Greetings and welcome to the Lincoln Electric 2021 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.

Good morning, Cara, and good morning, everyone. Welcome to Lincoln Electric's second quarter 2021 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.

Thank you, Amanda. Good morning, everyone. Turning to slide three. The second quarter marks the one-year anniversary of COVID's significant impact across our business, and our team has done a tremendous job persevering through this challenge. Many of the regions we operate in are starting to return to more normalized business activity. However, we remain vigilant on rising global COVID cases and are continuing to operate under stringent best practice health and wellness protocols to ensure our employees' safety. Turning to slide four for second quarter highlights. I'm pleased to report that we achieved record earnings in the quarter, driven by record sales, diligent price/cost management, increased productivity, and the benefits of our prior cost reduction actions. I would like to thank our employees, our customers and our partners who continue to excel in such a challenging operating environment. Sales increased approximately 40% in the quarter or 36% on an organic basis on broad recovery momentum from the prior year trough. Consolidated sales, as well as International Welding and Harris Products Group sales trended above 2019 levels, and we expect Americas Welding to inflect positively in the third quarter. Our team did an outstanding job addressing supply chain constraints and inflationary headwinds in the quarter. We leveraged our elevated inventory levels and supply chain partners to maintain product availability across substantially all of our portfolio, reaffirming Lincoln as a trusted and reliable supplier during this challenging period.

Thank you, Chris. Moving to Slide 7. Our consolidated second quarter sales increased 39.9% due to 26% higher volumes, a 10% benefit from price, a 3.3% favorable impact from foreign exchange, and a 60 basis point benefit from the Zeman acquisition. Our gross profit margin increased 110 basis points to 33.2%, as benefits from volumes and cost reduction actions were offset by higher raw material and freight costs including a $9.5 million LIFO charge. LIFO charges for the first six months were approximately $13 million, and we expect an equivalent charge in the second half of the year. Price/cost in the quarter was slightly positive and neutral year-to-date. We continue to target neutral price/cost on a full year basis as we work to mitigate inflation including LIFO charges. Our SG&A expense increased 19.9% or $25 million to $152 million in the quarter. Higher incentive compensation and employee costs represented substantially all of the increase and we incurred $3 million in unfavorable foreign exchange. We expect 2021 SG&A expense to remain at this level through the balance of the year, due to higher wage and incentive compensation. SG&A as a percent of sales decreased 310 basis points to 18.3% due to higher sales. Reported operating income increased 206.4% to $121.8 million or 14.7% of sales. Operating income included approximately $3.3 million of special items. Excluding special items, adjusted operating income increased 98.6% to $125.1 million or 15.1% of sales, a 440 basis point increase versus the prior year. Adjusted operating income benefited from improved volumes, cost reduction benefits and diligent price/cost management which generated a 26.3% incremental margin. For the six months, incremental margins were 28.5%.

Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. Your first question comes from the line of Bryan Blair with Oppenheimer.

Hello everyone, very solid quarter.

Hey, thank you. Good morning, Bryan.

Chris, you seem to really emphasize that we're in the early stage of an industrial expansion. We're on the same page with that. But it has been a while since we've had a healthy industrial cycle. Hoping you could offer a little more color on what drives your team's confidence in having some real demand runway.

Well, I would say a couple of things, Bryan. First is just the momentum we see across the breadth of the business as well as some of the things that we see within the specific segments. So I think an example of that would be the mining segment. It's been a while since we've seen a really strong mining segment within the business. You see the escalation in some of those commodity input costs that they've got from the mining side, whether that would be iron ore or copper or coal. And quite frankly, that drives demand and drives activity and replacement activity within those industries. And that's just an example of one of them.

All makes sense. And great to see automation return to growth in the quarter, is there any incremental detail you can offer on automation or order rates, expected back half growth? And also I know it's early days of owning the asset, but it would be great to hear a little more on Zeman integration and how a combination of SBA and PythonX is impacting growth prospects in structural steel.

Well, I'll talk a little bit about Zeman, and then I'll let Gabe give you a couple of comments about automation broadly. But I'll tell you, I'm happy with the projections that we think we have with the automation business. It's turned a little earlier than we had expected. And the team is really working hard at it. At the Zeman acquisition, I think it's just the right strategic fit in a growing global segment for Lincoln Electric, at the right time. Many individuals are very familiar with our Python technology, really a market-leading technology out there for robotic cutting for that structural steel industry. And now we can provide another solution for that marketplace for them to be able to assemble the structural steel pieces for that industry. And I will tell you I've already talked to a couple of customers out there in the marketplace, and they're very interested and excited about Lincoln Electric being able to provide them the complement of solutions which really can take care of a great deal of the activity inside the structural steel manufacturing process. So we believe it's going to be a great solution for us. The teams are working hard on the integration portion. I know that we'll be working with our customers and partners out there around the world. We've already developed a relationship here in the U.S. marketplace, where we're going to be able to expand upon that offering with them. So I would say, off to a very solid start, very positive on the technology and the people that we have there. And I think it's a great strategic fit, and then I'll let Gabe give a couple of other comments about automation broadly.

Yes. So Bryan, thanks for that. As you know, we're very excited about the growth opportunities we see in our automation business. And we had discussed seeing an inflection point towards the middle of this year. So we did see an acceleration of that in the second quarter. It was good to see we're in the high-teens type of growth. And we've got strong quoting activity, very good backlogs going into the second half. So we'll continue to see that kind of momentum into the second half of the year. I'd also comment our margin profile is improving. We've done things within our business model to integrate the acquisitions that we've done over the years. And so we're very confident that we're on the trajectory of reaching our target operating profit profile as we continue managing and growing in this business. So we're very excited about automation. And we're well positioned for continued growth, as the capital markets start to expand and we see a reinvestment in the necessary automation capabilities within factories of the world.

Okay. Appreciate all the color. Thanks for taking my questions.

Your next question comes from the line of Mig Dobre with Baird.

Good morning. This is Mig Dobre.

Hey, good morning, Mig.

Hi. I wanted to ask a couple of questions on international. And I guess, the first one, performance here both volume and pricing quite a bit better than what I would have guessed. So two parts to my question. First, when I'm looking from a pricing standpoint, I obviously understand that input cost commodity prices have gone higher but this is the strongest pricing I've seen in international for far back as my model goes. So I'm wondering if you're doing something different or if there's something sort of different in the environment now in your international business than maybe prior inflationary periods? And then the second question is on volumes. It looks like in International, now you're running your volume is basically back to pre-COVID levels, back to 2019 levels. And I'm curious as to how you're sort of seeing the business progress here. Because it seems like you're picking up a little bit quicker in International than the Americas. So I'm wondering if there's some difference here that we need to be aware of.

Well, Mig, I'll start. I think the first piece is we've been talking to you and others about our continued expectations of improvements in the International business. Part of that improvement was a requirement of us to get better at managing that piece of the business. Part of that was some system implementation that we needed to get across the portfolio. Because I would tell you that one of the key elements of us managing some of the challenges that you have out there in an inflationary market like this is getting the right tools in place and then making sure that our teams are utilizing those tools and managing that process. And we have been very good at that at Lincoln Electric in general, but maybe not as good at that in that particular market. And we are making those improvements and I'm excited about the work that the team is doing there on that. So I would tell you that a portion of that is just, quite frankly, process-driven. Second thing I would tell you is we've been talking about going back out and making the improvements in the broad business to regain some of the customers and some of the relationships that may be during the integration over the last couple of years that were mitigated. And I think we're seeing that. We're seeing strong performance from the teams, especially in the European marketplace, for us to be able to generate the improvements we're seeing in International at this point. So a really solid quarter. We need to show consistency with that type of performance. I believe that we will, obviously, there is some seasonality associated with a portion of that in international markets that will be out there in Q3. But very excited about making this initial target and evaluating exactly then where we think we can take this area of our business as we're moving towards the end of the year and into 2022.

Okay. That's helpful, Chris. And you anticipated where I was going to go with my follow-up. I guess margins were quite good as you pointed out here. And I'm wondering on the sustainability of this margin, as I'm thinking about the back half of the year, especially within the context of the seasonality that you talked about. Thank you.

Yes. Look, I would tell you that we expect to see seasonality. And then the one thing which I believe is just probably a little more opaque, a little bit more of a wildcard in the business. And this isn't just an International comment, it's probably a comment even across the Americas business. It's very difficult to get a feel for exactly what type of summer shutdowns we may see in various segments across the world. I hear everything from some people saying, look, there could be supply chain challenges, maybe in automotive around chips and maybe they might extend some activity. And then I also hear that many customers are also worried about the backlogs they have and they may actually try to work through portions of those windows. And it's more difficult for us at this point in the cycle maybe to get a good handle on it. I would expect normal seasonality. But I will share with you, we believe that we've made structural improvements in that business, and we expect to maintain those double-digit margins as we're moving through the rest of the year and then identifying what should be the next step improvement for that International business as we're moving into 2022.

Great. Very helpful. Thank you.

Your next question comes from the line of Steve Barger with KeyBanc Capital Markets.

Hey. Good morning. Thanks.

Good morning, Steve.

Looks like 2021 revenue probably gets back nicely above 2018 and 2019 of just over $3 billion, with price and volume as strong as they are along with the structural cost actions you talked about. Do you think this year's gross margin can get back to the 33.5% of last year or even the 34% from 2018?

Yes, Steve. Thanks for that question. One of the dynamics obviously is the mix of business and also price/cost. But we're pretty confident that we'll continue to manage price costs. And whether or not we exceed the gross profit profile going back to 2018, that's yet to be seen with the growth up in the financials, but we'll continue to manage price/cost in a neutral level.

Yes. And Steve, this is Chris. Look, I know your comment was centered on gross margins, which I can assure you we're very focused on them. But I will tell you what excites me about the business as we see the momentum in the business, yet I still believe strongly we've got two areas of the business that will continue to improve as we drive those strategic initiatives. And that's getting the automation business up to the average target margins that we have for the company and the higher standard strategy. That should be able to provide us with some margin lift. And as I mentioned in the earlier question, although we've achieved the first level within our International business, we certainly expect over the next several quarters to identify how we make further improvement. So, I see those two areas of the business still as a catalyst for continued margin improvement for the business as we work through the next several quarters.

It's a good comment on the automation business. And I know the team is working hard to keep up right now across all product lines. But, as you look at the bigger secular trends, how do you drive growth in the automation business? Are there opportunities to expand the material handling aspects further from the welding cell itself, or just how do you see that playing out?

Yes. That's a great question, Steve. And I would tell you, I believe we've already made that step that at the end of the day many of the processes and solutions or content within the cells that we're providing are already outside just the core welding expertise that we can provide. So that is one element of it. But I will tell you, when I think about those broad secular trends, I don't think that the pandemic and the challenges associated with the pandemic have done anything except accelerate that trend. And when we think about challenges associated with labor, challenges associated with supply chain, many people especially in this market with the low cost of capital that's out there are going to quickly think about automation. And I believe they're going to do that because I know that's what we're doing within our own business. So, I believe that what we've had to manage through over the last 18 months or so only reiterates the confidence that we have in the automation business. And I believe it will just continue to be a larger and larger portion of our portfolio as we look at driving it to the higher standard strategy that we're trying to execute in 2025 of that being nearly $1 billion business for us within the portfolio.

Yes. I think just one quick one on that. Are you back to mid-teen-ish percent of automation relative to the total top line, or is it still a little light?

No. That's about right, Steve. That's our run rate currently, yes.

Your next question comes from the line of Dillon Cumming with Morgan Stanley.

Good morning. Thanks for the question. Not to kind of beat a dead horse on automation here. But Chris you obviously sound a lot more confident in the M&A pipeline. I think you changed the language in the slide deck from acquisition to fertilize that word. Just curious in terms of your confidence in the pipeline now, do you feel like something is more imminent? And if so, I guess is that more focused on the automation side of the portfolio versus the legacy Welding business?

We are indeed concentrating on both areas, Dillon. To effectively implement our higher standard strategy, we need to incorporate an acquisition execution aspect. I'm particularly interested in the automation business, and the execution of the Zeman acquisition highlights our commitment to investing in that sector. Additionally, there are essential elements within our core welding operations that require our attention as part of our long-term strategy. Our M&A pipeline is very active, and we are confident in our ability to leverage our balance sheet. I'm optimistic about our investment profile and believe we will successfully identify and pursue opportunities that align with our long-term goals.

Okay. Thanks for the color. And maybe just one question on the end market kind of outlook. Obviously, infrastructure is already kind of growing in the double-digit rate. So, it seems like that business is improving nicely. But just curious like in your conversations with customers and the kind of, I guess backlog and quoting activity that you're kind of seeing on that side of the business. Do you get the sense that your customers are actually positioning for a build by year-end or do you feel like they're just kind of willing to invest kind of ahead of any infrastructure package in the US?

Look, I'm not getting a feel that we've got anybody doing any build. I'm not getting a feel that there's any front running associated with that particular type of opportunity. I think that quite frankly, that would be another catalyst for us within the business. But I can't tell you that when I think about the business or the conversations I have with our customers that we've had people that are trying to get ahead of that by accelerating activity into their business. I see the infrastructure bill as a potential additional opportunity for us as it relates to the demand profile for the business. The other thing I would share as it relates to that question, I think the other challenge associated with that is the supply chain challenges that the industries are having. So, our customers are having these supply chain challenges also mitigate some of their abilities to be able to maybe move as quickly as they would like. So, it actually may elongate out some of that demand. But I don't think there's any early activity on infrastructure.

Okay, great. Thanks for the time.

Your next question comes from the line of Nathan Jones with Stifel.

Hey, good morning. This is Adam Farley on for Nathan.

Good morning Adam.

Now, why don't we go back to employee costs. Can you provide some color on what you're seeing there? Is it increased wages finding new employees to add? And then similarly, could you talk about maybe the labor on the...

Adam, it seems like you're experiencing some connection issues. However, I believe you're asking for insights on employee costs and trends. As we've previously discussed, our annual run rate for anticipated increases and merit ranges is about $12 million, and we are largely on target with that. Additionally, our incentive compensation has been a significant factor, showing an increase of approximately $17 million over the past six months. We currently anticipate around $35 million in relation to our business profile. Overall, we are aligning closely with our expectations from earlier discussions. I would like to reiterate that we mentioned our incremental margins are in the higher 20s, which takes into account employee costs, incentive compensation, and other factors.

Okay, that's helpful. Maybe on supply chain are you seeing any impacts from supply chain constraints on the ability to ship to customers on time? Could you be realizing higher revenue if the supply chain allowed it?

Yes. Look, I think there's no question that if our supply chain was completely optimized at this point, we probably would have been able to move part of that backlog out to the marketplace. So, the answer to that would be yes. The amount of that maybe is not as easy for me to give you a data point. But there's no question in my mind that if supply chains had been optimized, we probably would have been able to have more revenue in the quarter as we move those products into the marketplace.

Okay. Thanks for taking the questions.

Your next question comes from the line of Walter Liptak with Seaport.

Hey, good morning guys.

Good morning Walt.

I wanted to ask a couple of follow-up questions. First, regarding the infrastructure bill, it seems like it could be happening. Do you have any insights on what that might mean for your markets, customers, and the construction sector? Have you come across any valuable studies on the potential impact of the infrastructure bill for your business?

No. I'll tell you Walt. That's a great question. We've talked about it internally and obviously talked with a host of market participants about that piece. Remember that about 15% to 20% of our revenue are exposed into that particular segment. So, it obviously can be significant enough that it has an impact for us. But we're really waiting to see more specifics around the bill and exactly how and when those dollars would come to the marketplace if the bill moves forward. But in general, we recognize there could be a real favorable catalyst for us if we see that bill passed here before the end of the year, as long as it's passed in a manner which actually is talking about physical infrastructure improvements.

Okay. All right. Great. Thanks. And then just a follow on the earlier questions about the summer shutdowns and the seasonality. And I wonder if you could talk a little bit just about what you're hearing from your customers in the US and in Europe about the summer shutdowns? Because I've heard from a couple of companies that they're going to shut down early in the third quarter and let the supply chains catch up and then they're hoping that they could run all out going into the end of the year and not take as long or even any winter shutdown. Is that what you're referring to or was that something else around the seasonality?

Walt, that's exactly the challenge. From customer to customer and segment to segment, the situation varies significantly. Some automotive companies are facing challenges related to power electronics and chips in their production processes. We've heard about the possibility of longer shutdowns during the summer. There's also been discussions around trying to speed up operations in other segments. Currently, it’s challenging for us to gauge how shutdown activities will unfold in the third quarter or if decisions will be made regarding extended shutdowns in the fourth quarter. However, I believe this may create some fluctuations, but it won’t hinder the overall momentum we observe in the business or the demand in these sectors. We'll need to collaborate with our customers and assess the situation as we progress through the quarter.

Okay. In July, did you notice any fluctuations as some customers might have opted for early shutdowns?

Only a couple and I wouldn't say that it's material across the entire portfolio. Of course, as you know, on an international basis, most of that occurs in the latter part of the quarter versus the July window.

Okay. Okay, great. All right. Thank you.

And our final question comes from the line of Steve Barger with KeyBanc Capital Markets.

Hey, thanks for letting me back in. Chris, the pricing strength obviously reflects the big steel price increase in the market. Our steel analyst expects more capacity is going to come online, maybe imports pick up and service centers are getting restocked, which will bring steel costs back down. So, A, do you expect lower steel in the back half? And how would that play out for you?

Well, I'll tell you Steve. I know that it looks like our steel costs at Lincoln Electric are going to be slightly higher in the third quarter than they were in the second quarter. So, if those elements are starting to impact the marketplace, we're not seeing them in the execution of running the business on a global basis moving into Q3. So look, I've read some of the same things that your team may be talking about, but they just haven't started to materialize yet. Obviously, if we were to start to see major reductions, then we'd be working with our customers and understanding exactly how and when that would flow through our business to be able to support them. But right now, we're not seeing that type of activity. And again, Q3 steel price is slightly higher than Q2 steel prices for Lincoln Electric.

Understood. Thanks. And then for the five years before 2020, Harris margin averaged 12.2%. And obviously, that stepped up with volume and price and cost cuts last year and it's running ahead again this year. Do you think the new upcycle normal for Harris is mid-teen, or can it run to high-teens? And what happens if precious metals moderate?

Yes. Steve, I would tell you that we were always talking to our teams inside of Lincoln Electric much like we were talking to our automation teams that we expected them to get to our targeted average in our higher standard strategy, which you know is around that 15% target. So we believe they're doing the things to be able to continue to operate at that level. There are some mix challenges inside that business. You may see a window of time as portions of the portfolio maybe are expanded that need to be addressed. But in general, just love the performance of that business. Love the fact that our international business has made their first target, but expect to continue to drive our Harris business where they would be operating at the average of the higher standard strategy.

Got it. And, I guess, one last question on that. I think new home sales took a step back because of maybe price appreciation or something. But what's the Harris team seeing in terms of demand in the back half?

Well you and I both know when you're talking about new home sales, the primary portion of that is generally the replacement market off the HVAC side because that's still probably 75% to 80% of the total market within HVAC. So I still think that the hot summer that many of the large HVAC producers are seeing and talking about as they're coming out with their second quarter earnings leading to still solid momentum within that business. So, yes, much like the International business, that business has some seasonality because of its exposure to HVAC and that new home construction as well as replacement components. But there appears to still be very solid momentum in the business as we're looking towards the end of the year.

That’s great. Thanks.

This concludes our question-and-answer session. I would like to turn the call back to Gabe Bruno for closing remarks.

I would like to thank everyone for joining us on the call today and for your continued interest in Lincoln Electric. We look forward to discussing the progression of our strategic initiatives in the future. Thank you very much.

This concludes today's conference call. You may now disconnect.