Franklin Electric Co Inc (FELE) 2016 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Franklin Electric Company third-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the call over to your host for today's conference, Mr. Jeff Frappier, Treasurer of Franklin Electric Company. Sir, you may begin.

Thank you, Bridgette, and welcome, everyone, to Franklin Electric's third-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 third-quarter business results, and then John will review our third-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. 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 metrics which the Company believes help 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 results in the third quarter, with 3% overall sales growth. Our Fueling Systems organic sales decline of 1% was more than offset by the 5% organic increase in Water Systems sales. Our Water Systems sales growth continued to be led by higher groundwater sales in the US, combined with strong Water Systems sales in Latin America and Asia Pacific.

Our organic sales growth, along with stable input costs, increased prices, and a favorable sales mix drove our adjusted earnings per share of 7% for the quarter. John will cover more of the financial highlights for the quarter in a moment.

Turning to end markets, the US and Canada groundwater business again showed a nice improvement over last year, with 13% growth. Sales of residential groundwater systems increased 17%. With all the focus on weak crop prices and wetter weather in key growing regions, we're pleased that our agricultural pump sales have increased 2% in the quarter.

Our service pumping business in the US and Canada declined in the quarter due to weak sales of large dewatering pumps. Overall, revenue in our water business in the US and Canada was up 2% compared to the third quarter of 2015.

Outside the US and Canada, Water Systems results were similar to what we saw last quarter. Excluding the impact of foreign translation, we achieved organic growth of 8% in the third quarter.

Revenue growth in Latin America was strong and broad-based. Business in Brazil continued at a record clip, delivering 9% organic growth. Mexico, Guatemala, Chile, and Ecuador all saw over 20% growth rates in the quarter. Growth in Asia-Pacific revenue continued unabated to generally favorable weather conditions in Southeast Asia, and solid performance in Australia propelling the Business forward.

Europe, Middle East, and Africa Water Systems revenue was flat to last year. In local currency, our Business in Turkey had record results, but political and economic turmoil in the region remains. And the lower price of oil has reduced investment by the public sector, particularly in Saudi Arabia.

After 17 quarters of organic growth, our Fueling Systems revenue, excluding foreign currency translation, declined 1% organically. However, the US and Canada team delivered another solid quarter up 5%. Our fueling team strategy of total system solutions continues to gain traction and share.

Outside the US and Canada, Fueling Systems organic sales were down about 10%, a significant portion of which were underground storage tank sales in Europe. In addition, most of the gas stations outside North America are controlled by the major oil companies. While we saw some markets with revenue growth for the quarter, like China and Africa, we estimate the weak price in oil to curtail downstream spending by the major oil companies and some plant shipments have been delayed.

Looking forward, for our Water Systems business we expect the fourth quarter to have a similar pattern to the third quarter. Even with the soft ag market, we expect the US and Canada Water Systems business to continue to grow with our new drive controls and pressure boosting systems gaining broader acceptance.

Outside the US and Canada, we anticipate continued strong performance in Latin America, and to a lesser degree Asia Pacific against a tough comp from last year. And much like Q3, we expect Europe to be steady. While we're mindful of the political and economic uncertainties in the Middle East, we expect to see some improvement in end markets in the Gulf region.

For our Fueling Systems business, we expect continued mid- to high-single-digit revenue growth in the US and Canada. Outside the US and Canada, we expect our fueling business to deliver revenue growth as well.

Against the backdrop of a weak global economy, Franklin employees around the globe are executing on our strategy. Our global footprint, which has a focus on developing regions, increases our exposure to foreign translation headwinds, but it has also positioned us well to support and capitalize on the inherent growth in the use of water and fuel as an outcome of increased standards of living in those regions.

Further, with our proven profitability over the last year, we're spending more in new product development. Listening to our customers, we are focused on system solutions that are safer, more efficient, connected, and provide value through lowest total cost of ownership. From a financial perspective, we believe that our 2016 results will be in line with our guidance of $1.60 to $1.70 adjusted earnings per share, which we're now narrowing to $1.62 to $1.67 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 third-quarter 2016 versus $0.43 for the third quarter of 2015. As we note in the tables in the earnings release, the Company adjusts the as reported GAAP operating income and earnings per share for items we consider not operational in nature.

Non-GAAP items for the third quarter of 2016 netted to a gain of $1.4 million. We sold the land and building of the old manufacturing facility in Brazil during the quarter and recorded a gain of $2 million. This was offset by about $600,000 of other restructuring and non-GAAP-related when factoring realignment costs and other retired executive pension costs. The third-quarter 2016 non-GAAP adjustments had a net EPS impact that improved earnings by $0.02.

Non-GAAP expenses for the third-quarter 2015 were $1.7 million and included $1.3 million in restructuring costs, primarily for the continuing European and Brazilian manufacturing realignment, and $0.4 million for other non-GAAP expenses related to business realignment costs, primarily severance and targeted fixed cost reduction actions and retired executive pension costs. The third-quarter 2015 non-GAAP adjustments had a net EPS impact that reduced earnings by $0.02. So, after consideration of non-GAAP items, third-quarter 2016 adjusted earnings per share is $0.48 versus the third-quarter 2015 adjusted earnings per share of $0.45, an increase of 7%.

Water Systems sales were $182 million in the third quarter of 2016, an increase of $8.5 million, or about 5% versus the third-quarter 2015 sales of $173.5 million. Water Systems organic sales growth was also about 5% compared to the third-quarter 2015, as the impact of foreign currency translations was not significant.

Water Systems operating income was $30 million in the third-quarter 2016, up $6.9 million or 30% versus the third-quarter 2015 as reported, and up $3.7 million or 15% versus third-quarter 2015 after non-GAAP adjustments. The third-quarter operating income margin was 16.5%, up 320 basis points from 13.3% in the third quarter of 2015. The third-quarter operating income margin after non-GAAP adjustments was 15.5%, an increase of 140 basis points from the 14.1% of net sales in the third quarter of 2015 after non-GAAP adjustments.

Fueling Systems sales were $57.8 million in the third-quarter 2016, a decrease of $1.2 million, or about 2% versus the third-quarter 2015 sales of $59 million. Fueling Systems sales decreased by $0.3 million or about 1% in the quarter due to foreign currency translation. Fueling Systems sales declined about 1% after excluding foreign currency translation.

Fueling Systems operating income was $15.2 million in the third quarter of 2016, down $0.2 million, or about 1% compared to $15.4 million in the third quarter of 2015 as reported, and down $0.1 million, or 1% compared to $15.4 million after non-GAAP adjustments in the third quarter of 2015. The third-quarter operating income margin was 26.3%, an increase of 20 basis points from the as reported 26.1% of net sales in the third quarter of 2015. The third-quarter operating income margin after non-GAAP adjustments was 26.5%, an increase of 40 basis points from the 26.1% of net sales in third quarter of 2015 after non-GAAP adjustment.

The Company's consolidated gross profit was $85.5 million for the third quarter of 2016, an increase of $8.7 million, or about 11%, from the third quarter of 2015 gross profit of $76.8 million. The gross profit as a percent of net sales was 35.6% in the third quarter of 2016, and increased about 260 basis points versus 33% during the third quarter of 2015. Gross profit margin increase was primarily due to favorable pricing, lower direct material costs, and sales mix.

Selling, general, and administration expenses were $55.4 million in third quarter of 2016 compared to $47.7 million in the third quarter of the prior year, an increase of $7.7 million or about 16%. Roughly half of the Company's SG&A expense increase in the quarter, or about $4 million, was due to higher variable compensation expenses. Marketing and selling-related expenses increased about $1 million to support sales growth. And research, development, and engineering expenses increased by $0.8 million in the quarter.

The tax rate before discrete events in the third quarter of 2016 was about 27%, flat to the third-quarter 2015 tax rate before this readjustment. The effective tax rate as a percentage of pre-tax earnings for the third quarter of 2016 was about 25%, primarily due to the favorable impact from equity compensation share-based payment. The tax rate before discrete adjustments as a percentage of pre-tax earnings for the full year of 2016 is projected to be about 26%.

The Company ended the third quarter of 2016 with a cash balance of $79 million, which was about 3% 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 $71 million in cash flows from operations in the first nine months of 2016. The Company had no borrowings on its revolving debt facilities at the end of the third quarter 2016 or at the end of 2015.

The Company did not purchase any shares of its common stock in the open market during the third quarter of 2016. And as of the end of the third quarter 2016, the 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 November 17, 2016, to the shareholders of record on November 3, 2016. This concludes our prepared remarks and we would now like to turn the call over for questions.

Thank you.

(Operator Instructions)

Edward Marshall, Sidoti & Company.

Hello, Gregg and John, how are you guys?

Good morning,

Good morning.

So I wanted to talk about the geographic mix, and I'm wondering if there are more profitable regions around the world than others, especially as it relates to the water division.

Yes Ed, I would say that any region where we have a concentration of groundwater pumping equipment, so that may be is more cross mix than it is geography mix, but our Asia-Pacific business is a highly profitable business because it has that concentration. Generally our European business is highly profitable business because it has that concentration as well. So any of our geographic region that have a greater concentration of groundwater versus surface equipment where the Company has discussed in the past is more vertically integrated from a supply chain perspective, are generally going to be more profitable and have higher margin than those that are more concentrated in surface pumping equipment.

Got it.

I want to look to take on continental Europe, and if you include the Middle East in that number, can you, is there a way to break out kind of what you are seeing continental Europe versus the Middle East in general, as it relates to water from a growth perspective?

As we discussed, it has been ongoing for several quarters. Europe is flattish. We say that in the Middle East it's hard to get a record of current local currency that's been impacted by the strengthening dollar and the weakening Turkish lira.

Where we see in weakness been in the Gulf region, particularly in Saudi, we thought we would start seeing sales actually kind of back half of the first half of this year, it just did not materialize and it's clear that Saudi is reducing infrastructures spend, splitting over to couple of the other smaller countries in the Gulf region as well. We're just not seeing infrastructure spent. We are beginning to see some inquiries as we're coming into the back half of the year particularly (inaudible).

Right. How much would you contribute to that to political say versus the infrastructure spend on oil, I guess they are somewhat related but --

That's tough to call. Robert do you have a point of view on that?

They are very much intertwined. Certainly war has impacted us in the near and Middle East. The oil situation in Saudi has been, in our opinion, relatively stable, but the oil prices are killing their economy and they do have cash, quite honestly, to spend on infrastructure and other development.

Right. As we look forward, with respect to the more positive comments to 4Q in those regions, as we look out 2017 do you think that, is it contingent on what happens in energy or is this a replacement demand that you see that can kind of offset some of that or kind of how you see that playing out or how are you planning for that to play out in 2017 and beyond?

Broadly, as we have discussed several times, and we have very large replacement component, that exists throughout the globe in our water business. It's a very large replacement markets generally, that is why availability is so important when we have products out in regions (inaudible) to have products closer to the customer. As we look at that from a broad point of view, we would say that it's more related to economic factors, weather conditions, and overall GDP growth.

We would expect in that region, if you see some stability in the environment, that we would expect to see improving sales. I think the oil price has worked its way through the region, say the Gulf, as we go into 2017, our comp obviously in Saudi would be easier and around the globe for those areas of the globe that have trickle-down effect of the lower oil price, we should see easier comps going to 2017 has pretty much worked its way through our sectors.

And finally I'm just looking the fourth quarter SG&A expense, John, if I could. I know seasonally it tends to be a little bit weaker heading to 4Q but you have ramped up kind of that conversation expense into the back half of the year as things improved a little from some of what happened last year. So I'm looking for quarter, can you give some guidance as to SG&A as a percentage of sales of something that you kind of consider that the fourth quarter just because of the seasonality of that number throws it off a little?

We haven't historically. I think that as we look at the fourth quarter, on a total fixed cost basis which would be both SG&A and the fixed cost that is in our cost of goods sold, I think, we're thinking something pretty much in line with the third quarter. In total number was $79 million and in the third quarter we think it will be $79 million to $80 million in the fourth quarter.

The big point that happens in the fourth quarter as you know is we can really lockdown some of the compensation of reserve balances of the fourth quarter as we get much clearer picture of where we are going to be to some of the targets. Last year in the back half of the year, we were actually lowering those types of reserves but this year the back half of the year we are actually increasing those type of reserves so that becomes a meaningful maneuver for our back half and more specifically for the fourth quarter.

Great. Thanks for the detail. Sorry about putting you on the spot there. I appreciate it. Thanks, guys.

Ryan Cassil, Seaport Global.

Good morning guys.

Hello, Ryan.

Just a clarification on fueling. Did you say you are expected growth in the international market in the fourth quarter?

That is correct. We are expecting growth in the fourth quarter in fueling and our international markets.

Okay. Could you help bridge the gap on what you see changing from third quarter to fourth quarter? Any color on the competitive dynamics you are seeing in the fueling side? I know there's some potential consolidation of the space and whether or not you're seeing any impact on the competitive market as things were challenging in the quarter.

Yes. To respond to the first part of your question, we saw a push out of orders in India which we expect to see going into Q4, we saw some push out in orders in Australia and the Asian market more broadly. We expect improvement in Q4.

We will have a little easier comp on the underground floor, it's not a major part of the business, but the margin was part of the sales falloff with North Sea oil production coming down before last year so it will be a little bit easier. We generally just see a little breather here to see if international we expect to see that start picking up in Q4.

With respect to your question about competitive dynamics, again, the consolidation effectively is in a dispensing stage, which we do not plan and it has yet to actually occur. I think the acquisition of (inaudible), I believe their pending acquisition is still subject to review by authorities, so certainly there is no consolidation yet that occurred and it's in dispensing state which we do not currently operate.

Sure. Thanks for that.

And then on the US side, there has been a thought that there has been some increased refresh in the developed markets that changed out some of the financial payment systems. Do you think you are seeing any benefit that, and can you gauge what the impact is and if there is any follow-on effect as we move forward here?

Sure. We continue to get steady organic growth for the US market. We continue to gain traction with our products and you can look at the change on payment systems as being somewhat of a double-edged sword, on the one hand it diverts capital to do that change out. On the other hand, if you look at, there was a major upgrade of other ground tanks in the US market back in the late 1990s. And that is when many of the stations were refresh at the same time when we put in double wall tanks in the 1990s.

Those tanks are all, those stores are all now15 to 18 years old. I think you're just seeing as you point out a general refresh and people looking at payment systems, putting in expenses, doing kind of ground-up restoration of stations, moving stations because stations that were built 20 years ago may not be in the right areas for where the population is today. And so you just barely see a -- it's been a good stable market for us.

We are continuing to gain share. Our approach to the whole system package, we can deliver an underground package to a customer that is complete for the tanks, the dispensers. So it has been generally favorable conditions for us and we looked into a trade show and it was an upbeat show.

Great. Thanks, guys. I'll jump back in the que.

Matt Summerville, Alembic Global Advisors.

Thank you. Good morning. A couple of questions. First, what drove the magnitude of strength you saw on the residential side of the business as it pertained to groundwater? I believe you said it was up 17% in the quarter. That may have been against an easy comp but if you could just clarify that and similarly comment on your experience in agriculture in Q3 versus kind of have conflict there as well.

Sure, Matt. On the residential, our business was very strong East of the Mississippi which is where you have the majority of residential pumping systems. We have a strong distribution base. We are recovering some share we lost and we are building share based on new product introductions. We have had a refresh in our drives and our new center of connect and generally Franklin is more visible in the marketplace and it's paying off.

When you look at agriculture, you point out, agriculture West of the Mississippi, we've got rains which precluded probably second growing season or that second irrigation season where we often see in the central region of the country. Certainly the wet weather has improved the climate in California with reduced drilling activity in California so we see generally West of the Mississippi is a softer environment. But as we talked before, we have a large replacement for business so even again with comp rates where they are, with what are conditions, we had a positive year-over-year comparison.

What are you seeing in 2016 overall in both water and fueling in terms of price realization versus 2015, and I recognize it's early but these are discussions you're probably starting to have now, what are your plans in terms of pricing for 2017?

Well, we saw in the quarter about 80 basis points of improved rights over last year's third-quarter on a consolidated basis. All of that was in water and almost all of that was in our international units, including in Brazil. The price, environment in North America on the water side remains very difficult and competitive and our price in fueling in the quarter was down from last year as well.

So as we look to 2017, to answer your question, I do not think our expectation is going to be too different from what we historically put into our annual operating plan. I think it will be something in the 200 to 225 basis point assumption. We are optimistic that we will recover more in North America as we kind of get through this agriculture situation which is weighed heavily on price and we are confident in many of our international market stability to get price.

So I would say if anything versus what we normally would be looking at, this time of year, maybe it's backed up 25 to 50 basis points, something like that as we look at 2017. I mean, North America water is still very competitive. We're happy with the growth we've had there but it's a very competitive end market.

If you could comment on what you are seeing, there are some commentary in the prepared remarks in the release, just a little more specificity perhaps on input costs and what the outlook is there moving into 2017? I guess at the end of the day what I'm trying to get to is what the leverage, the incremental margins could look like in these businesses as we move into next year.

A lot of that will depend on mix and realized price, Matt. What I can say to you is as we look at the fourth quarter on a input raw material costs, we are still expected to see in a deflationary position versus last year's average price. But it is going to be a tighter one than what we have experienced so far year-to-date or experienced in the third quarter.

In terms of 2017, and we have not fully vetted 2017 from a full margin perspective, and it's better to leave that to another day when we can talk more candidly about our guidance there, but I think the key moving parts are we still expect that we will get some raw material benefit. For example, we look out at our full purchases of copper and other steels, we feel pretty good about where we are at on some of that. But mixed as I said, we will plan for the role in that as we will achieve price.

Great. Thank you, guys.

Ryan O'Donnell, Baird.

Good morning, guys. Thank you for taking my questions.

Hello, Ryan.

Just starting on the water side, can you guys just give an update? I know you mentioned pricing is still tough in North America. Just how inventory levels look at distributors, how the reset is going for you guys?

Really, we have distribution in place across the country that we need so really that is 2015 type news in our mind. Clearly with the achievement on the residential side and broadly east of the Mississippi, I think we're getting good traction and I think it is also a reflection of the product development we have had as well.

Yes. Okay. Just on the inventory levels, how those look in the year-end? Any chance you guys given the better year you might see more customers reaching for some of those year-end discounts and quantity discounts and things like that.

Yes. We do not hear a lot about real expensive inventory levels, Ryan. I think the channel inventory level as a core groundwater distributor market in North America are not bad. They are about right.

So yes, I think there is the possibility. We're certainly expecting growth in the fourth quarter in our core water business in the US. How much growth is the key question. I think there's a possibility those distributors could be reaching for some of their year-end incentives, so that gets all in play as we move though this quarter.

Okay. That make sense. And then just given some flooding of certain areas of the US and hurricane Matthew, obviously in the past couple of weeks, is there any chance you guys get benefit on some of the big dewatering pumps and things like that, or is that not really baked into your guidance at this point?

It is not baked into the guidance. Our distribution in the Southeast could be better than it is. There is still again -- for the pump growth companies, the fuel aquatics, while many of those pumps that we sold were fracking they redistributed those pumps to other locations. So I wouldn't think we would see much of the margin, we haven't heard a lot from our guys on that.

There was a little bit of construction for groundwater business in the Southeast, obviously. We lose power and the ability to get in to do the normal work. That now appears to be behind us because people have moved back to kind of a normal business here and certainly in Florida and I expect the Carolina's to follow.

All right. Last one for me just on the Pioneer side. Any change to rental, channel CapEx, things like that in outlook into next year?

What I would say is not a ton of change. It's still, it's not a very good outlook. Let's put it that way. I think if anything, it's marginally worse for us now than it has been.

What we're seeing is our large rental customers still dealing with a fleet that is in excess of what they need and trying to manage through that. We are busy, our intention is to find new outlets and find new distribution capability that we can tap into. Our business in that area I would not say looks much better. What we've been doing, we've been refocusing activity to other channels, more industrial so we are expecting Pioneer to have a higher top line next year than this year.

Okay. Appreciate the time guys.

Edward Marshall, Sidoti & Company.

Just want to follow up on Matt's question on pricing. We talked about the international being the driver of the price right now and in North America is difficult.

If I think about what is going on in the industry and you talk about one of your competitors had divested a business, a valve business, talked about the cash and the influx of cash to grow, among other things their water business, I am curious about how you are preparing for pricing pressure in North America to intensify? Also what that might do from an international perspective as well where you're not seeing the price pressure yet?

You're speaking, I believe, of Centera as divestiture, their business, where we were directly aligned with them is a relatively small part of their business. The competitive nature of the North American market to really be similar to where we are now, I do not expect it to change much with the decision on divested valves. Outside the United States, we really don't run against Centera in very many markets. Because of our more groundwater focus in their focus in other areas.

Got it. Thank you, guys.

Let's be a little clear though that the pricing environment internationally is also highly competitive. We have been able to see price in areas that are seeing a fair amount of inflation.

Like Brazil?

Exactly. Right.

Okay. Thank you, guys.

Thank you. I'm not showing any further questions. I will now turn the call over to Mr. Gregg Sengstack for closing remarks.

Thank you for joining us today and I look for to speaking to have our fourth quarter and the new year. Have a good week.

Ladies and gentlemen, this does conclude the program and you may now disconnect. Everyone have a great day.