Franklin Electric's (FELE) CEO Gregg Sengstack on Q1 2018 Results - Earnings Call Transcript

Franklin Electric Co., Inc. (NASDAQ:FELE) Q1 2018 Results Earnings Conference Call May 1, 2018 9:00 AM ET

Executives

John Haines - CFO

Gregg Sengstack - Chairman and CEO

Robert Stone - SVP and President, International Water Systems

Analysts

Edward Marshall - Sidoti

Matt Summerville - D.A. Davidson

Operator

Good day, ladies and gentlemen, and welcome to the Franklin Electric Reports First Quarter 2018 Sales and Earnings Conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, this call is being recorded.

I would now like to turn the conference over to John Haines, Chief Financial Officer. Sir, you may begin.

John Haines

Thank you, Ashley and welcome everyone to Franklin Electric's first quarter 2018 earnings conference call. With me today are Gregg Sengstack, our Chairman and Chief Executive Officer; and Robert Stone, the Senior Vice President and President of our International Water Systems Unit. On today's call, Gregg will review our first quarter business results, and I'll review the first quarter and financial results. When we're through, we will have some time for questions and answers.

Before we begin, let me remind you that as we conduct this call, we will be making forward-looking statements with the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to various risks and uncertainties, many of which could cause actual results to differ materially from such forward-looking statements. A discussion of these factors may be found in the company's Annual Report on Form 10-K and in today's earnings release. All forward-looking statements made during this call are based on information currently available, and except as required by law, the company assumes no obligation to update any forward-looking statements.

With that, I will turn the call over to our Chairman and CEO, Gregg Sengstack.

Gregg Sengstack

Thank you, John. 2018 started with strong organic growth in our Water and Fueling businesses, both domestically and internationally driving first quarter operating income up 23% versus the first quarter of 2017. In the U.S. and Canada Water Systems business, Pioneer branded dewatering pumps continued to lead the way, more than doubling last year's revenue. Ground water pumping systems grew double-digits and other surface pumping equipment yielded similar revenue gains.

Outside the U.S. we saw strong growth in Europe, the Middle East, and Africa which grew organically about 7%, but this growth is not enough to offset continued weak demands in Brazil and Southeast Asia. The strong operating leverage we saw in the U.S. and Canada Water business was somewhat muted by the margin compression we experienced in the international markets. Even with the international challenges we are pleased that our Water segment operating margin improved year-over-year.

In addition, you may recall that we have taken pricing actions to offset anticipated inflation. John will talk about additional pricing actions in a moment. We should see further improvement in Water Systems margins in Q2.

Our Fueling Systems business delivered another record quarter. Our systems approach to the market resonates with domestic marketers and sales in the U.S. and Canada grew by about 11% with every major product categories showing revenue growth. Internationally we continue to grow as well and China is the key growth engine. The country is in the early stages of a mandated multiyear upgrade to the underground piping systems in retail gas stations.

As I mentioned last quarter, we expect this upgrade to add significant revenue in income to our Fueling business over the next several years. Further, some partners are choosing to extend our upgrades beyond piping systems to pumping and leak detection systems as well. Outside of China, Fueling Systems had strong results throughout Asia and more modest growth in Europe, the Middle East and Africa. In Latin America we are seeing slow recovery of business as well.

Turning to distribution, you may recall that last year three significant pump suppliers elected to discontinue selling to Headwater companies. These decisions impacted Headwater's short-term results. In the fourth quarter of last year pro forma revenue was down 11%. However, with the addition of new pump lines and a major focus on customer service, our distributions business improved sequentially.

First quarter 2018 pro forma revenue was down less than 3% compared with the first quarter of 2017 and ahead of our expectations. Headwater sells multiple pump lines from multiple manufacturers to address the range of pumping requirements. However, when Headwater replaces a former supplier's pump with a Franklin product, Headwater earns a distributor margin and Franklin Electric earns manufacturing margins as well.

Sales of groundwater pumping permits to Headwater in the first quarter were a key driver of growth in the Water Systems business in U.S. and Canada. As we move into the second quarter we expect Headwater sales will continue to strengthen. As we have noted last quarter, Headwater is a highly seasonal northern hemisphere business which means almost the entirety of its earnings will be in the second and third quarters of each year.

Given our strong start to the year in both the Water and Fueling Systems segments, in our better than expected sequential growth in distribution we are raising our revenue guidance for 2018. We now believe our organic revenue growth which excludes the impact of foreign currency translations will more likely be in the 6% to 8% range. This is an increase from the 4% to 5% range for Water Distribution and 5% to 7% range for Fueling provided in our previous guidance.

Further, based on these higher growth assumptions and resultant earnings, we are raising our full year 2018 estimate for earnings per share to a range of $2.27 to $2.37, an increase from the $2.16 to $2.28 provided in our previous guidance.

I'll now turn the call over to John to discuss the numbers in more detail. John?

John Haines

Thank you, Gregg. Our fully diluted earnings per share were $0.45 for the first quarter of 2018, versus $0.33 for the first quarter of 2017, an increase of $0.12 per share or 36% over last year. Restructuring expenses did not impact the earnings per share in the first quarter of 2018 or 2017.

First quarter 2018 sales were $295.6 million compared with 2017 first quarter sales of $220.3 million, an increase of 34%. The sales increase was from acquired distribution entities for the world's organic sales increases in both Water Systems and Fueling Systems of about 10%, that was increased by about 4% in quarter due to foreign currency translations.

Water Systems sales were $191.8 million in the first quarter of 2018 versus the first quarter of 2017 sales of $167.6 million, an increase of 14%. Water Systems organic sales were about 11% in the quarter when you exclude the impact of foreign currency translations. Water Systems sales in the U.S. and Canada increased by 28% organically in the first quarter on broad based improvements for each major product grouping. Pioneer branded dewatering equipment sales more than doubled in the quarter with due to strengthening oil and gas end markets.

Sales of ground water pumping equipment increased by about 30% which strengthened both residential and agricultural product lines. The increase was driven by increased sales of the product to the Headwater companies who as we have said have improved sequential sales performance.

Additionally, as other pump OEMs discontinued selling to Headwater, many of their products have been replaced with products from FE. Recall that in the first quarter of 2017 the Headwater Company significantly reduced the amount of purchases from Franklin Electric in anticipation of the early second quarter acquisitions by Franklin.

Finally the product sales to Headwater from the Water Systems segment are flowing through to the end customers and not building inventory at Headwater. The company had already announced a 3% increase in Water Systems prices in the U.S. to offset raw material inflation. Today we will announce a second increase of 3% in the United States effective June 1, specifically for the purpose of offsetting the Section 232 tariff on steel and aluminum imports. We do not expect margin deterioration in 2018 due to raw material inflation for tariffs.

Water Systems sales in markets outside the U.S. and Canada increased by about 3% overall. The impact of foreign currency translations increased sales by about 5%. International Water sales were led by improved sales in Europe, the Middle East and Africa, but were offset by lower sales in Brazil and Asia when compared with the first quarter 2017. Water Systems operating income was $25.2 million in the first quarter of 2018 up $3.8 million versus the first quarter of 2017. The increase in operating income is primarily related to higher sales.

Fueling Systems sales were $59.4 million in the first quarter 2018 versus the first quarter of 2017 sales of $52.7 million or about 13% higher. Fueling Systems organic sales were about 9% when excluding the impact of foreign currency translations. Fueling Systems sales in the U.S. and Canada increased by about 11% compared with the first quarter of 2017. The increase was broad based and included numerous product categories including pumping, fuel management systems and piping. Outside the U.S. and Canada, Fueling Systems revenues grew by about 16% led by stronger sales in China and Europe partially offset by lower sales in India.

Fueling Systems operating income was $13.6 million in the first quarter of 2018 compared with $11 million in the first quarter of 2017. The increase in operating income is primarily related to higher sales.

Distribution segment sales were $56.2 million in the first quarter of 2018. Management estimates at the first quarter Distribution sales declined by 3% from the first quarter of 2017. The Distribution segment recorded an operating loss of $0.8 million in the first quarter of 2018.

The company's consolidated gross profit was $99 million for the first quarter of 2018 an increase from the first quarter of 2017 gross profit of $75.8 million. The gross profit as a percent of net sales was $33.5% in the first quarter of 2018 versus 34.4% during the first quarter of 2017. The gross profit increase was primarily due to higher sales. The decline in gross profit margin percentage is primarily due to product and geographic sales mix shifts as we believe the global realized price has offset material cost inflation in the quarter.

Selling, general, and administrative expenses were $76.3 million in the first quarter of 2018 compared to $57 million in the first quarter of the prior year. The increase in SG&A expenses from acquired businesses were $17.7 million. Excluding the acquired entities, the Company's SG&A expenses in the first quarter of 2018 were $58.6 million an increase of about 3% from the first quarter of 2017.

The company recognized discrete tax benefits related to certain deferred income tax provisions in the first quarter of about $5 million which lowered the first quarter effective tax rate to a 9% benefit. This tax benefit in the first quarter was planned and included in our original earnings guidance for 2018.

We also call attention to the fact that the first quarter of 2017 tax rate was only 1%, again because of discrete tax benefits realized in that quarter. Consistent with our previous guidance, the company believes the full year 2018 effective tax rate will be about 15% expense on pretax earnings. As we said in our earnings conference call for the fourth quarter 2017 the net impact of the new tax law in the United States on 2018 earnings per share is an improvement of about $0.08. This estimate has not changed and the increase in our current earnings per share guidance for 2018 we are announcing today is entirely driven by improvement in the operating results of the company.

The company ended the first quarter of 2018 with a cash balance of $67 million which was flat for the end of 2017. Inventory levels at the end of the first quarter of 2018 were $343 million versus year end 2017 of $312 million. The inventory increase is primarily due to seasonal working capital needs. The company had $119 million in borrowings on its revolving debt facilities at the end of the first quarter of 2018 and $67 million in borrowing at the end of 2017. These borrowings were primarily to fund acquisitions and working capital needs.

The company purchased about 182,000 shares of its common stock for approximately $7.3 million in the open market during the first quarter of 2018. As of the end of the first quarter the total remaining authorized shares that may be repurchased is just under $2 million. On April 23, the company announced a quarterly cash dividend of $0.12 an increase of about 12% from the previous quarterly dividend amount. The dividend will be payable May 17, to shareholders of record on May 3.

This concludes our prepared remarks and we would now like to turn the call over for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Edward Marshall of Sidoti. You line is open.

Edward Marshall

Good morning guys. Good morning gentlemen.

Gregg Sengstack

Good morning, Ed.

John Haines

Hi, Ed.

Edward Marshall

So, I just wanted to try and get a sense on what the contribution in the quarter from Valley Farms was, as I know it was acquired during the quarter, acquired revenue the distribution, just was trying to get a sense just that piece [indiscernible] as required?

Gregg Sengstack

Yes, Ed it was not very significant. Valley Farms is a really good distributor. They have very strong performance in the branches that they are modeled it has larger branches from a revenue perspective, but they are almost entirely based in Michigan and Northern Indiana and the first quarter is not particularly a strong period for them from a weather perspective. But what we can say is they contributed positively to operating income in the first quarter, but it was not meaningful.

John Haines

And as this pro-forma that we gave where the estimated revenue being down just under 3% included them from both the first quarter of 2017 and the first quarter of 2018, so that’s an apples-and-apples comparison.

Edward Marshall

Got it. I was trying to look sequentially but that’s fine. Any additional discrete tax items in the guidance for the year?

John Haines

There are, but nothing of any material significance Ed like what we saw in the $5 million or so in the first quarter. So the issue with discrete tax items are somewhat new compliance, somewhat if you kind of look out and see, other ones raised throughout the year. So right now there is no real significant discrete tax items planned for the balance of the year.

Edward Marshall

Got it and then you talked about 232 pricing and it looks like last night there were some delays to the outliers [ph] on the decision on the taxes. I’m curious, how do you think that might affect your price increases as we move forward, does it delay if we should after June, how you think about that?

John Haines

Well, the decision last night as it relates to many of the European Union countries has far less significant impact on us, and the ones that we are most, the tariffs we're most focused on are Chinese tariffs and imports of metals and products from China. So the 3% that we're announcing today that will be effective June 1 is really focused on the tariffs related to imports from China. The [indiscernible] has reported a fluid situation as you know and we’re trying to stay on top of that best we can.

We certainly would not say that should something in the future or balance of 2018 change that we wouldn’t go back and look for additional price. What we are trying to do is stay committed to the fact that we are not going to let tariffs impact our margins in our Water Systems business in the United States. The month delay Ed is really for typical as it relates to price increases. We try not to just spring price increases on our customers. So that's really the thinking behind the June 1 and May 1. It's really just a lot of customers trying to prepare to react to that.

Edward Marshall

Got it. Thanks for the comments.

Operator

Our next question comes from Matt Summerville of D.A. Davidson. Your line is open.

Matt Summerville

Thanks. Good morning, guys.

Gregg Sengstack

Good morning, Matt.

Matt Summerville

So with respect to your inventory sort of situation I think Gregg on the last conference call you had felt the inventories heading into 2018 were a bit on the high side. May be if you can kind of reconcile that comment to how you're feeling about not only your own inventories but to John's comment what you're seeing in distribution just more broadly speaking on the industry. So maybe just talk about inventories a bit?

Gregg Sengstack

Sure Matt. Our inventories are on the high side. Fortunately, it’s the time the year because of our being a Northern Hemisphere that’s not a bad place to be. We would say that the inventory in the channel is normal and we would say that certainly in the U.S. markets we've seen good demand and good flow through, so we expect that as the season picks up that, that will help us address coming in a little bit strong inventory.

A couple of those factors are that we did have a small acquisition here in first quarter that adds to our inventory balance in the quarter. And also with currency we're also having impact on a year-over-year basis to inventory level as well. But I’d say generally we are moving and directionally with the company greater focus now on inventories. This generally across the whole company throughout this year and we’d see that we would expect that our quarter-over-quarter comparisons we’re improving from here.

Matt Summerville

Got it and then if you can John may be if I missed it I apologize, where you in terms of realized price sort of round numbers year-over-year in Q1 and where you still net, I’m trying to understand if you are still net favorable on the spread between [indiscernible] again just getting back to the gross margin compression you saw?

John Haines

Yes, so our calculation with choose prices in the quarter Matt is about 150 basis points, that excludes Headwater. I'm not sure, we’re just looking at kind of Water Systems and Fueling Systems combined.

And so while we were in the first quarter of 2017, but we do believe that offset the raw material inflation in the quarter, did not stratify a lot but we believe that it did offset and that’s what we’re staying committed to for 2018 is to say okay as we see this raw material inflation coming at us keep in front of it with price increases, so that’s what we saw in the first quarter.

Matt Summerville

And then may be if you can talk about a little bit more detail what you are seeing internationally your comps fees pretty meaningfully in Latin America for the balance of the year I believe you’re up against negative comp. They get a little bit tougher in EMEA and they sort of bounce around a bit in Asia. But just may be more broadly speaking throw in a little end market color if you are able to as well by geography? Thank you.

Gregg Sengstack

Sure, I'm going to turn that question over to Robert, he can talk to you about how we see the APAC region turning here in Q2 and then those are the winter months in Brazil. Robert do you want to talk more about the recent [indiscernible] and the Water business.

Robert Stone

Sure, the situation Matt in Asia Pacific we expect to start to improve really from this quarter forward and we have a very difficult comp relative to last year and I said there also where we had some inventory in the channel that should be turning around now that’s our expectation there. We have gotten some price. We'll probably need to get more, but not driven by tariffs, just driven by other cost increases that we've all had.

Latin America, South America in particular continues to be challenging. Market conditions are off versus prior years price competition there is severe as everybody tries to do – to grab as much of the smaller market as they can. As Gregg mentioned, we're coming into the weaker part of the season for South America and we should see that pickup here in September, October, but it’s going to take us a while to get back there.

Europe is and I mean are looking strong so far this year and we have pretty good indications that this year is going to develop nicely versus prior year. Middle East activity is picking up a bit as well. Probably thanks to the oil price increases, but we’re seeing some increased activity there as well. Africa, especially Southern Africa continues to be very weak economic and again social political situation is not very favorable at this point in time. And in spite of some foreseen good news anyway with the change of leadership in South Africa and Zimbabwe, but that actually is way out.

Matt Summerville

And then just may be one final question, just with respect to pioneer can you remind us where that business bottoms in revenue, I want to say it was sub $50 million, but may be help me recollect that and kind of how that bumped up in 2017 and may be where you expect the business to be from a revenue stand point in 2018?

Gregg Sengstack

Yes, Matt the high watermark for Pioneer you will recall was 2014 were all in consolidated approach top line of US$100 million. That declined very meaningfully in 2017. It was right in the $50 million. I’m sorry 2015 it went too many fives there, in 2015 it’s declined right into the $50 million, lower $50 million mark, kind of tread water in 2016 and then 2017 we saw Pioneer come back some. And then this year they are having a very strong start to the year.

They've got some nice channel and customer diversification going on. So we haven’t put out a number specifically for Pioneer, but they’re going to be, they’re going to grow dramatically in 2018 over last year’s level. I don’t turn around and say they are going to get back to that $100 million mark, but they’re going to grow very dramatically.

Matt Summerville

Got it. Thanks guys.

Operator

[Operator Instructions] And we have no further questions in queue. I’d like to turn the call back to Gregg Sengstack for closing remarks.

Gregg Sengstack

Thanks you, Ashley. We appreciate you to joining us for the quarter conference call. We look forward to speaking to you in July at our second quarter results as well.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.