard to drive our day sales and inventory down, but we will also have to adjust our business to current and expected line levels.

Holden Lewis - BB&T Capital Markets

Then just lastly the pricing, if you look at PPI data, it’s really suggesting that in the quarter machinery and consumables were maybe slightly down, less than 1% year-over-year, and you are going to be talking about more like down three, I mean have you ever looked at that data what’s the difference?

Vincent Petrella

Well we look at a lot of data, but we don’t know everything that goes in the machinery number, and I’m sure that we are a fairly modest percentage of that aggregate macro economic figures. So, we can provide you with any further color on why Lincoln might separate itself from the overall machinery figures.

Holden Lewis - BB&T Capital Markets

Yes, this is North American machinery consumables, so I gather if you are probably a big contributor to that, but I mean I guess it comes down to, I mean do you feel like you are sort of using price perhaps to sort of boost the volumes or anything like that, or do you feel you are ready with the market?

Vincent Petrella

No, we are not using price and down the equipment side of business price has moved very little. I will comment that our equipment business prices has moved very little. I will comment that our equipment orders and sales have during the course of the quarter ticked up particularly in export international markets.

So, the point where September was our best month in exports in 2009, worked certainly on a year-over-year basis down significantly but we are starting to see some re-ignition of the export market particularly on the equipment side of the business.

Operator

Thank you. Mr. Petrella, I would like to turn the conference back over to you for closing statements.

Vincent Petrella

Okay, thank you Melissa, and thank all of you that joined the call today and we appreciate your questions and your interest in Lincoln Electric, and we very much look forward to providing you with the progress of our plans for the fourth quarter, and full year next year in 2010, thank you.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Lincoln Electric Holdings Inc. Q3 2009 Earnings Call Transcript
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