Franklin Electric Co Inc (FELE) 2009 Q2 法說會逐字稿

Good day, everyone, and welcome to today's Franklin Electric second quarter 2009 earnings conference call. This conference is being recorded. Now for opening remarks and introductions I would like to turn the conference over to Patrick Davis. Please go ahead.

Thank you, Anthony, and welcome to the Franklin Electric second quarter 2009 earnings conference call. With me today are Scott Trumbull, Chairman and CEO; John Haines, our CFO; Robert Stone, SVP of Americas Water; Gregg Sengstack, SVP of Fueling and International Water; and Dee Davis, VP and Business Unit Manager of U.S. and Canada Water Systems.

On today's call, Scott will review our second quarter business results, and John will review our second quarter financials. When John is through we will allow some time for questions and answers.

Before we begin, let me remind you that any forward-looking statements contained herein, including those relating to market conditions or the Company's financial results, expense reductions, profit margins, inventory levels, foreign currency translation rates, liquidity expectations, business goals and sales growth, involve risk and uncertainties including but not limited to risks and uncertainties with respect to general economic and currency conditions, various conditions specific to the Company's business and industry, weather conditions, new housing starts, market demand, competitive factors, changes in distribution channels, supply constraints, technology factors, litigation, government and regulatory actions, the Company's accounting policies, future trends, and other risks which are detailed in the Company's Securities and Exchange Commission filings included in Item 1A of Part 1 of the Company's Annual Report on Form 10-K for the fiscal year ending January 3, 2009, Exhibit 99.1 attached thereto, and in Item 1A of Part 2 of the Company's quarterly reports on Form 10-Q.

These risks and uncertainties may cause actual results to differ materially from those indicated by the forward-looking statements. All forward-looking statements made herein are based on information currently available and the Company assumes no obligation to update any forward-looking statements. I'll now turn the call over the Scott Trumbull, our Chairman and CEO. Scott?

Thank you, Patrick. Our global addressable market continued to decline during the second quarter and this caused our sales to decline as well.

Our Water Systems segment represented 81% of our total sales during the quarter, and declined by 13% organically exclusive of foreign exchange. Most of the organic decline occurred in the U.S. market, where the recession continued to slow the installation of water pumping systems in many residential irrigation and industrial applications. In addition, tight credit conditions particularly for smaller companies caused our distributor customers to continue focusing on liquidity and operating with lower inventories.

While our U.S. sales declined, we believe we continue to gain share in the U.S. Water Systems market. Based on trade association data, we have evidence of share gains across our major pump product lines including our four-inch ground water pumps, six-inch ground water pumps and sump sewage effluent and utility pumps. On this basis, we're confidant that our U.S. Water Systems sales decline is due to recessionary market conditions and not market share loss.

International Water Systems represent a little less than half of our total Water segment and in the second quarter experienced a modest organic sales decline exclusive of foreign exchange. Our sales growth in Asia Pacific and Latin America was offset by a decline in Europe. Foreign exchange translation rates caused our International Water sales to decline by $8.7 million, or 38% of the total Water segment second quarter sales decline.

During the quarter, our Fueling segment represented 19% of our total sales and declined by nearly 30% organically, exclusive of foreign exchange. Last year we had surging sales in California as station owners installed vapor control systems in response to that state's environmental mandate. Also last year, we had heavy shipments of vapor control systems to the Beijing area as the Chinese undertook environmental improvement initiatives prior to the Olympics.

During the second quarter this year, California regulators deferred enforcement of the vapor control deadline from April 1, 2009 to January 1, 2010. This decision had the effect of curtailing our sales in the first half of the year, but should benefit our sales during the fourth quarter.

We were encouraged that our second quarter operating income margin before restructuring grew sequentially from the first quarter by 300 basis points. This sequential improvement was driven by a 500-basis-point sequential margin improvement in the Water Systems segment.

This was particularly encouraging because during most of the quarter our cost of goods sold did not reflect the benefit of recently negotiated raw material cost reductions, and also during the quarter we experienced cost penalties associated with the transfer of production from our Siloam Springs facility to Linares, Mexico. During the second half we expect that our cost of goods sold will reflect lower material costs and we will recognize fixed and variable cost reductions from the production transfer to Linares and the permanent reduction of manufacturing capacity in Siloam Springs.

As evidence of strengthening margins in the Water segment, operating income margin before restructuring for the entire second quarter was 14.1%, while during the month of June it was over 300 basis points higher. I should point out that while we reduced our SG&A spending during the second quarter and first half we increased our R&D spending in both Water and Fueling Systems. We continue investing in an attractive backlog of new product initiatives that should increase our organic growth rate in 2010 and beyond.

We are pleased that the Company improved cash flow from operations by $57.6 million versus the second quarter 2008, and that our overall net debt position was $51 million lower than the end of the second quarter 2008 driven in part by a $24 million reduction in inventory balances. Looking ahead, regarding revenues, during the third quarter we are forecasting that our total sales will continue declining by 15% to 20%.

Last year sales of vapor control systems in California peaked during the third quarter. So we expect that our Fueling Systems segment will account for well over half of our anticipated sales decline during the third quarter. In the fourth quarter, however, we are forecasting that our total consolidated sales will exceed the fourth quarter of 2008. This forecast is based on several factors.

First, during the fourth quarter we believe fueling sales will benefit from purchases by California station owners as the January 1, 2010 vapor control installation deadline approaches. Second, during the fourth quarter we expect to experience more favorable foreign currency translation comparisons. And, finally, during the fourth quarter we will compare Water Systems revenues to depressed prior year levels.

Regarding our margin outlook, because of the actions we have taken to reduce SG&A spending, as well as plant fixed costs and raw material costs, we expect that consolidated operating margin before restructuring in the third quarter will be in line with 2008 in spite of the fueling sales decline. In the fourth quarter, we are forecasting that our consolidated operating margin before restructuring will significantly exceed 2008. The operating margin for our Water Systems segment should significantly exceed the prior year in both the third and fourth quarters.

Finally, regarding our outlook for the balance sheet, we expect to end the year with a net debt position below $100 million. Now I will turn the call over to John Haines, our CFO, who will provide additional color on the quarter.

Thank you, Scott, and good afternoon. Our fully diluted earnings per share for the second quarter of 2009 were $0.25, a 62% decrease from the second quarter of 2008. Earnings per share before the impact of restructuring charges were $0.36, down 45% from 2008.

The Company's second quarter revenue was $165.3 million, down 18% from the second quarter 2008. As Scott mentioned, the revenue declines we experienced in our Water segment occurred principally in the United States and Canada, offset by gains in Latin America and the Asia Pacific region. The Fueling segment sales decreases were primarily due to reduced vapor control systems demand in California and China.

The strengthening U.S. dollar lowered revenue by $9 million versus the second quarter of 2008. Gross profit decreased by 240 basis points to 29.7% in the quarter, versus 32.1% in the second quarter of 2008. The bulk of the decline was due to volume, however, this was partially offset by fixed manufacturing cost reductions.

Operating income before the impact of restructuring charges as a percent of net sales decreased versus the second quarter of 2008 due to the significant loss in sales volume that Scott described above. However, sequentially operating margins before restructuring were up 300 basis points versus the first quarter of 2009. As a result of the significant market weakness, Water System sales declined by $22.9 million or 15% in the second quarter 2009 versus 2008; $8.7million of this decline was due to translation impacts as a strengthening U.S. dollar against most foreign currencies.

As Scott mentioned, the volume declined can be attributed to weak end market demand primarily as a result of significant residential weakness in the United States and our customers' continuing efforts to preserve cash and focus on working capital given the uncertain economic times. We believe the distributor inventories are at their lowest level in recent years. Acquisitions contributed $6.3 million in revenue during the second quarter of 2009.

Sequentially operating income before restructuring charges for the Water segment increased in the second quarter to 14.1% from 9.2% in the first quarter of 2009, an improvement of about 53% on a sales increase of about 18% from the first quarter of 2009. The margin improvement is attributable to fixed manufacturing and SG&A cost reduction efforts implemented by the Company.

Fueling revenues in the quarter were down 30% largely as a result of lower vapor control systems sales in California and China. International shipments outside of China of the Company's products increased from the second quarter of 2008 to the second quarter of 2009.

Operating income in the Fueling business declined to 16.2% of sales, before the impact of restructuring versus 24.6% in the second quarter of 2008. The decline in revenues forced the deleverage in our fixed manufacturing and SG&A cost in this business unit in the quarter. We incurred restructuring charges in the second quarter of 2009 of $3.8 million, primarily related to asset impairments and severance associated with the manufacturing realignment program.

Year-to-date we have incurred $4.6 million in restructuring charges. The 2009 restructuring charges were primarily non-cash items. For the full year 2009, we expect to incur between $5 million and $6 million in restructuring charges related to the Siloam Springs relocation and other severance costs related to reductions in our global work force. Approximately two-thirds of the restructuring costs will be non-cash.

The Company continued its focus on working capital improvement and generated $57.6 million more cash from operations in the first half of 2009 than it did in the first half of 2008. Inventory was a $39 million net improvement in cash generated in the fist half of 2009 compared to the first half of 2008. We ended the quarter with a balance of $14 million on our revolver versus $35 million at the end of 2008, and reduced debt outstanding by $21 million in the first half of 2009.

At the end of the second quarter, the Company needs ratio of gross debt divided by earnings before interest, taxes depreciation and amortization, or EBITDA, was 1.9 versus 1.8 at the end of 2008, and 2.3 at the end of the second quarter of 2008. We believe that cash on hand, internally generated funds, and existing credit arrangements provide sufficient liquidity to meet current commitments and service existing debt.

As we have previously disclosed, the Company's revolving loan agreement with its bank is in place until the end of 2011 and we have no scheduled principal payments on our long-term debt until 2015. Finally, on Friday, July 24, the board of directors of Franklin Electric declared a quarterly cash dividend of $0.125 per share payable August 27, 2009 to shareholders of record on August 13, 2009. This concludes our prepared remarks, and we would now like to open the call up for questions.

Thank you. (Operator Instructions). We will pause for just one moment to assemble our queue. We will take our first question from Mike Schneider with Robert W. Baird, please go ahead.

Good evening, gentlemen.

Good evening, Mike.

Maybe we can start just with the restructuring program. So the costs seem to be coming through very nicely. I'm curious if you can estimate what run rate of cost savings you are at? I believe you had been saying you were looking for $23 million to $27 million during 2009. I'm wondering just what run rate you are at, and if you could update that figure?

Yes, Mike, this is John Haines. The guidance we've given on the $23 million to $27 million still stands. We feel like the total cost reductions that we will see this year will fall in that range, still from the three primary sources of direct material cost reductions, direct labor and SG&A and fixed manufacturing costs. So the $23 million to $27 million is still a good estimate and the majority of that will fall in the back half of 2009.

Okay. Then on that topic, so the lower raw materials in the second half, can you just put some bounds around how much yet is to flow through the income statement because it seems like it's going to be fairly significant given your margin guidance for 3Q.

Well, on the raw material again the range that we had given was $3 million to $5 million. And we believe that's still a good range for the -- but the bulk will come in the back half of the year as Scott pointed out. Not a lot of that has come through so far.

Okay. Then the Siloam Springs move, could you just give us a sense of have there been disruptions as that move has occurred and just what the impact on the organization has been so far? It has gone really smoothly.

Mike, it has gone really smoothly. The move is largely done. We have something like 35 remaining employees in the Siloam Springs plant. At this point we have a stamping operation there that makes laminations and that's the only remaining operation in Siloam Springs.

All the rest of the four-inch motor production and much of our groundwater pump production is now in the Linares plants. So in Siloam Springs the work force really did a nice job of winding down that plant. We have had a bit of a learning curve hiring several hundred new people in Linares and training them. And there's no doubt in the second quarter we incurred extra cost associated with that and that our cost per earned standard hour in Linares is not as low as it will be when we have all of -- when the plant is running as smoothly as it will be running as I anticipate 60 days from now.

We have a really, really strong management team in that plant and I'm not at all worried that we are going to have problems there. But there is some learning associated with taking on additional responsibility.

Okay, and then --

Go ahead.

In the U.S. Water market, you made the point that you are gaining share per the industry data. I'm curious what you believe your market share is now and if the significant gains, if the gains this year have been significant and how you've gone about them?

Well, we don't really disclose our market share position. We did disclose that our aspiration was to move in the 35% to 40% range at least as far as the four-inch PMA is concerned, which is the principal product line in the industry and indicative, I think, of your overall market share and distribution strength.

And the reason we've chosen that number is that it puts us in a leadership position and a significant leadership position. I'd say that we started out with a 5% market share. So we've largely made it to where we want to go and at this point we are not as focused on market share gains as we are margin improvement.

Okay, and on that topic of margins in the industry, what is the update on pricing as you've gone through this seasonal peak now and volumes are, obviously, off hard in the industry, could you give us an update just on discounting and different pricing mechanisms in the industry, and then, I guess, your outlook as well if we maintain this type of industry volumes?

Okay, I'm going to let Dee Davis who runs our business in the U.S. and Canada respond to that.

Mike, I'd say pricing levels in general on pump products continue to be very competitive and relative to last year during this period we are seeing about the same level of discounting. I would characterize the first half of the year as lighter discounting than prior year. We do not see as much discounting outside of the pump products.

Okay. Good news, thank you.

Yes.

We will hear our next questions from Paul Mammola with Sidoti and Company.

Hi, good evening, guys.

Hi, Paul.

If we can start in Water, just on that market share comment you just made, Scott. If you are saying that the goal is 35%, I think you said, to 40%, we are talking on the groundwater market, correct?

Yes. And we're talking about a particular segment of the market.

Just in the four-inch you're saying?

Yes.

Okay. On the high thrust market, obviously, being the [ag] season have you seen that competing pump motor assembly come into the market as of yet from Faradyne, or no still?

We've seen it in the market, but we haven't seen it have any material impact on the market at this point.

Okay. That's fair. You spoke a little bit about Linares last time saying it was your most profitable facility or most well run. Now what was the utilization of that facility in the quarter?

Well, I want to comment that the question about it being well run and the question about its utilization are related. Our management team in Linares has really embraced lean manufacturing principles, and as we designed that factory, we designed it to really accommodate the production that we are currently -- that we just finished moving there. I mean that was to be the Linares plant was to be fully utilized at that point.

Because of the great job our team down there has done in leaning out the processes that we've moved down there to date, we are probably going to have another 50,000 to 100,000 square feet available for additional production moves to the Linares plant which is by far our lowest cost facility. So to the extent that they have physical space to take on more production, it's in our interest to move that production down there.

So Linares with the processes that are in it today is still under utilized at least as far as square foot potential is concerned.

Okay. That's very helpful. Thanks for that detail. Moving to Fueling, do you have an installation number for Phase 2 systems during the quarter? I would assume it is low. But is there one?

I will let Gregg respond to that.

We aren't -- we don't typically disclose our installations in the quarter, but, yes, the quarter fell off significantly as Scott mentioned earlier. With the delay in the enforcement of the regulations in California it slowed down the whole conversion effort.

Gregg, so I guess, do you know the overall installation number or is that level of granularity just not out there? Because I guess I would wonder if maybe a competing system had an effect on those sales?

Paul, the state has published some information in the middle of June that would say that there are about 7,800 systems that were installed by that point. And that they believe that 10,400 stations were subject to the regulation.

Okay. So there is nothing to say that there were 1,000 installs in 2Q and potentially your share of it shrunk? There is nothing to say that at this point that you are suggesting, right?

No. There are competing systems, and so our share would be lower than it has been historically. But there would be nothing to say what you just said.

Okay. And then, finally, do you guys have an internal projection for housing starts in 2009 and 2010 by any chance?

No.

Okay. Fair enough, thanks for your time.

We are, it is our belief that in the fourth quarter housing starts will be higher than they were in the fourth quarter last year, which will be the first time in a long time -- well, in a year -- where we've seen housing starts higher year-on-year.

I mean that's our projection right now because it was only about 450,000 or lower than that in the fourth quarter last year, and so we think that there is a pretty good chance that we will start seeing at least a stabilization in that metric come the fourth quarter of this year.

Okay. Thanks, again, for your time.

Our next question comes from Matt Summerville with KeyBanc.

A couple of questions. First, I believe it was Mike's first question, John, you had indicated raw material savings of $3 million to $5 million. I just want to make sure I have my numbers right. I have a figure of $5 million to $7 million on your last conference call, which figure should I be thinking about?

The $5 million to $7 million, Matt. I apologize, I inverted the direct labor with the raw material.

Okay, great. I just wanted to clarify that. And then I believe you guys typically give a little bit of color around in North America, your overall shipments versus the market, if you gave the data earlier I apologize. I believe you disclosed that on the first quarter call. And then can we just get a little bit more granularity in terms of how the market performed in the three major North American verticals, the small motor market, or the small submersibles, the big submersibles and then the Grey Water business?

Well, the -- we believe -- first of all, Matt, I want to be a little careful about revealing market share data or detail shipments data by product line. I really think that that could hurt us competitively. And so I --

I guess more, Scott, what I'm looking for is industry -- the industry numbers.

Okay. The industry in the second quarter, at least as far as four-inch product is concerned we believe was down more than 20%. That's the total industry. And we know that our shipments of that product were down at less than half that rate.

Okay. That's helpful. Do you have similar figures, again, I will just take the industry if need be, on large submersibles and then the products that are involved, some sewage effluent in your Grey Water, or dirty water business?

At this point, we have pretty good data on sump sewage effluent and utility pumps through the first quarter. But industry data lags in that segment and so we don't have anything on it for the second quarter yet. And we really don't have information other than our own shipment information on large motors.

Okay. A follow-up question on pricing. I heard your comments from earlier, I guess I'm curious if the magnitude of discounting is certainly no worse, relatively similar to what you had in first half of 2008, are list prices higher than what they were last year and, I guess, have there been any changes in list prices in the last three months?

Okay, now you are talking about the U.S. and Canada market right?

Correct.

Okay. In the U.S. and Canada, we had a list price increase that I would characterize as nominal and our primary competitors did the same.

When was that?

That would have been announced in February.

Okay. Scott, can you maybe give some color on just your water business overall, so global Water Systems, how incoming order rates looked as you progressed throughout the quarter, just a little bit of sequential color, April-May, versus June, and then if there is any discernible difference in what you are seeing with the data you have for July?

Okay. Our -- I would say quite honestly as we were ending the first quarter, I thought our second quarter Water shipments would be stronger than they turned out to be.

We thought that the impact of inventory reductions would start to diminish. We didn't have any evidence that primary demand was picking up, but we thought at least that downdraft would play a lesser role through the second quarter, and I really -- I didn't see any evidence of that. In fact, our sales in the second quarter were down in Water modestly more, organic sales, than they were in the first quarter.

And it would be misleading for me to give you statements that imply that we've seen either the situation get much better or much worse as we've entered the third quarter. The guidance we provided was sales down in the third quarter 15% to 20% which is kind of in line with where they've been down through the first part of the year. To hit that given that our fueling sales are going to be off more than they have been because last year was absolutely the peak of the California installation, our Water business has to do somewhat better in the third quarter than it has been doing.

And I think that's realistic, but there is a little bit of -- optimism, I think, in that just based on the hard facts. So I feel as though we -- that inventory reduction has to be less of a factor. Inventories we know are very low in the trade and that on that basis that its logical to me that we are going to see some improvement, at least a reduction in the rate of decline of our Water business during the third quarter. But I really haven't seen strong evidence of that based on the first couple of weeks.

John, based on revenue guidance or your thoughts that you shared in terms of revenue for the third and fourth quarter, what would be the FX headwind embedded in your third quarter down 15% to 20% and then how much tailwind in FX do you see right now in the fourth quarter given not only the dollar versus the euro but versus the Brazil and South African currencies as well?

In the third quarter we think the headwind is going to be similar to the second quarter, Matt. And then it started, most of the strengthening started to happen in October, as you'll recall last year. So we see that a lot of the headwind that we've experienced sequentially this year will go away in the fourth quarter. But the third quarter ought to, [FX-wise], be similar to what we've seen in the second quarter.

And then, Scott, you mentioned in your prepared remarks that Water Systems incurred some cost penalties in the second quarter. I can't find the exact language around your comment, but is there any way that you can quantify what you believe that impact was? And then just help bridge, I guess, in June you mentioned that the margin performance in the segment, I want to make sure I have this right, was 300 basis points or more better than what the operating margin number was for all of Q2. What drove that big -- what drove that big sequential improvement from one month to the next if it certainly did not sound like it was volume driven?

I would say it was several things. First, SG&A spending was, as a percentage of sales, was better in June. Fixed manufacturing's costs were down as we had more costs out of our North American plants and transferred to Linares, although certainly it isn't at the level that it will be at for the balance of the year. But it was improved, fixed manufacturing costs were lower.

And then, finally, costs of raw materials came down at the back half of last year and into the first half of this year, but they are only now starting to come through our cost of goods sold. And, for instance, in April we were still reflecting in our cost of goods sold for the most part the higher cost materials and that continued into May and then in June it really kicked in.

We got through inventory layers and started to move into the lower cost inventory layers. So what I think we are seeing is in June the economics, certainly of our Americas Water business, our U.S. and Canada business, being more reflective of what we might anticipate in the back half, and hopefully now June benefited from being a pretty good volume month, too. So you've got to factor that into your analysis.

But I think just the costs started to line up in June the way we anticipate that they will line up as we go into the back half of the year.

Okay. Just one final question then I'll get back in queue. Gregg, I was wondering if you could talk about outside the U.S., what you're looking for over the next six to 12 months out of China, out of India, out of some of the countries in Europe and other parts of Asia that are talking about vapor management and control regulation?

Matt, in China, I would say that it has been slowed down. We still are expecting to see the area in the south, the Guangzhou area and the Shanghai areas to upgrade their vapor recovery or upgrade to vapor recovery, but we expect that to start later this year and probably be drawn out over a longer period of time.

We have not heard from any of the Indian oil companies of any vapor control initiatives at this point. But like China, they can make an announcement and then they can move relatively quickly, although India does go through a bidding process.

In Europe, as you may recall, there has been a decision to move forward over the next eight years or so to upgrade all of the non-vapor recovery systems in Europe for stations over a nominal size of throughput to vapor recovery. I would expect there to be somewhat of a hockey stick approach that the compliance will come later in the next decade.

Other possibilities, for example, Australia has been deferred, I think, six to nine months. Korea has been deferred six to nine months, maybe up to a year. So what the message you are seeing around the world is with this economic slowdown is that these types of improvements are essentially being pushed out for a period of time, but not to my knowledge being canceled anywhere.

Great. Thank you, guys.

Our next question comes from Ned Borland with Next Generation Equity Research.

Good evening, guys. Just on the California [appealing] opportunity, there is about 3,400 stations left, can you characterize what you think your share will be for those remaining stations?

Ned, I think you need to look at it in a couple of parts. A section of those 3,400 stations may not convert at all. They may choose to close. Of the remainder, we are optimistic to continue to have a majority of the share, but the degree that this program is delayed, other systems will become available and so there will be other choices that people can make.

Okay. And then on Linares, given the slowdown in activity, I want to say that you guys were planning next year, I think, to move, what, about 350,000 man hours additionally into Linares. I was just wondering if that may be accelerated a bit given the pace of volume so far?

Well, yes. We are going to move on filling Linares as quickly as we can. But, Ned, we have been -- our program on this whole move to Linares has been to only move when we are absolutely certain that the quality will be as good or better out of Linares than it has been out of the transferring plant.

So that causes us to go slow. And I could go a little slower than we could if we decided we are just going to do this at -- all at once. We are just going to move, let's get it done. We have not taken that approach. We are not going to take that approach.

We are going to make absolutely certain that our people in Linares are capable of meeting or exceeding the quality levels out of the transferring plant. So that will cause us to go a little more cautiously than we otherwise could. So it will be through 2010 that those jobs will move in.

Okay. Thank you.

There are no further questions at this time. I would like to turn the conference back over to Scott Trumbull for any closing remarks.

Thank you, good-bye.

This does conclude today's conference call. We do thank you for your participation.