Franklin Electric Co Inc (FELE) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Franklin Electric's Second Quarter 2011 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded. I would like to turn the conference over to Mr. Patrick Davis, Treasurer. Please, go ahead.

Thank you, Teresa, and welcome to Franklin Electric's Second Quarter 2011 Earnings Conference Call. With me today are Scott Trumbull, our Chairman and CEO, John Haines, our CFO, Robert Stone, SVP of America's Water, and Gregg Sengstack, SVP of Fueling and International Water. On today's call, Scott will review our second quarter and year to date business results and John will review our second quarter and year to date financial results. When John is through we will have some time for questions and answers. F

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, cost, expenses, expense reductions, profit margins, inventory levels, foreign currency translation rates, liquidity expectations, business goals, and sales growth involve risks and uncertainties. These risks and uncertainties include but are not limited 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, raw material costs, technology factors, litigation, government and regulatory actions, the Company's accounting policies, and future trends and other risks which are detailed in the Company's SEC filings and are included in item 1A of part one of the Company's annual report on form 10K for the fiscal year ending January 1, 2011, exhibit 99.1 attached there to and in item 1A of part two of the Company's quarterly reports on form 10Q. 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 will now turn the call over to our Chairman and CEO. Scott?

Thank you, Patrick, and good morning, everyone. Franklin people worldwide achieved outstanding financial results during the second quarter. Sales, operating income, and net income were all records for any quarter in the Company's history with net income exceeding the prior record by over 25%. I was particularly pleased that we were able to achieve these earnings results while at the same time increasing our RD&E spending by about 30% compared to the prior year. While our sales and earnings increased broadly across our global regions and product lines, our largest profit increase was in our US-Canada region where ongoing market share gains, surging demand for our agricultural irrigation products, and solid cost controls combine to drive up our profits and margins.

During our last two quarterly conference calls I pointed to commodity costs, inflation, as a factor that was impacting our margin improvement rate. Because of this raw material cost inflation we implemented price increases during the first quarter of this year that averaged 3% to 5% on product lines that we now estimate account for nearly 90% of our pre-acquisition global sales volume. These price increases were effective and largely offset the impact of the raw material inflation during the second quarter. Our global water business represented 82% of our consolidated sales during the quarter and grew by 15% compared to the second quarter prior year. Excluding acquisitions, our water sales grew by 12%. Excluding both acquisitions and foreign exchange effects, our water sales grew about 5% during the quarter.

Our water sales in the US and Canada were 41% of our consolidated sales and grew by 10% compared to the second quarter prior year. Leading our growth in the US and Canada were our sales of pumping systems for industrial and irrigation applications which increased by about 30% during the quarter. The combination of high crop prices which have led to more discretionary capital for farmers along with dry conditions in portions of the Southwest and Midwest has resulted in strong demand for our agricultural irrigation products in the United States. Our sales of pumping systems for residential and light commercial clean water and waste water applications in the US and Canada grew by 7% compared to the second quarter prior year as we continued to gain share in this market.

Our water sales in EMENA -- which is Europe, the Middle East, and North Africa -- were 17% of our consolidated sales and grew by 42% compared to the second quarter prior year. Excluding acquisitions and foreign exchange translation effects, our EMENA sales grew by a solid 7% during the quarter. Our EMENA team achieved double digit organic sales growth across nearly all of our product lines both in Europe and the Middle East. As previously announced in May, we completed the acquisition of Impo, the leading ground water pump and motor Company in Turkey. The acquisition integration is underway and on track. As a result of the Impo acquisition, the growing market in the Middle East now represents 35% to 40% of our total EMENA sales, up from less than 25% prior to the acquisition.

Our water sales in Latin America were about 13% of our consolidated sales for the quarter and grew by 14% compared to the prior year. Our sales in Mexico continued to grow at a 20% plus pace. Our second quarter year on year sales increase in Brazil was 12% which is somewhat slower than the 20% growth we've experienced in Brazil over the past several quarters. Our Brazilian management team is expecting our sales will grow at high single digit rates over the balance of the year, reflecting in part efforts by the government to cool the Brazilian economy.

Our water sales in Asia-Pacific were 6% of our consolidated sales and grew by 5% compared to the second quarter prior year. Last year, several of our Taiwanese customers elected to purchase most of their requirements for the year during the second quarter. This year, these customers area spacing their orders more evenly throughout the year. Excluding Taiwan, our water sales in Asia-Pacific grew by 24% compared to the second quarter prior year which is in line with the growth rate that our Asia-Pacific team has accomplished over the prior several quarters.

Our water sales in Southern Africa represented 5% of our consolidated sales during the quarter and declined by 4% compared to the prior year. Heavy rains and flooding in South Africa's farm belt and labor strife in a number of industries combined to reduce our agricultural and industrial pump and motor sales during the quarter.

In summary, our water business benefited from geographic diversification during the second quarter. Developing regions have been driving our sales growth over the previous two quarters. This quarter our sales growth was driven by the US-Canada and EMENA regions. This sales growth combined with our pricing and productivity initiatives enabled us to increase our adjusted water operating income by 25% and our adjusted operating income margin by 180 basis points.

Our fueling business represented 18% of our consolidated sales during the quarter and grew by 34% compared to the prior year. Excluding acquisitions, our fueling business grew by 9% during the quarter, excluding both acquisitions and foreign currency effects, our fueling sales grew by 7% during the quarter. We achieved solid double digit organic sales gains across most of our major fueling product lines. Our pumping system sales grew by 21% as station owners worldwide continue their conversion from suction to pressure pumping technology for dispending gasoline.

Our year on year sales of our proprietary fuel management systems also grew by 10% during the quarter. Our pipe and containment sales grew by 11%, excluding the PetroTechnik acquisition and by over 90% including the acquisition. Our year on year sales of vapor control equipment declined due to strong shipments of these systems to China during the second quarter of last year. Overall our fueling business delivered a solid performance during the quarter with organic sales growth of 9% and adjusted operating income growth -- growing by 28% compared to the prior year.

Turning to our for the third quarter, while we believe that raw material cost inflation will continue to pressure our margins, we also believe that our growth, pricing, and productivity initiatives will more than offset this pressure and that our year on year adjusted operating income margins will continue to increase. We are forecasting that our water sales will increase by 10% to 13% over the prior year quarter and that our water operating income before non-GAAP adjustments will increase by 12% to 15%. We believe the water sales and earnings improvement will be led by ongoing gains from our business in the US-Canada.

We're also forecasting that our fueling sales will increase by 25% to 30% over the prior year quarter and that our fueling operating income before non-GAAP adjustments will increase by 35% to 40%. We anticipate improved fueling margins year over year in the third quarter as we realize cost synergies from the PetroTechnik acquisition. On a consolidated basis we believe that our third quarter sales will increase by 12% to 16% compared to the prior year and that our corporate expenses will be essentially flat with the prior year during the third quarter so that our consolidated operating income will increase by 25% to 30%. I'll now turn the call over to John Haines our CFO who will provide some additional information on our financial performance. John?

Thank you, Scott, and good morning.

Our fully diluted earnings per share were $0.91 for the second quarter 2011, a record for any quarter in the Company's history and an increase of 94% compared to the 2010 second quarter fully diluted earnings per share of $0.47. As we note in the table in the earnings release, there are a number of specific items collectively referred to as the non-GAAP adjustments in the second quarter of 2011 and 2010 that impacted operating income and EPS that were not operational in nature. We believe presenting these matters in this way gives our investors a more accurate picture of the actual operational performance of the Company. In the second quarter of 2011, the Company's EPS included $0.01 of restructuring charges. Therefore, the EPS after these non-GAAP adjustments was $0.92 versus the reported $0.92.

In the second quarter of 2010 there were two non-GAAP adjustments to EPS. First, fueling systems incurred a $3.8 million pretax expense for various legal matters. This expense which was recorded in SG&A lowered 2Q 2010 EPS by $0.10. Second was an EPS adjustment of $0.08 for restructuring charges during the quarter. In total, EPS after non-GAAP adjustments in the second quarter of 2010 would've been $0.65 and when compared to the $0.92 from the second quarter 2011, increased by 42%.

Second quarter 2011 sales were $224.1 million, an increase of 18% compared to 2010 second quarter sales of $190.4 million. Water system sales were $183.5 million in the second quarter of 2011, an increase of $23.4 million or 15% versus the second quarter of 2010. The Company acquired 80% of the outstanding stock of Impo Motor Pompa of Izmir, Turkey during the second quarter which contributed $4.2 million or about 3% to sales.

Excluding acquisitions, water system sales grew by 12%. Foreign currency translations rate changes increased sales $10.7 million or about 7% compared to sales in the second quarter of 2010. As Scott indicated, sales of industrial and irrigation pumping systems in the US and Canada, along with higher sales in EMENA contributed to the sales growth in the quarter versus the second quarter of 2010.

Water systems operating income after non-GAAP adjustments was $36.8 million in the second quarter of 2011, an increase of 25% versus the second quarter 2010. The second quarter operating income margin after non-GAAP adjustments was 20.1% and increased by 180 basis points compared to the second quarter of 2010. This increased profitability was the result of operating leverage, pricing, and productivity improvements.

As Scott said, the Company took pricing actions on about 90% of the estimated pre-acquisition 2011 sales in anticipation of raw material cost increases. All of these price increases are now in effect and contributed to our second quarter 2011 operating income and operating income margin improvements. It's important to understand however that not all of the raw material cost increases of those pricing actions we're intending to offset have passed through our inventory and into our cost of goods sold. The Company expects operating margins to continue to be impacted by higher raw material costs in the second half of the year.

Fueling system sales were $40.6 million in the second quarter of 2011 and increased $10.3 million or about 34% from the second quarter of 2010. Excluding the PetroTechnik acquisition, second quarter sales were $32.9 million and grew by about 9% with most of the growth in the United States and Canada. Fueling systems operating income after non-GAAP adjustments was $7.3 million in the second quarter of 2011 compared to $5.7 million after non-GAAP adjustments in the second quarter of 2010, an increase of 28%. The second quarter operating income margin after non-GAAP adjustments was 18% and decreased by 80 basis points compared to the 18.8% of net sales in the second quarter of 2010 due to the mix impact of the lower margin PetroTechnik sales and higher material costs.

The Company's consolidated gross profit was $77.2 million for the second quarter of 2011, an increase of $12.6 million or 19% from the second quarter of 2010 and a record for any quarter in the Company's history. The gross profit as a percent of net sales increased to 34.5% for the second quarter of 2011 from 33.9% for the second quarter of 2010. The gross profit margin improvement was due to leveraging fixed costs on higher sales, increases in pricing, and productivity initiatives.

Selling, general, and administrative expenses were $43.9 million in the second quarter of 2011 compared to the $43.1 million from the second quarter of 2010, an increase of $0.8 million or about 2%. During the second quarter of 2010, fueling systems incurred $3.8 million in SG&A expenses for various legal manners. In the second quarter of 2011, increases in SG&A attributable to acquisitions were $2.6 million, additional increases in SG&A costs during the second quarter of 2011 resulted from in technology related expenditures for acquisition, integrations, higher research and development expenses, and increased costs for marketing and selling related expenses.

The effective tax rate for the first half of 2011 was 27.4%. The Company believes this is a reasonable estimate for the balance of 2011. The projected tax rate will continue to be lower than the 2010 tax rate before discreet events or about 30% and the statutory rate of 35% primarily due to the indefinite reinvestment of foreign earnings and reduced taxes on foreign and repatriated earnings as were the restructuring of certain foreign entities. The Company has the ability to indefinitely reinvest these foreign earnings based on the earnings and cash projections of its other operations as well as cash on hand and available credit.

Since the end of 2010, the Company's cash position has declined by $45.9 million. Major uses of cash during the first half of 2011 included net increases in seasonal working capital of $37.5 million, the Impo acquisition of about $25 million, purchases of Company stock of $10.6 million, benefit plan contributions of $11.2 million, and additions to property, plant, and equipment of $8.3 million.

At the end of the second quarter 2010, the Company's cash balance was $94.2 million which was $1.3 million higher than the end of the second quarter 2010. Impo, which was acquired in the second quarter accounts for all of the increase in the Company's debt as of the end of the quarter. The Company has no outstanding balance on its revolving debt agreement at the end of the second quarter 2011 or at year end 2010.

This concludes our prepared remarks. We'd now like to open the call up for questions.

(Operator Instructions) Our first question is from Matt Summerville of KeyBanc. Your question, please?

Good morning, guys. This is actually [Joe] on for Matt today.

Hi, Joe.

Can you talk a little bit more about the pricing environment. If I'm not mistaken, I think you saw a slight uptick at the end of the first quarter in terms of discounting and there was some concern that it could get a little more aggressive in June. Did that not happen? Or are you finding that basically the distributer and customer lines are drawn and that purchasing decisions isn't ultimately effected too much by slight variations in prices?

There really was not a material amount of price discounting in our US-Canada water business during the second quarter. I think all of our competitors -- not just in the US-Canada, but worldwide -- were impacted by material increases and I think the industry felt a need for price and elected to move forward with us in making those price increases effective.

Okay. So, how are you thinking about the need for additional price increases later this year? It sounds like you covered your raw material increases with that price increase earlier in the year, but then, John, you mentioned that that hasn't all passed through the P&L? Help me understand, do you think that increase earlier in the year is where raw materials stand today, is that going to offset it? Or do you think you might need to go back to the channel later in the year for another increase?

First of all, I'd say I don't like to raise prices more than once during the year. It is difficult on customers who publish catalogues, who have price commitments out there themselves. And so, raising prices multiple times during the year I think for long-term relationships with our distributer customers worldwide is just a bad practice and it's something I don't like to do and resist doing but would do if the economics of our business demanded it.

Right now, we're seeing our commodity costs coming down a little bit. They rose throughout the first half of the year but then in June and July, June they leveled off and in July they actually have started to come down a little bit and so our read right now is if that continues there will not be a need for additional price later in the year but we have to recognize that during the second quarter we have the price increase in effect essentially for the whole quarter but what was coming through inventory were the material costs that were in effect early in the quarter or even in the fourth quarter of last year because of the lag.

So, we're still going to have some going through the third quarter, higher cost materials coming through our income statement. That will have some impact on our margins in the third quarter relative to the second quarter. But, as I mentioned in our outlook comment, we still expect to see margins improve on a year on year basis. Then in the fourth quarter as we started getting in -- we really think our margins are -- have the potential to not be as effected by raw material inflation because of the trends we're seeing right now.

Joe, this is John Haines. The other thing we always talk about is that in addition to price increases, we get a fair amount of operating leverage when volume goes up, when sales volume goes up, and then we also have other variable costs productivity. So we kind of look at the combination of those three things as being offsets to raw material inflation. As Scott said, year over year we still see margin improvement but we think it's prudent for our investors to just point out the way these costs flowed through our inventory and into our cost of goods sold. There's going to be some more of that in the third quarter.

Okay. If I could just ask one more on the outlook, if you look historically second quarter to third quarter, it tends to be pretty similar in terms of revenue. Sometimes one -- second quarter's higher, sometimes third quarter's higher. Given the strength that you're seeing in the agriculture end markets, coupled with what's been a pretty dry summer, what appears by all accounts to be pretty lean inventory in the channel as distributers manage that inventory pretty tightly, why wouldn't you expect to see a sequential uptick in the third quarter revenue-wise?

The agriculture market is very difficult to predict and typically the ag market starts in the spring and continues into the second quarter but then starts to slow down in the third quarter and obviously in the fourth quarter. And we -- although depending on weather conditions in regions of the country that are heavily dependent on irrigation, that may not be the case this year, we elected to reflect in our forecast and our guidance what we see as the normal pattern for shipments of those kinds of products.

Okay. So, Scott, have you seen that in July order rates so far? Or is it more just being conservative because you don't want to -- weather's volatile and you don't want to assume it's going to continue to be strong?

I'd say June was a very strong month for us. We normally see a little bit of a slowdown in July just seasonally and we saw a normal pattern in July.

Great. Thanks a lot, guys.

(Operator Instructions) Our next question is from Mike Halloran of Baird. Your question, please?

Good morning, everyone.

Good morning, Mike.

Just to do the final loop on the price cost, on a sequential basis, it sounds like you're expecting the price cost relationship to get a little bit worse 2Q to 3Q. Is that fair? Or are you saying full pricing comes in and you have a little bit less of the higher raw materials in the third quarter and therefore price costs gets a touch better?

No. We're saying that during the second quarter we have the benefit of the entire price increase for the whole quarter. During the third quarter we'll have the same benefit on the revenue side but we're going to see higher cost materials flow through our statement because we had inflation throughout the first half of the year and the second quarter reflected costs from earlier in the year but third quarter will reflect higher cost materials that were purchased later in the year.

Perfect. That makes a lot of sense. That's what I thought you were thinking about. When I think about the water margin, the guidance range implies a meaningful step down 2Q to 3Q. Is a lot of that taking the revenue into account but then I'm assuming a lot of that is just a little bit softer -- maybe not softer, but just a seasonal ramp down in the agriculture market and the fact that that really strong mix is going to maybe not be quite as strong in the third quarter as well as a little bit on the price cost side. Are those the three main reasons for the move downward from an op margin standpoint for water?

Yes. That's pretty much it. The higher cost materials coming through, a somewhat less rich mix.

Then on the fueling system side of things, could you talk a little bit about the reasoning behind the sequential upticks that you're forecasting on that side?

We mentioned that we're expecting to see some of the cost synergies that we have been working on for the PetroTechnik acquisition come into place and one of the factors that has been impacting our fueling business's year on year operating income margin comparisons have been the addition of PetroTechnik to our mix with the PetroTechnik sales being at a materially lower margin level than our traditional fueling business margin levels, recalling that as we mentioned at the time of the acquisition, PetroTechnik is largely a Company that buys product and resells it.

It has contract manufacturers and on that basis is declined to be a lower margin business than our more vertically integrated fueling business. And so PetroTechnik has diluted the margins of our business up to now and our objective in buying the Company was to bring the Company up to margin levels that were more in line with our traditional fueling margin levels and we're starting to see that and as a result the mix impact within our fueling business is not as great as it was during the earlier quarters this year.

Mike, you may recall that when we did the PetroTechnik deal, we had said it would be late this year, early next before we believed you would see a recovery of the entire fueling business operating income margin back into this high teens range which is kind of where we think this business will perform longer-term. We actually are very pleased that we got to that 18% level in the second quarter. Now it's below last year's second quarter, however, as Scott pointed out, the integration's working and there -- we're reaching milestones on the operating income related to PetroTechnik sooner than we had believed.

We also did raise prices in our fueling business at the end of the first quarter and that's helped us. Our fueling business -- our water business, we buy a lot of copper. We buy a lot of commodity materials that have seen the highest rate of inflation. Our fueling business buys a different mix of raw materials and has been somewhat less impacted by inflation and we would expect that the price increases in the third quarter may have a somewhat bigger impact on their margins than the water will because of the type of inflation we've seen in that business generally.

That's great color. I certainly appreciate the time today, guys. Talk to you soon.

Okay. Thanks, Mike.

(Operator Instructions) Our next question is from Linda Lipp of Business Weekly. Your question, please?

Good morning. This is really more of an operations type question. But there's been a lot of speculation in Indiana in particular about Franklin's plans to leave Bluffton and establish a new headquarters elsewhere. Can you update us on that?

Yes. Linda, this is John Haines. As we've said, we've made four points really as it relates to this matter of moving the corporate headquarters. The first one is that our facility in Bluffton is inadequate for the future needs of our Company. The space and especially the research and development facility that we have here for our engineering teams. We definitely need a new facility and the space in Bluffton is inadequate. We have not as of yet reached a final decision on a new location.

When we do reach a final decision on a new location we will issue a press release and I guess I would say to you, Linda, that day is coming sooner rather than later as we continue to work through this. The final point that we've made is we have worked cooperatively with representatives of the state, with representatives of Allen County, with representatives of the city of Fort Wayne to explore economic incentives that may be available to the Company. That's the update on that and like I said, when we have a definitive decision, we will issue a press release and be more clear about what our intentions are.

Thank you.

Thank you. Our next question is from Matt Summerville of KeyBanc.

Just a couple quick follow-ups. Maybe this is for Gregg. Can you give an update on what you're seeing in terms of global opportunities on the fueling side? Has there been any movement with respect to the vapor cover mandates and I think in Europe, India, South Korea, UK -- any of those international opportunities that you've touched on in the past? Or is the primary opportunity still pretty much just that gradual conversion from pressure systems?

You asked two different questions there. With respect to vapor recovery, it's steady as she goes. We had a bit of a nadir here in China in the first half of the year. We do understand there will be additional cities converting over the next couple of years. We expect that to continue to roll out as China rolls out their vapor recovery program throughout the country. So, we expect to see continued growth in that market. In India, it's been relatively quiet.

In Europe there is a mandate that's in place, that has been in place. There have been no changes to that mandate. That will have an effective end date of 2018. So, I expect that similar to other mandates we'll see that later this decade. Your question about pressure systems in general, that's with our pumping systems. There we do see continued growth around the world, people converting to pressure, particularly in emerging markets. It's just a more efficient way to deliver fuel to the end user.

Great. Thanks, Gregg. And then, John, just quickly on corporate expense, I think -- I don't know if it was in the release or if you said it, I think you're guiding to flat sequential corporate expense. Is that right, second quarter to third quarter?

That's correct, Joe.

What's driving the increase year over year on that line?

Part of it is just normal inflation. Part of it is these integrations that we've done, a portion of the costs for these acquisition integrations on the ERP system that we mention as falling into corporate as well.

Okay. Great. Thanks.

Thank you. I'm showing no further questions in queue at this time. I'd now like to turn the conference back over to Mr. Scott Trumbull for any further remarks.

Thank you for your attention. This will end our conference call.

Ladies and gentlemen, thank you for your participation. That concludes the conference. You may disconnect and have a wonderful day.