Franklin Electric Co Inc (FELE) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Franklin Electronics Co. Inc. quarter to 2016 earnings conference call. (Operator Instructions) As a reminder to our audience, this conference is being recorded for replay purposes. I would now like to hand the conference over to Jeff Frappier, Franklin's Treasurer. Sir, you have the floor.

Thank you, Brian. And welcome, everyone, to Franklin Electronics' second-quarter 2016 earnings conference call. With me today are Gregg Sengstack, our CEO, Robert Stone, Senior Vice President and President of our International Water Systems unit, and John Haines, our CFO.

On today's call, Gregg will review our second-quarter business results and then John will review our second-quarter 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. Discussion of these factors may be found in the Company's annual report on Form 10K 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 Sengstack.

Thank you, Jeff. Our Company delivered solid execution in the second quarter with 2% overall sales growth and 5% organic sales growth, excluding the impact of foreign currency translation.

Our sales growth was broad-based and led by higher groundwater sales in the US combined with stronger Water Systems sales in Latin America and Asia Pacific. Consolidated adjusted operating income increased 33% as we realized the continual benefits of lower raw material costs, increased prices, and a favorable sales mix. The performance of our Water Systems business continue to improve. After non-GAAP adjustments, water system operating income increased 24% on a recorded 2% increase in sales. Water Systems adjusted operating margins increased 160 basis points sequentially and 290 basis points compared to the second quarter of 2015.

On a 3% sales increase, Fueling Systems' adjusted operating income was $15.5 million, an increase of 22% versus the second-quarter 2015 and a record for any second quarter in the segment's history. Fueling Systems second-quarter adjusted operating margin was 27%, an increase of 420 basis points compared to the second quarter of 2015.

Turning to end markets, with more normal weather conditions in the US, our groundwater business showed a nice improvement over last year's depressed levels, with 13% growth in agricultural and 8% growth in residential pumping system sales. Our surface pumping business was studying the quarter. Overall, our water business for the US and Canada was up 7% compared to the second-quarter 2015.

Outside the US and Canada, business was again uneven but overall positive. Excluding the impact of foreign translation, we again saw organic growth of 4%.

Revenue growth in Latin America is strong. Business in Brazil recovered from a soft first quarter delivering 14% organic growth more than offsetting lower sales in Mexico and Argentina.

Sales growth in Asia Pacific continued unabated with generally favorable weather conditions in Southeast Asia and strong performance in Australia propelling the business forward. Results in [AMINA] were below our expectations for two principal reasons. Generally, weak demand in the Gulf region due to reduced investment by the public sector and a weak end market demand in Turkey.

In our Fueling Systems business, excluding the 1% head wind from foreign currency translations, our business grew 4% organically. Domestically the US team delivered another strong quarter, up 6%, with fuel management sales continuing to increase as more marketers specify our products.

Outside the US, organic sales were down about 1% with strong performance in Asia-Pacific, in India not being able to totally offset weak results in Mexico, Argentina, and Europe. Our European fueling business is weak due to two factors. Weak demand for storage tanks for North Sea oil production, and the lack of infrastructure spending in Russia.

Looking towards the back half of the year, we expect our US water business to continue to improve. We continue to get traction with new products, particularly drives controls and pressure boosting systems. Outside the US with the exception of the Middle East, end markets remain firm. We anticipate continued strong performance in Asia and, to a lesser degree, Latin America. We expect Europe to be steady with some improvement in sales to the Gulf region, however, the impact of recent events in Turkey and our water business is currently not clear. Fire fueling business, we expect continued high single digit revenue growth in the US. Outside the US, we expect our fueling business to deliver revenue growth as well.

Accordingly, we remain confident that our 2016 results will be in line with our guidance of $1.60 to $1.70 adjusted earnings per share.

I will now turn the call over to John Haines, our CFO.

Thank you, Gregg. Our fully diluted earnings per share as reported were $0.50 for the second quarter of 2016 versus $0.33 for the second-quarter 2015, as we know that the tables and earnings release of the Company adjust the as reported GAAP operating income and earnings per share for items we consider not operational in nature.

Non-GAAP expenses for the second quarter of 2016 were $0.3 million, related to retired executive pension costs. The second-quarter 2016 non-GAAP adjustment had a net EPS impact that reduced earnings by $0.01.

Non-GAAP expenses for the second-quarter 2015 were $1.7 million and included $0.8 million in restructuring costs, $0.5 million related to business realignment costs, primarily severance, and targeted fixed cost reduction actions; $0.3 million related to retired executive pension costs and $0.1 million for pending and completed acquisition-related costs. In total, the second-quarter 2015 non-GAAP adjustments had the effect of lowering the EPS by $0.02. So after consideration of the non-GAAP items, the second-quarter 2016 adjusted earnings per share is $0.51 versus the second-quarter 2015 adjusted earnings per share of $0.35, an increase of 46%.

Water Systems sales were $194.6 million in the second-quarter 2016, an increase of $3 million or about 2% versus the second-quarter 2015 sales of $191.6 million. For currency translation reduced Water Systems sales by $7.2 million or about 4% in the quarter. Excluding foreign currency translations, Water Systems sales grew about 6% compared to the second quarter of 2015.

Water Systems operating income was $31.5 million in the second quarter of 2016, up $7.2 million or 30% versus the second quarter of 2015 as reported, and up $6.1 million for 24% versus the second-quarter 2015 after non-GAAP adjustments.

The second-quarter operating income margin was 16.2%, up 290 basis points from 13.3% in the second quarter of 2015 after non-GAAP adjustments. Fueling Systems sales were $57.5 million in the second quarter of 2016, an increase of $1.7 million or about 3% versus the second-quarter 2015 sales of $55.8 million.

Fueling Systems sales decreased by $0.3 million or about 1% in the quarter due to foreign currency translation. Fueling Systems sales were up about 4% after excluding foreign currency translation.

Fueling Systems operating income was $15.5 million in the second quarter of 2016, up $3.1 million or about 25% compared to $12.4 million in the second quarter of 2015 as reported and up $2.8 million or 22% compared to $12.7 million after non-GAAP adjustments in the second quarter of 2015. The second-quarter operating income margin was 27%, an increase of 420 basis points from the 22.8% of net sales in the second quarter of 2015 after non-GAAP adjustments.

The Company's consolidated gross profit was $90.7 million for the second quarter of 2016, an increase of $10.5 million or about 13% from the second quarter of 2015 gross profit of $80.2 million. The gross profit as a percentage of net sales was 36% in the second quarter of 2016, and increased to about 350 basis points versus 32.4% during the second-quarter 2015. The gross profit margin increase was primarily due to favorable prices, lower direct material costs, a better sales mix, and lower fixed manufacturing costs.

Selling, general, and administrative expenses were $58 million in the second quarter of 2016 compared to $56.3 million in the second quarter of the prior year. An increase of $1.5 million or about 3%. The Company's SG&A expense increased by $2.5 million in the quarter due to higher variable compensation expenses which were partially offset by lower fixed costs and the effect of foreign currency translation.

The effective tax rate for the second quarter of 2016 was flat to last year that about 25% before the impact of discrete events was about 26%. The effective tax rate for the second quarter of 2015 was 25% and before the impact of discrete events was about 28%. The tax rate as a percentage of pretax earnings for full-year 2016 is projected to be about 26%, flat to the second quarter of 2015 tax rate before discrete adjustments.

The Company ended the second quarter of 2016 with a cash balance of $72 million, which was $10 million lower than at the end of 2015. The cash balance decreased primarily due to higher capital expenditures and seasonal working capital requirements in the Northern Hemisphere. The Company generated about $30 million in cash flows from operations in the first half of 2016.

The Company had borrowings of $22 million on its revolving debt facility at the end of second-quarter 2016. The Company had no borrowings on its revolving debt facility at the end of 2015. The Company did not purchase any shares of its common stock in the open market during the second-quarter 2016. As of the end of the second-quarter 2016, total remaining authorized shares that may be repurchased is about $2.2 million.

Yesterday, the Franklin Electric Board of Directors declared a quarterly cash dividend of $0.10 per share payable August 18 to shareholders of record on August 4, 2016.

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

(Operator Instructions) Edward Marshall, Sidoti.

Good work on the gross margin line and I know there's some seasonality from the first half versus the second half -- rather the second half versus the first half and I just wanted to get your sense on the delta that we should anticipate especially as materials like cold rolled steel and copper, which I think you consume, is increasing as well. How do you think about it?

Yes, the way I would best speak to that is more on the OI or the operating income margin line. The gross profit line should continue to see some of the benefits that we saw in the first half of the year, although as you are pointing out, we are seeing the inflation in some of the raw materials, most notably some of the categories of steel. But the way we're thinking about the back half overall marginalize on the operating income margin line is that we made $0.80 in the first half of the year to make $1.70 which is the high-end of our range, and we need to make $0.90 in the back half of the year.

We figure if we can get 3% to 4% topline growth and then expand our operating income margins 50 to 75 basis points from where they were in the second half of 2015, we should effectively be on top of that $0.90.

Now you may say, well, wait a minute, $0.90 -- the expansion of 50 to 75 basis points on the OI wireline, there's some moving pieces in there as Gregg and I both pointed out. In the first half of the year, we were up about 300 basis points on operating income margin; we shouldn't expect that in the back half of the year for a variety of different reasons, not the least of which is the comparable, from 2015's back half, is already 12%.

So we have already made some progress in the back half of the year last year. So we will still see generally raw material deflation, but not as much as we saw in the first half.

Price was a key contributor to both gross profit and operating income in the first half. We will still continue to see that.

Where we're going to have some throwbacks is in higher SG&A costs, most notably around compensation-related costs, which as you may recall in the back half of last year, was decreased or lower in a pretty meaningful way.

So, that's the way we're thinking about the back half, the way we're thinking about margins. I think the gross profit, coming all the way back to your question, will be a plus, but we are seeing some material inflation is going to hit us. Especially in the fourth quarter and on an OI basis, we see margin expansion, but not nearly the expansion that we saw in the first half.

Got it. Any benefit in 2Q or in the current quarter regarding Zika or -- and/or the Olympics that you can measure?

We would say -- no, there is no tailwind or head wind from either of those. When you have the World Cup in Brazil, I would say maybe there was a little modest uptick beforehand and a little bit softer business during the event. But our products are principally focused in agricultural markets in Brazil.

Yes, there were some in the municipal sector which is a growing sector for us, and the residential sector. But these sectors have been pretty much not impacted by the activities of either Zika or the Olympics as we see it.

Got it. And then I guess a competitor, Dover, acquired Wayne and what can you tell me about the competitive landscape? And I'm particularly interested in how maybe you are preparing for changes in the distribution customers.

Yes, I don't know if that deal has closed yet. They also acquired [Tokheim] earlier in the year. And Europe, I expect that there will be a fair amount of expense or consolidation activity in the European theater. We have been competing with Barco here, a subsidiary (inaudible) for a number of years. Well over a decade, they have some vertical integration of aboveground dispensed equipment and belowground equipment.

So we expect that in these markets, we will see a similar competitive environment. We have done well there, so we expect we will continue to do well in the future with the combination of Tokheim and Wayne and OPW.

Got it, thanks, guys.

Ryan Connors, Boenning & Scattergood.

I want to talk a little bit about the agricultural vertical for you. You called out in the press release, double-digit topline growth there, which is quite a bit more bullish than some of the other companies selling into that space. So just want to give you some color behind where that strength is coming from.

Sure, Ryan. A couple of factors. One is, you may recall, I think the quarter last year was particularly soft. It was the second wettest second quarter in US history. All Texas was underwater and it was a very difficult environment throughout the middle of the country.

So we have frankly -- we have an easier comp in that respect.

The other thing is yes, keep in mind that as people compare us potentially to -- people do irrigation equipment, we have more replacement items than a capital good. So given the large installed base out there with more normal weather conditions, people are going to operate their existing pumping systems, many of which were probably not operated last year. So that's what causes the -- or drives the replacement market which -- it's a much bigger part of our business than the initial installed market.

So I think that would be -- those would be a few principal reasons why our numbers are up compared to say others that you would look at in this industry.

Got it, okay. And then my other one had to do with ForEx. I apologize if I might have missed this but I think in the past, you have given some pretty good granularity around what ForEx assumptions you are making in the guidance. Do you have any updates for us there?

Yes, Brian, the ForEx will continue to abate as we go through the back half of the year.

I think in total, we're expecting something in the 300 to 350 basis point impact from foreign exchange. The key culprits remain the real, the South African rand, we saw some movement obviously just recently in the Turkish lira.

So we are going to lap some of this as we go through the back half so the FX won't be nearly as big as the impact as it has been on Franklin, but they are still going to be some headwind there.

As we think about the euro, it's been fairly stable in that [1.10, 1.12] range. That is something that -- if he gets stronger, that is certainly beneficial to us, but given everything that's going on in Europe economically, politically, Brexit, all of that, it's hard to predict that.

But that's kind of the way we're thinking about FX right now.

Okay, that's very helpful, thanks for your time.

Matt Summerville, Alembic Global.

First, with respect to the Middle East and Turkey, could you just review what your revenue exposure is to that region and have you actually seen a hit to your business at this point?

Our revenue exposure, Matt, good morning, in Turkey is around $30 million and our water business -- our fueling business is certainly relatively small. We had a good first quarter in Turkey and then a slowdown in the second quarter which was more kind of -- it was a wet start to the year.

We are not seeing any current disruptions to the business. As a matter of fact, our leadership team over there is business as usual. It's just a question of is this going to have some impact over the next couple of quarters at the margin? Robert Stone traveled there most recently. Robert, what's your view on that?

From our business standpoint, Gregg and Matt, we are largely unaffected other than by whether as Gregg already mentioned. The bigger impact for us is the situation in the Gulf and the Middle East area, in particular Saudi, where the government there is just really cutting back on spending and the government probably represents 80%, 90% of the GDP of the area.

And with oil prices where they have been, Saudi is not spending, so we've seen a definite slowdown there. In other areas, we are roughly comparable to prior year.

Got you. And then just here's a follow-up, you mentioned the fueling business, particularly in the US, sales of fuel management systems have been pretty robust. Is that being driven by an upgrade replacement cycle or is this sort of a gas station for the first time implementing one of these things? And I guess what I'm trying to get at is is there legs to this?

Yes, there is legs to this. Over the years, we have upgraded and reinvented our fuel management system platform and we worked very, very hard to get the specification of the end market or for our system. And we have been doing that now and we are beginning to see the fruits of a lot of labor by a lot of people in the marketplace.

That is the key in this business is getting the end marketer [specify] their product, and to provide them systems where they can see the lowest total cost of ownership. And so we're getting more traction in that space.

There's been a lot of talk about the [EMV Tsunami] which would be a upgrade of the card reading equipment and the dispensers. One could look at the EMV pending deadline is being -- people are going to allocate capital to dispensers and maybe not so much to underground. Other people are going to look at it and say look, I'm going to be doing my dispensers. The last major upgrade of gas stations was back in the late 90s when all the underground tanks were replaced. So many stations are coming up maybe on a 20 year anniversary so they are saying, look, it's time to do the whole station.

So we have seen again solid organic growth quarter over quarter in the North American, US and Canadian market in particular, and we are getting the success and fuel management through people changing their spec to Franklin.

Got it. And then just one last one. You talked about restructuring your European operations, restructuring some things down in Brazil. Is there a way to quantify the savings you generated from those programs and still what is on the horizon on an incremental basis? Thank you.

Yes, Matt, we haven't quantified that in terms of the actual allied or margin impact of those activities. We have said generally that when we take on these restructuring projects, we are generally looking at a three-year or less type of the payback. Now the one in Europe was longer than that just because of how unusual the cost of that was, relative to severance and closing that facility in Germany.

As we look forward -- as we have discussed in the past, we constantly are evaluating our global footprint, our manufacturing and distribution footprint. We have ideas and thoughts about other opportunities that may be out there, but we won't -- until we are ready to actually commit to that, we won't talk about what those are or what the potential savings of those can be.

I would say generally that the Brazilian restructurings that we've talked about has been a success and is contributing to the financial -- contributing positively to the financial results of that business unit and I would say the same for the action in Europe. But it is basically wound down now and completed. We are seeing the labor benefits, we are seeing the fixed cost benefits of those actions, but we haven't specifically laid out those savings.

Got it. Thanks, guys.

Ryan Cassil, Seaport Global.

Looking at Water Systems, I didn't see much commentary there on the surface. Could you give a little comment on what the trends you are seeing there, the competitive landscape; then, maybe more specifically, whether you are getting positive pricing in this environment?

Sure, Ryan. We are seeing in the North American business, we are seeing some strengthening in our Pioneer product line over last year. We are still pretty soft in the some sewage ethylene space. And market demand is in the regions of the country we sell is in fairly soft. Again, we didn't have much in the way of weather events and in North -- Central portion of the United States where we've had a strongest demand for various pumping systems, but pricing, pricing is okay.

We are getting a little bit of price there in North America for that product line. If you go down to our surface pumping business in Brazil, we are clearly getting price there. We have recovered from the challenges of inflation in the exchange rates, where the Brazilian real was really weakened, relative to the dollar or the currencies last year.

The demand for surface pumping in residential is okay and the Brazilian economy is not great. We are [gaining] share in the industrial and commercial space in those markets, so that was the other significant surface pumping market for us.

Okay, great. Should we expect then -- I guess in the second half -- that groundwater continues to outpace surface and maybe that ratio of ground to surface normalizes back towards a more historical levels here in the back half of the year?

Yes, I would make two points to that. Yes, we should continue to see the groundwater business improve. That will certainly continue to drive a more favorable mix because we are more vertically integrated in our groundwater space.

At the same time, with it being hotter out there, our condensate pump business which again is -- relates to the demand for the air-conditioning equipment and, again, it was a relatively cool start this year. We would probably see more -- we anticipate to see more activity there as well.

Okay, great. And then changing over to fueling, sort of a bigger picture question here. I think you guys talked about in the past profitability in normalizing in that segment down towards more of the low 20s in terms of margins, but if things keep trending higher, has that outlook perhaps changed at all? And does the consolidation that is taking place in the industry maybe help that overall outlook for better profitability for everyone in the space?

Well, I think, Ryan, as we discussed, the mix, both product-wise, angiographic-wise matters a lot on the fueling operating income margin. So I don't think anybody here would get too carried away with going beyond the low 20s -- [22, 23, 24, just because it is so sensitive to the mix factors, what types of products we're selling.

For example, this quarter we sold a lot less of these storage tanks -- these underground tanks in the UK as Craig mentioned and those have very, very poor margins. So, less of that from a revenue perspective means higher operating income margins.

So, that is probably the best we can do on that right now. The business is doing a good job at getting price. The business is doing a good job at leveraging its fixed costs, i.e., growing its top line but growing its fixed costs less than that. So, all the things that are margin enhancers are present there, but I don't know that I would get too carried away about where that end margin can go, despite the second-quarter results.

Greg commented on the consolidation that is going on in the space and just the -- to further that, our fueling business (inaudible) has been competing in this environment where you had some very big competitors -- distributors actually like independent players. They like the idea that there is a alternative from a product perspective to some of the bigger players and all this equipment -- I would like to point out all of this equipment is compatible with itself. So the guy that is expecting out of station can say I want the Dover equipment here, I want the Franklin equipment here, I want the [Glibarco Videroo] equipment here, and so far that has served our fueling business fairly well.

Now there's a lot -- these are big changes that Dover has made. It is a very bold play into the space. There's no question about it.

So we are going to have to wait and see what the real impact of that is, but we -- it's not like we haven't operated in this type of environment, basically have been operating this segment in that environment for its entire life.

Okay. That's helpful. And the last one for me, I think you talked about increasing the dividend and then you guys saw a little small opportunistic tuck-in acquisition. But can you talk about priorities for capital allocation moving forward here? Thanks.

Yes, the priorities haven't changed meaningfully. The dividend at $0.40 a year, we're trying to manage a payout ratio in the 20 range, low 20 range. And as we -- as our trailing 12-month earnings-per-share improves, I think we will be there. Our primary objective for free cash is accretive acquisitions and to the extent that we don't see a robust pipeline or inability to close on those acquisitions, we will consider share repurchases. However, we will only consider those share repurchases when we think that our forward multiple is lagging at a historical level or a peer group level.

In terms of the [GridSense] acquisition, we don't often talk about it but our fueling business has a nice, smaller business that is around monitoring devices for electrical distribution equipment, and this was a great example of a product line extension where we can go buy products, fold that into our commercial and manufacturing operation, and be able to leverage that with the Franklin name.

So it's not particularly big. We are not expecting much out of it for the back half of 2016, but it is a -- it's a nice product fit into a small set of existing products that we have in that business. I don't know, Gregg, do you want to add anything?

Yes, this is a -- we go back to our fueling business -- fuel management systems, that product line was when we acquired 14 years ago. And again, the history of the business as we acquire each company so then we systematically upgraded products. We did the same thing with a small product line that came along with that purchase of INCON. And that was in the power liability system space for the transmission distribution space and we have a series of monitoring devices for transformers. We developed another device for monitoring assets, fixed gas, and high-voltage circuit breakers, and our guys -- we are watching the [Acorn] business and saw GridSense as being an opportunity of buying a product line that just naturally folded in.

So it's a small transaction but it was key to that level of business (inaudible)

Appreciate the color, guys. Thanks.

Edward Marshall, Sidoti.

I just had a couple follow-ups. What was the other income of $1.4 million? Typically that's, I think, other income from securities but generally that runs about $100,000. Why so high in this quarter?

It's about the same as it was last year. About $1.4 million. So, it would be earned interest on cash deposits for example in Brazil, (inaudible), the minority earnings of equity investments that we have. There's really nothing too unusual in that number in the second quarter.

Got it. And then I'm wondering if fueling operating margins -- you may have touched on this, but I just wanted further clarification, was it mixed for pricing that got you there? And was there anything unusual from a shipment perspective, say, in Indian tender or something like that?

I wouldn't say there was necessarily anything unusual that would make them end price. We did have some India business in the quarter as well, so that even makes it more positive.

We did have some -- we didn't just have a particularly spectacular second quarter in 2015 in doing -- we have a few accounting and inventory type adjustments that we took to lower the margin last year a bit, so the comp wasn't particularly aggressive, let's say. But as I said, the business is getting price, the business is leveraging its fixed costs. They're getting some of the same raw material input benefit that the water side businesses are getting. They are certainly participating in that as well.

So all of those factors combined with less business in some of the least profitable businesses in that segment are contributing to what we see in the second quarter.

Maybe I can ask a different way. I think you said in the prepared remarks it's the highest in the Company's history in any quarter for the fueling business. When you look at the full year in your [$160 million] to [$170 million] guidance, what are you forecasting for fueling margin on operating level?

Yes, it may be down in the 20 -- 20 -- sub-25 range.

Sub-25, got it. And then finally, the pioneer business in the UK, is it large enough to cause any mismatch between costs and sales? Maybe cost in pounds and sales in the euro region?

No, the -- if you think about it, pioneer business in the UK is relatively small and it has two parts. It's a rental component and a sales component and it's doing that in pounds, principally for the local market on an export basis. Some of the sales may be in dollars or other currency, but it's not going to be a major -- you are not going to see a major cost mismatch.

Yes, the product is imported in the country from other parts of the world but again, we're talking about a business that on a run rate basis is GBP10 million, GBP12 million a day so it's not going to have a major move.

Got it. Okay, guys, thanks very much.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session for today. I would now like to hand the call back to Franklin Electric's CEO, Gregg Sengstack, for closing comments.

We thank you for following our company and look forward to speaking to you after the third quarter. Have a good week.

Ladies and gentlemen, this does conclude today's program and you may all disconnect. Everybody, have a wonderful day.