Franklin Electric Co., Inc. (FELE) Q2 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Franklin Electric Second Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. (Operator instructions) As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Jeff Frappier, Treasurer, Franklin Electric. Please go ahead, sir.

Thank you, Daniel. And welcome everyone to Franklin Electric's 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, and 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 discuss certain Non-GAAP financial measures 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.

Thank you, Jeff. During the second quarter the company achieved record sales and adjusted earnings. And our adjusted earning 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 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 continued 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 has exacerbated for the July 1st strike of a national union metalworkers with which our employees are affiliated. So these two issues in two of our relatively small developing region markets mask what was a very good performance across the balance of our businesses. In the U.S. and Canada, our sales grew by 7% driven largely by surging demand for our 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…

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 noticed in the table 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, we believe presenting this matter in this way gives our investors a more accurate picture of the 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 trend vision 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 of 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 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 record 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…

(Operator Instructions) And our first question comes from Matt Summerville from KeyBanc. Your line is now open. Please go ahead.

Hi, couple of questions. First, Gregg may be on the restructuring or manufacturing realignment plan in Europe that is commencing later this year and extending into 2016. First, can you perhaps quantify what you expect a return on that investment to be i.e. or annualized cost savings once complete.

Hey, Matt. Good afternoon, this is John. It will have the significant benefit to the company, Matt. We are not specifically disclosing the annual cost savings from it simply because we are still in discussions with our partner, labor council and the unions in public to reach a final agreement on the severance. And we don't think it would be fair to talk -- start talking about those benefits until that matter is resolved. But when it is we will come 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 is quite few moving pieces in the water business. Whether it's mix induced by pioneer, whether it's the sort of political instability in Thailand, whether it's the strike that was in the mining industry, now it is in metalworkers union, can you talk about is there anyway 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. If you try to break it down because there are several moving parts. If you look at Asia-Pacific, we had stronger sales with our service pump business pioneer which is typically little bit lower margin, our commercial business is off double digit so that mix drives down the profitability. In addition, we were selling Thailand because of what was going on, selling as much, and so the margins were compressed because our sales in other parts of region have somewhat lower margins and there is also the way in orders or timing of orders coming out of Korean heartland and Japan, some of that's related to currency, and they do some speculation on currency. So that was a big chunk and in the situation in South Africa, the country has been generally and always with so much contraction of the economy and so that's overhang for our business. The strike in our facility or actually strike by the metalworkers which affected our facility started 1st, July. Plus the impact of South African currency, the impact is a top line and if you just look at those two situations Asia- Pacific and South Africa, there is really 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, resulted the last year's profitability for those two businesses would have made that difference.

And then what sort of the outlook I guess for this current strike. Is it still ongoing? Is there a view that it is going to be resolved? I guess how do you know what the ultimate impact is going to be in Q3?

Well, 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 will be back working by the 1st of next week. And hopefully there is some pent up demand that will help quarter, we do have to get our production going and get the sale.

Okay. And then just lastly in the Fueling Systems business, how much of a growth do you think you are seeing now is been driven by its conversion to pressure systems? And then I guess using the baseball analogy, how far long do you think the rest of the world is outside North America with this conversion? I am 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 tender activity in India. And I think that give 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, and we are not going to make the investment but generally speaking pressure is more efficient than suction. It allows for larger station as people want to put in larger station. It's really the only way you can operate them. And I would say that we are -- it is 90% converted the United States maybe 99%. The rest of the world, we would say less than half, maybe less than a third and will continue to convert over a period of time. So they have got pretty long runway. The other thing is that you are thinking of number of gas stations and rest of the world is four to five times that they are in U.S. and Canada. And so as we get larger installed base, now the system do last for 10 years, 12 years maybe but they have to be replaced. So we are going to get larger installed based which will allow for larger replacement business over time.

And then just lastly it sounded like your break revenue was very good whether it's skewing or even otherwise. I guess are you not then Gregg seen any impact from issues in Eastern Europe and Russia and the Middle East currently?

I wouldn't go that far. I would say the first off, our business in Russia in fueling had been somewhat soft for a period of time and we've made some changes and we are getting traction again so we had a recovery over an easier comp and Russia. Certainly India is doing very well. China is doing very well. And we've been growing our business from a small base in Brazil. So specifically those four countries, we see nice growth. Middle East, it is more of have been -- I think more directly disrupted for the water business in some countries. We go surge in sale like we did in Algeria last quarter. And then we will see countries go offline like Syria, certainly a situation in Iraq and other parts of Middle East are disruptive for our water business. Probably not so much for the fueling business. But specifically to Russia, Ukraine, relatively small base, we made some changes, we are getting traction and that's why we got the result

Thank you. And our next question comes from Ryan O'Donnell from Robert Baird. Your line is now open. Please go ahead.

Good afternoon, guys. This is Ryan on for Mike. Hey, so it sounds like the Ag outlook has weakened a little bit. Can you guys just talk a little bit about what are you seeing there and kind of the outlook for the year into next year?

Again, our outlook is fairly limited because we don't operate out of backlog, a much upside of the pioneer pump business. But I can give you these observations. As we reset our distribution, results kind of came in where we thought they were, they are little bit up in the West Coast, were little drier, little bit down maybe in Southeast was still little bit, the weather has been less favorable but overall our reset distribution, the sales been flat to last year. In the center of the country where sales been little softer and we are --we've seen both for weather and also prices, we are seeing a little bit impact. I don't think, I read in couple of press releases for center point guys obviously they have much better capital equipment and a lot more of their business I suspect is new installed and we are a very large installed base so more of our business is replacement. But we are seeing some softness in the center of the country and we suspect due to weather and due to crop prices.

Got you, okay. And then on the distribution changes. How are those tracking relative to your kind of internal expectations? And are there any reasons why some of the new distributors might be taking a little longer to get up the speed on the inventory side?

Yes. As I mentioned just a little bit ago, basically flat in those areas where we made the changes which met our expectation. And I think that distribution have to go through a de-stocking and restocking trend and if markets are little soft, it's going to be a little slower. So that's why we offer some caution to Q3 although we still expect our U.S. larger than sales to be up in the third quarter.

Okay. And then last one for me guys, the timing of the in-house shift and some of those components with the pioneer business. How are you guys thinking about that? And what are the margin benefits we should be thinking about in the back half I mean into next year?

I'll let Robert Stone speak to the pioneer businesses and some of the activities they are going to deal with the strong growth in pioneer and some of the thoughts about re-sourcing.

So the quarter started very well. I'll discuss customer NPC was acquired by United Rental. We have been running with a really good backlog as United Rental starts to add branches where it is stocking and renting pioneer pumps. The ramp up came very quickly and as you know there is a very long supply chain on engines and some of the casting things that we get. So we've been forced to go outside and decided to take care of our customers' request in terms of demand and we've 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 supplier and in-sourcing product bought the kind of rolls through the income statement it's going to take a couple of quarters to get there.

Thank you. And our next question comes from David Rose with Wedbush Securities. Your line is now open. Please go ahead.

Good afternoon. 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 detail. We could say that our U.S. and Canada water business was down less than 2% in revenue and it was flat on earnings. So we are able to actually improve operating margin in the quarter relatively to last year. And generally we can look at sales to distribution and say that our overall sales in regions that were major changes were flat to last year.

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

Again, what I 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 de-stocking and that was down -- that's down by high single digits.

David, I think the way we would say that as Gregg said, I think we are pretty pleased and feel more confident that we are on the right track here. When you pull pioneered product out of the U.S., Canada sale and which leaves you kind of core groundwater business and the surface water business, we are 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 that it's going to be as Gregg mentioned inventory resetting and the pace at which our new customers ramp their inventory down the buyer which they start with us, all of that was a bit uncertain but generally we look at the results excluding pioneer again all and all pretty much what we expected and pretty confident that the decisions in the moves that we made are going to be right ones long term for our company.

Okay. I get it. It's a little hard to parcel that out. And change of gears to the fueling systems numbers. Can I infer then that U.S. was down?

No. We said that all regions and all products lines are up in the quarter.

Okay, sorry that includes U.S., got it. And your expectations in terms of product line in the U.S. because your vapor recovery is got to be down, right?

Well, certainly vapor recovery outside the California is being decommissioned and so that is then a drag for last several quarters. And we will making that up in other product line across the board again. Pressure pumping system, fuel management system, piping systems. So we continue to see good growth in North America even with what we call prior single digit decline in our vapor recovery system.

Okay. And then outside of the U.S., how should we think about the trajectory? I mean the business maybe lumpy, it's not terribly smooth, that's the way to think about right, should we sort of think about the same sort of growth rate you had this last quarter ex-India or how should we think about for the next couple of quarters?

David, as we talk, our fueling business has a tremendous growth opportunity in front of it primarily in the developing region. And we would look at this on consistent basis to be high single, low double developing region growth kind of business. So you are going to see some spike based on timing and customer order and tenders in India and things like that. But generally, this is a high single digit, low double digit growth platform for us into developing region.

Okay. So outside of the $2 million that you called out in a quarter for India, there really was not an anomaly here?

There is always timing of shipments. When you look at the fueling business, David. But to call it anomaly I am 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, slightly lower basis. The ASEAN countries were strong. So this fueling growth is pretty broad based.

Pretty broad based, we are seeing some traction in China. You have seen a cycle through and this is in vapor recovery, and we are seeing some pretty good growth for China this year as vapor recovery area and we expect that to continue in the back half.

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

We are continued to be on track, we are looking to get $45 million revenues here. We continue to get more test site as with one of our user the other day listening to -- they were happy with the system and they have tools on the ground and like try to some more. And that's kind of what's the business have been, they want continue to testament, pushes the limit and see how far they can go with our pumps, they are holding up well. And we are on track for this year.

Thank you. And our next question comes from Edward Marshall from Sidoti and Company. Your line is now open. Please go ahead.

Good afternoon. How are you guys doing? Good? Okay. So I wanted to ask, looks like first of all back on to the artificial deliver system. I think you said you are on-- you just said you are on track for this year. But I think your expectation was to double revenue again next year. Are you still on track for that goal?

Well, it's difficult to have visibility for that. But we have a lot of individual projects that are irons in the fire. And we remain optimistic that one or more of them are going to pop. We continue to get interest in the system. We just installed a couple of systems in China. We have orders coming -- systems that we delivered going to go to 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 -- we are not focused on. So we are getting some interest but that it is to convert into orders and we'll see offer could come.

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 are 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 got a lot of new amortization and other kind of 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 the strong sales force and good products. So we are optimistic on that. And as we get more into this integration we will have more to say about that business.

Then finally I guess it relates to the acquisition and this common 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 acquisition or does that include the Brazilian acquisition? Just to clarify that point.

Yes. That would that mean that we are not assuming any future acquisition.

Okay, perfect. So 8% to 10% includes the acquisitions you've already made in 2Q.

Yes.

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 interest in our company. You all have a good evening.