Franklin Electric Co Inc (FELE) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Franklin Electric second-quarter earnings conference call.

(Operator Instructions)

As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Jeff Frappier, Treasurer of Franklin Electric. Please go ahead, sir.

Thank you, Danielle, and welcome, everyone, to Franklin Electric second-quarter 2014 earnings conference call. With me today are Gregg Sengstack, our CEO; John Haines, our CFO; and Robert Stone, Senior Vice President and President, International Water Systems. On today's call, Gregg will review our second-quarter and year-to-date business results. Then 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.

Before we begin, let me remind you that as we conduct this call, we will be making forward-looking statements within 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.

During this call, we will also discuss certain non-GAAP financial measures, which the Company believes helps investors understand underlying trends in the Company's business more easily. A full reconciliation of non-GAAP to GAAP financial measures is included in today's earnings release, which you can find on Franklin Electric's website. With that, I will now turn the call over to our CEO. Gregg?

Thank you, Jeff. During the second quarter, the Company achieved record sales and adjusted earnings, and our adjusted earnings per share exceeded the prior year by about 2%. We achieved single-digit sales and earnings growth in Latin America, and double-digit sales and earnings growth from our Water Systems businesses in North America, Europe, the Middle East, and North Africa, as well as from our Fueling Systems business. But this strong performance was offset by a decline in profitability driven by several factors in our Water Systems business in Asia Pacific and southern Africa.

In Asia Pacific we are running against a very difficult comparison. During the second quarter last year, our sales mix was substantially more profitable, as it included large orders for irrigation pumping systems in southeast Asia. This year, second-quarter sales were depressed due to political factors in Thailand and the timing of customer orders in Korea and Japan. The combination of these factors reduced our profitability versus the prior year.

The earnings performance of our subsidiaries in southern Africa continue to be impacted by strikes in the mining industry and contraction of the South African economy. While these strikes were resolved at the end of the quarter, the situation is exacerbated by the July 1 strike of the National Union of Metalworkers, with which our employees are affiliated. So, these two issues in two of our relatively small, developing-region markets masked what was a very good performance across the balance of our businesses.

In the US and Canada, our sales grew by 7%, driven largely by surging demand for Pioneer product line in the pump rental channel. In order to keep up with demand, we are outsourcing a number of our Pioneer pump manufacturing activities. Bringing some of these activities in-house over the next several quarters will improve overall profitability.

Recall that last quarter, we announced that we had decided to reset our groundwater pump distribution footprint in the US. This change involved curtailing our relationship with a large national distributor and expanding our relationships with a number of important regional distributors. We anticipated that this change would result in one or two quarters of sales declines as trade inventory levels are rebalanced, but that as we go into the back half of 2014 and into 2015, our sales and earnings would benefit.

During the second quarter, we were pleased that our groundwater shipments in the US and Canada were only down modestly, and our earnings were flat. We are interpreting this as an early indication that our distribution changes for having the desired effect.

Our business in Europe, the Middle East, and north Africa, or EMENA, achieved double-digit sales and earnings growth, compared to the second quarter prior year. Our European Management Team has been able to overcome a generally weak macroeconomic climate by expanding distribution and introducing new products for both submersible and service pumps. Impo, our subsidiary in Turkey, was a major contributor and achieved double-digit growth during the quarter.

Finally, our Fueling business had another great quarter, with sales growing 16% and earnings growing by 25%, compared to the second quarter prior year. Fueling Systems grew across all product lines in all regions of the globe. Filling station owners are continuing to invest in a Franklin pressure pumping system. We're delivering fuel to the dispensers as well as our vapor control and leak detection system.

As we look forward to the third quarter, the continued weakness in the US agricultural market, coupled with the previously announced changes we made to our US division footprint in certain regions of the country, are causing some customer inventory liquidations and slowing inventory buildup for other customers. In spite of these factors, we are projecting US Water Systems sales up slightly in the third quarter. These inventory adjustments may continue through year end. However, we are confident that when this activity is complete, we will have stronger overall US distribution relationships and our sales will benefit.

Outside the US, we expect Europe to continue to post solid results, and for our developing regions, Water System business to strengthen, with the exception of South Africa, where our operations were shut down during July due to a nationwide strike. Additionally, we expect sales of Pioneer branded mobile dewatering equipment to continue to be strong the third quarter, but these sales have a lower overall profitability. As a result, we are projecting that our third-quarter 2014 global Water System sales will increase by 8% to 10% before acquisitions, and due to mix, adjusted operating income will grow 3% to 5%. We are projecting both Fueling sales and adjusted earnings to grow 8% to 10% the third quarter, and our overall Company adjusted earnings per share to grow 3% to 5%. I would now like to turn the call over to John Haines, our CFO. John?

Thank you, Gregg. Our fully-diluted earnings per share were $0.55 for the second quarter 2014, versus $0.58 for the second quarter of 2013. As we noted in the table and earnings release, the Company adjusts the as-reported GAAP operating income and earnings per share for items we consider not operational in nature. We believe presenting these matters in this way gives our investors a more accurate picture of actual operating performance of the Company.

Non-GAAP expenses for the second quarter 2014 were $3.6 million, and included $0.3 million in restructuring costs, $2.5 million related to executive compensation costs in the form of special equity awards, and pension curtailment charges, that resulted from the transition of the Chief Executive Officer role in the Company during the quarter, and $0.8 million for professional service fees related to pending and completed acquisition. The second-quarter 2014 non-GAAP adjustments had an EPS impact of $0.05.

The non-GAAP EPS adjustments in the second quarter of 2013 rounded to an impact of about $0.01. So, after considering these non-GAAP items, second-quarter 2014 adjusted EPS is $0.60, which is 2% higher than the $0.59 adjusted EPS the Company reported in the second quarter of 2013. Overall, the 2014 second-quarter revenue, gross profit, adjusted operating income, adjusted net income, and adjusted earnings per share were records for any quarter in the Company's history.

Water Systems sales were $226.7 million in the second quarter 2014, an increase of $13 million, or about 6%, versus the second quarter 2013 sales of $213.7 million. Sales from businesses acquired since the second quarter of 2013 were $2.3 million, or about 1%. Water Systems sales were reduced by $4.3 million, or about 2% in the quarter, due to foreign currency translation.

Water Systems sales growth, excluding acquisitions and foreign currency translation, was about 7%. Water Systems operating income after non-GAAP adjustments was $42.4 million in the second quarter 2014, a decrease of about 2% versus the second quarter 2013.

The second quarter operating income margin after non-GAAP adjustments was 18.7%, down 160 basis points from 20.3% in the second quarter of 2013. Water Systems adjusted operating income margin declined in the second quarter, due in part to global shift in sales mix, including a larger portion of Pioneer dewatering equipment sales. Additionally, in Asia Pacific, but also southern Africa and Brazil, the combination of factors, primarily lost leverage, contributed to lower earnings in those regions. While sales in the US and Canada, excluding Pioneer products, declined marginally, profitability for these same sales was flat compared to the second quarter 2013, improving operating income margin. Water Systems adjusted operating income margin also improved for European and Middle East market product sales.

In June 2014, the Company completed the acquisition of Bombas Leao S.A., based in Monte Azul Paulista, Brazil. Bombas Leao is a leading supplier of groundwater pumps principally used in agricultural, industrial, and municipal applications. Bombas Leao had sales last year of about $30 million US dollars. The Company paid $30.7 million US dollars and acquired outstanding debt of $5.5 million. We believe the acquisition will be accretive to 2004 (sic) earnings.

On July 1, 2014, the Company announced a new plan for manufacturing optimization, which includes the closure of the Wittlich, Germany manufacturing facility and a move of the production base currently there to an existing factory the Company operates in Brno, the Czech Republic. We expect this relocation, along with other miscellaneous European-based realignments, to be completed by the middle of 2016.

We anticipate pretax restructuring charges to be between $13.2 million and $14 million. These charges will begin in the third quarter of 2014 and will conclude by the end of 2016.

Fueling Systems sales represented 20% of consolidated sales and were $57.8 million in the second quarter of 2014, an increase of $8.1 million, or about 16%, versus the second quarter 2013 sales of $49.7 million. Fueling Systems sales increased by $0.8 million, or about 1% in the quarter, due to foreign currency translation. Fueling Systems sales increased 15% after excluding foreign currency translation.

During the second quarter, Fueling Systems shipped about $2 million of equipment to India to partially fill a large tender order. Excluding the impact of these India tender sales, Fueling Systems sales grew by about 12%. Sales growth was across all product lines and all regions of the world, with sales in the BRIC countries more than doubling.

Fueling systems operating income after non-GAAP adjustments was $13.9 million in the second quarter of 2014, compared to $11.1 million after non-GAAP adjustments in the second quarter of 2013, an increase of about 25%. The second-quarter operating income margin after non-GAAP adjustments was 24%, an increase of 170 basis points from the 22.3% of net sales in the second quarter of 2013. The increase was driven by a combination of productivity, favorable pricing, and synergies from the Flex-ing acquisition.

The Company's consolidated gross profit was $99.4 million for the second quarter of 2014, an increase of $4.8 million, or about 5%, from the second quarter of 2013 gross profit of $94.6 million. The gross profit as a percent of net sales was 34.9% in the second quarter of 2014, down about 100 basis points versus 35.9% during the second quarter of 2013. The gross profit margin decrease was primarily due to sales mix and loss of operating leverage in developing regions.

Selling, general, and administrative expenses were $60 million in the second quarter of 2014, compared to $53.2 million in the second quarter of prior year, an increase of $6.8 million, or about 13%. Increases in SG&A were primarily driven by higher marketing and selling expenses in support of higher sales and $3.2 million of cost included in non-GAAP adjustments related to executive transition and professional service fees for pending or completed acquisitions. After these non-GAAP adjustments, SG&A expenses increased by $3.6 million, or about 7% from the second quarter 2013.

The effective tax rate for the second quarter of 2014 was about 27%. The tax rate is a percentage of pretax earnings for the second quarter of 2013 was about 25%, primarily due to the completion of income tax audits and the favorable resolution of matters that were previously under review. The tax rate for the second quarter of 2013 before discrete adjustments was about 27%, flat to the second quarter of 2014. The of average effective tax rate after discrete events for the back half of 2014 is estimated to be 25%, an improvement of over 150 basis points from the back half of 2013.

The Company ended the second quarter of 2014 with a cash balance of $87.7 million, which was $46.9 million lower than at the and of 2013. The cash balance decrease is primarily attributable to the seasonality of the business and acquisitions. The cash balance at the end of the second quarter 2014 increased by 14% versus the $77.1 million balance at the end of the second quarter 2013.

The Company had about $48 million outstanding balance on its revolving debt agreement at the end of the second quarter of 2014. The Company intends to repay all of the revolver debt by the end of the fourth quarter 2014, and it had no outstanding balance on its revolving debt agreement at the end of the second quarter of 2013.

During the second quarter 2014, the Company opened its new manufacturing facility and Joinville, Brazil, which was a meaningful contributor to the nearly $18 million spent on capital expenditures in the first half of 2014. We believe total capital expenditures for 2014 will be around $40 million.

During the second quarter, the Company redeemed 10% of the non-controlling interest of Impo, increasing the Company's ownership to 90%, for $2.9 million. The cost of the additional 10% was more than the estimated redemption value for the non-controlling interest, and the incremental cost was considered a dividend distribution. Accordingly, earnings per share for the second quarter of 2014 were reduced by about $0.01 for this incremental cost.

The Company purchased about 115,000 shares of its common stock for approximately $4.4 million in the open market during the second quarter of 2014, which brings our total share repurchases year to date 2014 to about 140,000. Finally, on Thursday, July 24, the Board of Directors of the Company declared quarterly cash dividend in the amount of $0.09 per share for outstanding shares of common stock on August 21, 2014, with a record date of August 7, 2014. This concludes our prepared remarks, and we would now like to turn the call over for questions.

(Operator Instructions)

Matt Summerville, KeyBanc.

A couple questions. First, Gregg, maybe on the manufacturing realignment plant in Europe that is commencing later this year and extending into 2016. First, can you perhaps quantify what you expect the return on that investment to be, i.e., your annualized cost savings once complete?

Good afternoon. This is John. It will have a significant benefit to the Company, Matt. We're not specifically disclosing the annual cost savings from it simply because we're still in discussions with our partner, Labor Council and the unions in Wittlich to reach a final agreement on the severance, and we don't think it would be fair to start talking about those benefits until that matter is resolved. But when it is, we'll come back and share a little bit more with you and others just about how we think about the benefits and the savings.

Got it. And then there's quite a few moving pieces in the Water business, whether it's mix induced by Pioneer, whether it's the political instability in Thailand, whether it's the strike that was in the mining industry, now is in the metalworkers union. Can you talk about -- is there any way to quantify some of these impacts to give us a feel for what the real -- not real, but the more normalized, if you will, operating profitability of the Water business currently looks like?

Matt, I would put it this way. You -- probably break it down because there are several moving parts. If you look at Asia Pacific, we had stronger sales with our surface pump business, Pioneer, which is typically a little bit lower margins. Our commercial business is off double digits, so that mix drives down the profitability. In addition, we weren't selling into Thailand because of what was going on -- selling as much -- and so the margins were compressed because our sales in other parts of the region have somewhat lower margins. And there is also a delay in orders or timing of orders coming out of Korea, Thailand and Japan. Some of that is related to currency, as they do some speculation on currency.

That was just a big chunk, and the situation in South Africa is that the country has just been generally in a malaise with somewhat contraction of the economy, and so that's been overhang for our business. The strike in our facility -- or actually the strike by the metalworkers which affected our facility -- started July 1. But the impact of the South African currency, the impact to the top line, and if you just look at those two situations, Asia-Pacific and South Africa, that was really the difference between us having a 2% adjusted earnings quarter and a double-digit adjusted earnings quarter. So it was material to -- relative to last year. It [fell to the] last year's profitability for those two businesses would've made that difference.

And then what's the outlook for this current strike? Is it still ongoing? Is there a view that it's going to be resolved? How do you know what the ultimate impact is going to be in Q3?

We are doing some limited shipping. We heard two or three hours ago that there has been resolution of the economic matters. I do not know if the workers will be back in the facility this week. We are optimistic that they'll be back working by the first of next week and that hopefully, there is some pent-up demand that will help the quarter. But we do have to get our production going to get the sales.

Okay. And then just lastly, in the Fueling Systems business, how much of the growth do you think you're seeing now is being driven by this conversion to pressure systems? And then using the baseball analogy, how for along do think the rest of the world is outside North America with this conversion? And I'm assuming not every station will convert. But just can you walk through that a little bit?

Again, it's been a major theme for several quarters now of strong pressure pumping systems growth, and part of it is been driven by this continued tendered activity in India. And I think that gives you some indication that there are a lot of stations left in the world to convert to pressure. And will all of them convert to pressure? No. To your point, if you get into a small station that's remote, it probably doesn't make sense. We're not going to make the investment.

But generally speaking, pressure is more efficient than suction. It allows for larger stations. As people want to put in larger stations, it's really the only way you can operate them. And I would say that we're -- it's 90% plus converted in the United States, maybe 99%. The rest of the world we would say is less than a half, maybe even less than a third, and will continue to convert over a period of time. So I think it's got a pretty long runway.

The other thing is that you think the number of gas stations the rest the world is four to five times what they are in US and Canada, and so as we get a larger installed base, these systems do last for 10 years, 12 years maybe, but they do have to be replaced, so we're going to get a larger installed base, which will allow for a larger replacement business over time.

Lastly, it sounded like your brake revenue was very good, whether it's Fueling or even otherwise. Are you not, then, Gregg, seeing any impact from issues in Eastern Europe and Russia and the Middle East currently?

I wouldn't go that far. I'd say that first off, our business in Russia in Fueling has been somewhat soft for period of time, and we've made some changes, and we're getting traction again. So we've had a recovery over an easier comp in Russia. Certainly, India is doing very well. China is doing very well, and we've been growing our business from the small base in Brazil. So specifically, those four countries, we've seen nice growth.

The Middle East, more directly disruptive to the water business. Some countries, we'll get a surge in sales like we did in Algeria last quarter, and then we'll see countries go off line, like Syria. Certainly, the situation in Iraq and other parts in the Middle East were disruptive to our Water business. Probably not so much for the Fueling business. But specifically to Russia, Ukraine, relatively small base. We've made some changes. We were getting traction, and that's why we got the results.

Thanks, guys.

Ryan O'Donnell, Robert Baird.

Good afternoon, guys. This is Ryan on for Mike. It sounds like the ag outlook has weakened a little bit. Can you guys just talk a little bit about what you're seeing there and the outlook for the year and into next year?

Again, our outlook is fairly limited because we don't operate off of backlog much outside of the Pioneer pump business, but I can give you these observations. As we reset our distribution, results came in where we thought they would. They're a little bit up on the West Coast where it's a little dryer, a little bit down maybe in the Southeast where it's been a little -- the weather has been a little less favorable. But overall, where we reset distribution, the sales have been flat to last year.

The center of the country is where the sales have been a little softer and where we've seen -- both for weather and agricultural prices, we're seeing a little bit of impact. I don't think -- I've read a couple of the press releases for some of the center point guys. Obviously, they had a much bigger capital equipment, and a lot more of their business I suspect is new installs. We have a very large installed base of -- more of our business is replacement. But we are seeing some softness in the center of the country, and we suspect due to weather or due to crop prices.

Okay. And then on the distribution changes, how are those tracking relative to your internal expectations, and is there any reason why some of the new distributors might be taking a little longer to get up to speed on inventory side?

Yes. As I mentioned just a little bit ago, basically flat in those areas where we made the changes, which met our expectations. And I think that distributors have to go through a destocking-restocking trend, and if markets are a little soft, it's going to be a little slower. So that's why we've offered some caution to Q3, although we still expect our US water system sales to be up in the third quarter.

Okay. And then last one for me, guys. The timing of the in-house shifts on some of those components with the Pioneer business, how are you guys thinking about that, and what's the margin benefit we should be thinking about in the back half and into next year?

I'm going to have Robert Stone speak to the Pioneer business and some the activities they are doing to deal with the strong growth in Pioneer and some of his thoughts about insourcing.

So the quarter started very well. Our largest customer, NPC, was acquired by United Rentals. We had been running with a really good backlog as United Rentals starts to add branches where it is stocking and renting Pioneer pumps. The ramp-up came very quickly, and as you know, there's a very long supply chain on engines and some the castings that we get, so we've been forced to go outside. We've decided to take care of our customer's request in terms of demand, and we have been supplying them product, albeit at a cost. We have plans and have already executed a number of those in terms of sourcing from lower-cost suppliers and insourcing product, but by the time that rolls through the income statement, it's going to take a couple of quarters to get there.

Okay. Thanks a lot, guys.

David Rose, Wedbush Securities.

Thanks for taking my question. I wanted to follow up on some of the impact from the unusual events, particularly the change in distributors. Can you quantify the top line and margin impact from the distributor shift?

We don't have that level of detail. What we could say is that our US and Canada Water business was down less than 2% in revenue and was flat on earnings. So we were able to actually improve operating margin in the quarter relative to year. And generally, we can look at sales through distribution and say that our overall sales in the regions that were -- where we made the changes was flat to last year.

So if you -- in the regions you didn't make the changes, what was the delta?

Again, what I'm saying is that we saw some softness in the middle of the country and that we looked at as being weather, crop price related, maybe some destocking, and that was down in the -- about high single digits. Yes.

David, I think the way we would say it would be that, as Gregg said, I think we're pretty pleased and feel more confident that we're on the right track here. When you pull Pioneer products out of the US-Canada sales, which leaves the core groundwater business and the surface water business, we were down about 2%, and operating income was flat. So when you get underneath that a little bit, we knew it would be a little bit choppy.

We knew there was going to be this, as Gregg mentioned, this inventory resetting. And the pace at which our new customers ramp their inventory down, the buy at which they start with us, all of that was a bit uncertain. But generally, when we look at the results excluding Pioneer again, all in all, pretty much what we expected, and pretty confident that the decisions and the moves that we've made are going to be the right ones long term for our Company.

Okay. I get it. It's a little hard to parse all that out. And changing gears to the Fueling Systems numbers, can I infer, then, that the US was down?

No, we said all regions and all product lines were up in the quarter.

Okay. Sorry. So that includes US. Okay, got it. And your expectation in terms of product line in the US, because your vapor recovery has got to be down, right?

Certainly, vapor recovery outside of California is being decommissioned, and so that has been in a drag for the last several quarters, and so we're making that up in other product lines across the board. Again, pressure pumping systems, fuel management systems, piping systems. And so we continue to see good growth in North America, even with what we call probably a single-digit decline in our vapor recovery systems.

And then outside of the US, how should we think about the trajectory? The business may be lumpy. It's not terribly smooth. That's the way to think about it, right? Should we think about same growth rates than you had this last quarter, ex India, or how should we think about it for the next couple of quarters?

David, as we've talked, our Fueling business has a tremendous growth opportunity in front of it, primarily in the developing regions, and we would look at this on a consistent basis to be a high-single, low-double developing region growth business. So you're going to see some spikes based on timing and customer orders and tenders in India and things like that, but generally, this is a high-single-digit, low-double-digit growth platform for us in the developing region.

Okay. So outside of the $2 million you called out in the quarter for India, there really wasn't an anomaly here?

There was -- there's always timing of shipments when you look at the Fueling business, David, but to call it an anomaly, I'm not sure I would say that when you -- the Gulf region was strong. India, as we mentioned, was strong. China was strong. Japan and Korea were strong off slightly lower bases. The (inaudible) countries were strong. So this feeling growth is pretty broad based.

Pretty broad based. We are seeing some traction in China. You've seen us cycle through initiatives in vapor recovery, and we are seeing some pretty good growth in China this year in the vapor recovery area, and we expect that to continue in the back half.

Okay. And then lastly, the artificial lift system updates, do we have any?

We are continuing to be on track to -- we're looking to get $4 million to $5 million in revenue this year. We continue to get more test sites. I was with one of our users the other day, listening to -- they are very happy with the system, and they have two of them in the ground, and they would like to try a couple more, and that's what business has been. They want to continue to test them and push them to limits and see how far they can go with our pumps. They are holding up well, and we're on track for this year.

Okay. Great. Think you very much.

Edward Marshall, Sidoti & Company.

Good afternoon. So I wanted to ask, looks like, first of all, back onto the lift system, I think you said you were on -- you just said you were on track for this year, but I think the expectation was to double revenue again next year? Are you still on track for that goal?

It's difficult to have visibility for that, but we have a lot of individual projects that are irons in the fire, and we are -- remain optimistic that one or more of them are going to pop. We continued to get interest in the system. We just installed a couple systems in China. We have orders coming in -- or systems that we believe are going to go into Turkey, Indonesia, India. So interesting, through some type of word of mouth or other connections, we are getting interest in our systems in areas of the world that we currently were not focused on. So it's -- we're getting some interest, but that has to convert to orders, and we'll see how quickly that comes.

Okay. And then with the Brazilian acquisition, did you say how much you anticipate receiving from a revenue perspective this year?

We didn't, Ed. We're still very early on in the stages of that. We did say that we thought it would be accretive to our back-half earnings. I wouldn't get too excited about that. We've got a lot of new amortization and other integration work to do. But this is a great acquisition for Franklin and for our position in Brazil, and it's right in the strike zone of our products, and it's a strong company with a strong sales force and good products, so we're optimistic on that. And as we get more into this integration, we'll have more to say about that business.

And then finally, as it relates to the acquisition and this comment surrounding the guidance, that it doesn't -- that it excludes acquisitions? Are you referring to -- that 8% to 10% growth in Water, is that assuming that -- future acquisitions, or does that include the Brazilian acquisition, just to clarify that point?

Yes. That means that we're not assuming any future acquisitions.

Okay. Perfect. So 8% to 10% includes the acquisition that you already made in 2Q?

Yes.

Perfect. Thanks, guys.

Thank you, and I am not showing any further questions at this time. I would now like to turn the call back to Gregg Sengstack for any further remarks.

Thank you for calling in, and thank you for your interest in our Company. You all have a good evening.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.