Franklin Electric (NASDAQ:FELE) Q2 2020 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by, and welcome to the Franklin Electric Reports Second Quarter 2020 Sales and Earnings Call. At this time, all participants are in listen-only mode. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you would like to ask a question, you need to press star 1. And I would now like to turn the call over to Mr. John Hines. are chief financial officer. Sir, please go ahead.

0:33 Thank you, Rainn, and welcome everyone to Franklin Electric's second quarter 2020 earnings conference call. With me today is Greg Singstack, our chairman and CEO. On today's call, Greg will review our second quarter business results and the impacts our company is experiencing from the global pandemic, and I will review our second quarter financial results. When I'm through, we'll 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.

1:23 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. With that, I will now turn the call over to our Chairman and CEO, Greg Singstack.

1:52 Thank you, John. Thank you all for joining us. Similar to last quarter, I am going to cover four topics in my prepared remarks. First, I would like to address the health status of our employees. Second, I will review the results of our second quarter. Third, I will review the current state of our business. And fourth, give you our current thinking about how we see our business for the balance of the year. So first, the status of our employees' health. We continue to monitor our facilities globally. Our global product supply leadership and facilities teams have done a great job maintaining protocols to keep our people safe. We continue to follow the guidelines from the U.S. Center for Disease Control, the CDC, other global health authorities, and national, state, and local government requirements and guidelines.

2:42 I will now review the second quarter 2020 results. No one wants to report sales and earnings declines, but given the environment, I'm very proud of everything our team accomplished during the growing global pandemic. The product supply organization worked thoughtfully to keep the supply chain, factories, and distribution moving while maintaining a safe workplace under guidelines that were changing frequently. Sales, marketing, finance, IT, and other support functions continue to operate often remotely. It's been quite a journey for us and for all of you on this call. It's not over. but the Frank Electric team is even more nimble in its response to the challenges we have been presented. Turning to the quarterly results, similar to the first quarter, our second quarter results were better than our expectations we had at the time of our last conference call on April 28th. While manufacturing revenue was down double digits, improved mix, margins, and reduced operating expenses produced operating income that was higher than our expectations.

3:45 Our distribution segment revenue was ahead of expectations and second quarter sales and operating income were a record. You may recall that due to COVID-19 essential work restrictions in several states, distribution segment revenue was down 4% in April as compared to last year. However, with more normal weather and a relaxation of most restrictions, our distribution segment finished a quarter up 6% compared to last year. In the second quarter, our water systems revenue declined organically. The primary driver of this was the continued low level of sales of large dewatering pumping equipment to mostly equipment rental companies in the U.S. It was exacerbated by the decline in oil prices. These pumps are also used in mining, municipal, and other industrial applications. The decline in dewatering pump sales was the primary factor leading to the sales decline in our U.S. and Canada water business.

4:37 Sales in the plumbing channel were also lower. However, from our channel checks, we believe most, but not all, of this decline is due to inventory destocking. Groundwater equipment sales in the US and Canada grew organically in the quarter. Outside the US and Canada, water system sales in our major end markets of Asia, Pacific, Amina, and Latin America grew 9% organically. These end markets represent 40% of our global water system sales. Unfortunately, revenue in India and Southern Africa which accounted for approximately 3% of our water system sales in the quarter, was down about one-third due to those countries basically being shut down for about a month. The fueling business revenue decline in the quarter is pretty much in line with what we expected. The business in the U.S. slowed dramatically, and outside the U.S., business continued to be soft. Business in China continues to be down about 60% from last year's levels.

5:34 During the quarter, on a consolidated basis, we continued our focus on the reduction of working capital. The ratio of working capital to trailing 12-month net sales improved from the second quarter last year. This improvement, along with other factors, improved our free cash flow materially. With our seasonality, free cash flow is typically negative for the first six months of the year. I'm pleased to report that for 2020, our year-to-date free cash flow exceeded net income. As we reviewed with you at the end of last quarter, the global pandemic has primarily impacted our 2020 revenues in four areas. In water systems, demand for our largely watering pumps sold into a variety of industrial applications has diminished. This in large part to the sale of this equipment to rental companies that support oil and gas production primarily in North America.

6:24 As we have seen historically, this is one of the most cyclical areas of our water systems business. Our efforts to grow our large dewatering pump sales through geographic channel and in-market diversification has mitigated this situation somewhat, and we expect sales in the back half of 2020 to improve sequentially. Also in water systems that are consistent with what we experienced in the financial crisis of 2008 and 2009, we have seen our customers significantly reduce purchases from their suppliers to bring down their existing inventories in response to the uncertainty of future demand and to preserve cash. We see this is particularly true with our larger U.S. customers who buy surface pumping equipment for wholesale and retail distribution and to a lesser extent in our groundwater channel. We believe the impact of this destocking is mostly behind us.

7:11 The third area of end market disruption is in our fueling system segment. With reduced miles driven in the U.S. and the commensurate reduction in store traffic earlier in the second quarter, several large C-store marketers deferred or canceled plans for new station builds and upgrades. However, with gasoline consumption recovering, some of these marketers have decided to move forward with their original or a reduced plan. Additionally, although we see some signs of recovery in our fueling revenues in China, we knew 2020 would be a transitionary year between regulatory mandates there. Our current thinking is that our 2020 China fueling revenue will be about half of 2019. Finally, the strengthening of the U.S. dollar versus many global currencies hurts our year-to-date translation of foreign-denominated sales and earnings.

7:56 John will give more details on this in a moment. Looking forward, as we enter the third quarter of the year, our global supply chain is operating near normal. Supplier lead times have come down and are similar to the fourth quarter of 2019. To give some sense of our current revenue, during the first weeks of July, our distribution segment sales were up 8% over the same time last year. Water system sales are up 11% over last year. Fueling system sales are down 16% as compared to last year. Last quarter, we withdrew our earnings guidance. We had developed several scenarios. However, the range of our outcomes was so large and the uncertainty so great, we did not believe it appropriate to provide guidance. In looking back, our team delivered better than what we considered our, quote, most likely, unquote, scenario.

8:44 With this outcome, we are reinstating guidance. This guidance is based on our internal forecast, which we routinely update in June. Since then, however, the growth in positive COVID-19 cases in the U.S., Brazil, and other countries has accelerated and uncertainty has increased. Therefore, while we are reinstituting guidance, we have expanded the range of our guidance to reflect this greater level of uncertainty. We currently believe that we will achieve 2020 earnings per share before restructuring expenses of between $1.75 and $1.90. We also believe that our 2020 free cash flow conversion will be north of 130% of net income. I will now turn Over the call, back to John. John.

9:24 Thanks, Greg. Our fully diluted earnings per share were 52 cents for the second quarter of 2020 versus 70 cents for the second quarter of 2019. Second quarter earnings per share before the impact of restructuring expenses was 54 cents compared to 2019 second quarter EPS before restructuring of 70 cents. Restructuring expenses in the second quarter of 2020 were $0.9 million and were related to various manufacturing realignment activities in the water segment and resulted in a 2% impact on earnings per share in the second quarter of 2020. Restructuring expenses in the second quarter of 2019 were $0.2 million and had no impact on earnings per share in the second quarter of 2019.

10:15 Second quarter 2020 sales were $308.3 million compared to 2019 second quarter sales of $355.3 million, a decrease of 13%. Sales revenue decreased by $12.2 million or about 3% in the second quarter of 2020 due to foreign currency translation. Water system sales in the United States and Canada decreased by 16% overall compared to the second quarter 2019, primarily due to lower sales of dewatering equipment. Sales of dewatering equipment decreased by nearly 70% due to lower sales in rental channels and substantial uncertainty in oil production and markets.

11:04 Sales of groundwater pumping equipment increased by 5% during the second quarter 2019. increased by 5% versus the second quarter of 2019. Sales of surface pumping equipment decreased by 18% on lower sales of both wastewater and water transfer systems as customers in this channel saw a more uneven demand environment from their customers and lowered their own inventory levels. Water system sales in markets outside the U.S. and Canada decreased by 9% overall. Foreign currency translation decreased sales by 12%. Outside the U.S. and Canada, water systems organic sales increased by 3%, primarily driven by higher sales in Latin America and Asia Pacific, as well as increased sales in both Europe and the Middle East, offset by lower sales in the Africa market.

12:09 Water Systems operating income was $28.7 million in the second quarter of 2020 compared to $30.9 million in the second quarter of 2019, primarily driven by lower revenue. Viewing system sales in the U.S. and Canada decreased by 22% compared to the second quarter of 2019. The decrease was in all product lines and due to declining demand for new filling stations. Outside the U.S. and Canada, Viewing Systems revenues declined by 35%, driven by lower sales in Asia Pacific, primarily China. Viewing Systems operating income was $13.5 million in the second quarter of 2020, compared to $21.7 million in the second quarter of 2019, driven almost entirely by lower revenues.

13:07 Distribution sales were a record at 92.1 million in the second quarter of 2020 versus second quarter 2019 sales of 87.1 million. The distribution segment organic sales increased 6% compared to the second quarter of 2019. More favorable weather conditions versus the second quarter last year contributed to the revenue growth. The distribution segment operating income was $6.8 million in the second quarter of 2020 compared to $4.5 million in the second quarter of 2019, primarily due to higher revenues. The company's consolidated gross profit was $107.1 million for the second quarter of 2020, a decrease from the second quarter of 2019 gross profit of $119.7 million.

14:02 The gross profit as a percentage of net sales was 34.7% in the second quarter of 2020 versus 33.7% in the second quarter of 2019 and improved primarily due to better price realization and product sales mix. Selling, general, and administrative expenses were $72.3 million in the second quarter of 2020 compared to $75 million Thank you for joining us today. Due to the net result of unfavorable discrete events, our 2020 effective tax rate net of discrete events should be between 18 and 20% and consistent with our original financial guidance.

15:18 The company ended the second quarter of 2020 with a cash balance of $43.1 million and generated $37.6 million of free cash flow from operations during the first six months of 2020 versus a negative free cash flow in the first six months of 2019 of 5.4 million and had total incremental borrowing capacity of 480 million at June 30, 2020. Here are some additional thoughts to follow up on Greg's comments regarding our 2020 guidance and the impact of the global pandemic. We are reinstating re-initiating guidance for 2020 EPS before restructuring charges to $1.75 to $1.90, implying a second half EPS of $0.97 to $1.12. The global pandemic continues to challenge our customers in the end markets we serve and could potentially disrupt our manufacturing capability and disrupt our supply chain.

16:24 The factors that are most impacting us, as Greg said, are the continuing uncertainty around new filling station builds, the reduction in large to watering equipment demand, and the stocking of inventory levels by certain wholesale customers, primarily in the United States. Additionally, the strengthening U.S. dollar will continue to negatively impact the translation of foreign currency-denominated net sales and earnings. Right now, we think the foreign exchange impact on water system sales will be about 4%, and for fueling systems less than 1%. Despite the uncertainty the pandemic creates related to our top and bottom lines, we still believe we will achieve a 2024 year free cash flow conversion of between 130 and 150% of net income.

17:19 Yesterday, the company announced a quarterly cash dividend of 15.5 cents that will be paid August 20th to shareholders of record on August 6th. The company made no purchases of its common stock in the open market during the second quarter of 2020. At the end of the second quarter of 2020, the total remaining authorized shares that may be repurchased is about $934,000. This concludes our prepared remarks and we would now like to Turn the call over for questions. As a reminder, to ask a question, you will need to press star 1 on your telephone keypad.

18:04 To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from Mike Halloran from Beard. Your line is open.

18:19 Hey, good morning, everyone. Good morning, Mike. Good morning. Maybe just start on the inventory side. I understand that the wholesaler side of the inventory was depleted through the quarter. Where does that stand now? If you could, extend the question to the other channels, specifically Headwater, any of the other water businesses, and just where the inventory levels sit from your perspective in the channel.

18:47 Mike, so again, this is anecdotal information from some channel checks, is that to your point, in the surface pumping business, we sense that in the second quarter, particularly the first half of it, that there was a destocking going on. At some point, that seems to come to an end. There's some indication we're having a pretty hot summer, and so the HVAC condensate product line seems to be out the door sales from those guys are pretty good. So we'd expect that that's going to be a A potential tailwind for us in the back half. With respect to the groundwater channel in the U.S., I'd say a similar story, maybe a lesser degree. You remember last year was pretty wet in the first half. This year is a little getting more to a more normal year, normal weather pattern.

19:34 And so I would expect that we saw some destocking there, but not as maybe as material as we saw in the plumbing wholesale channel. On the largely watering in North America, that tends to be more. We get the orders in chunks. And certainly with oil, even though a negative in the first quarter, or second quarter, excuse me, that certainly was pause for cause. But I'd say looking at the back half here again, we're seeing interest by the rental companies and others to put in more orders. So we're seeing that stabilizing. Outside of North America, I don't see such dramatic changes in inventory levels. John, do you have any other thing you want to add?

20:14 Yeah, just on the dewatering, Mike, you know, we mentioned that we think sequentially that'll start to get a little bit better in part because of the comps. But in the first half, that equipment was down about 52% from the prior year. And in the second half, we think it'll be down about half that amount, about 26% versus the prior year. So, still down meaningfully, of course, for the reasons Greg described, but sequentially a bit better.

20:47 Well, that makes sense. Also, good jumping off point to the second question. Maybe talk about what's embedded in the guidance from a sales perspective. Obviously, the fueling piece, you're expecting to see sequential improvement from trough. You're running at pretty healthy levels in some of your water businesses as we sit here today. You know, what's embedded in that back half from an improvement perspective relative to normal sequentials? Feels like there's some growth that you're still expecting in some of those businesses that are doing pretty well right now. But any context around that would be super helpful.

21:25 Yeah, so on the guidance, Mike, I guess the way I would describe it would be that we kind of had two ends. We had a low end and a high end that we were manipulating this June forecast that Greg mentioned. And generally, the low end is basically assuming that there's kind of the same earnings per share decline in the second half that there was in the first half. Call that about 14%. And that the revenue improvements that we would see are pretty modest from water and fueling and pretty consistent in distribution with what we saw in the first half.

22:14 If you go to the higher end of our range, then we're starting to see EPS declines of about half of what we saw in the first half, about 7% versus the 14%. And there we're seeing pickups in water and most notably in fueling. So our fueling Thank you very much. has a more meaningful impact on our EPS. So I think relative to guidance, that's the way we would describe it. You know, we don't really see distribution changing much. They're having a great year. They're going to continue, we think, to have a great year. Water, incrementally better, but I think where the big improvement in our range is coming from is more on the fueling side.

23:27 And that is a more difficult one for us to predict simply because of... The U.S. market and China markets, we've got some ideas about what's going on there, but it seems to be changing frequently.

23:45 That's definitely a fluid situation. Makes sense. Last one for me. Really resilient, strong margins in the quarter versus where revenue is at. Could you just talk a little bit about the puts and takes in that margin profile qualitatively and then Also, just maybe how much is kind of normal incrementals versus what your specific cost-saving initiatives are?

24:15 Yeah, so I would say that the two primary factors that, well, the primary factor that was driving water improvement was we did have a fairly meaningful mix shift. So as we mix shift revenue, Mike, as you know, to groundwater, that improves. The other factors, however, were a pretty aggressive approach to SG&A and the water businesses, and then also raw material costs and direct costs being more favorable as well. So, as you see from our table in the release, the primary impact of our margin improvement was from The water business, followed by distribution, and distributions, I think, is just more, you know, kind of tight SG&A spending, but getting more volume through that fixed cost base.

25:13 The highest detrimental margins that we have in the company, as you know, are fueling systems, and we lost some margin there, mainly because of losing leverage on our fixed cost base. So as we think about the back half, I think the decremental margins that we saw here will likely still be in play in that range, although I think the viewing margins can get a bit better than where they were in the first half. And many of the same factors that improved our water margins, be it mixed, be it SG&A, cost takeout, or input cost improvements on the raw material side. We don't expect those to change dramatically as we go through the second half and would expect to see improving margins from the prior period, from prior year.

26:10 Thanks for that, John. Appreciate the time, guys.

26:13 Take care. Your next question comes from Chris McGinnis from Sidoti & Co. Your line is open.

26:24 Good morning. Thanks for taking my questions. Nice quarter. Good morning, Chris. Hi, Chris. I was just wondering if, just kind of given the kind of declines in the markets, are you seeing any opportunity to put the balance sheet to work? And, you know, is there any opportunities kind of presenting itself on the acquisition or the M&A side?

26:42 Yeah, Chris, a couple things with the balance sheet. One is that we had the opportunity to support, you know, customers and suppliers that are critical to us. I mean, all our customers are critical, their spotters are critical, but from a standpoint, they were in trouble to be able to work with them. So that was one use of the balance sheet. Another use, to your point, is M&A. And the pipeline seems to be pretty robust as of late, so we'll continue to look at that. We didn't do anything in the court, obviously, but we do see the M&A pipeline as being fairly active now.

27:19 Okay, thank you. And then just one question just on the water side. Talk about the large de-leveraging or de-watering equipment. You know, how quickly does that typically come back in kind of a, I know this is obviously a very different environment than 09 and 08, but how quickly does that come back? It seems like things are starting to improve a little bit.

27:41 I think you need to, yeah, that one I'd probably focus more on the 14, 15 when the last time it was bigger oil shock. and the financial crisis. John, do you have a sense for the kind of sequential improvements as compared to back in the 15, 16 time frame?

27:56 I'd have to look at that, Greg. A lot of it has to do with the rental channels. Chris, I think the biggest thing that is the headwind here is the state of the oil world, the gas, oil and gas exploration in the U.S., which drove some of the peaks here. The outlook for that is really poor, so I don't know that we have a lot of optimism about this coming back in a large way. The reality is that as we go through the back half, as I mentioned earlier, the comps to the prior year get a bit easier. But in terms of end market demand, we think that 75% of this business is in the U.S., so We think a large portion of that will stay relatively weak because of O&G in North America.

28:56 That said, this downturn was probably more dramatic than the 2015 downturn, and we have done a level of diversification in other end markets. John pointed out, we have 75% of the business in the U.S., but we've been growing the international piece. We have some offset, but it's like it was back then. It's going to take a little bit of time. It's a capital-intensive business, and it's one that you see more cyclicality.

29:21 Great. And then just one last question, just on the cost savings. How quickly do they, you know, if you see stronger trends come back, how much of the savings, you know, need to come back, I guess, you know, if you're thinking about that as trends improve?

29:38 Our SG&A in the second quarter was down about 5%. The way we're thinking about the back half is probably more likely going to be down 3% to 4%. That's on the total base. You know, there's a lot of assumptions in that. One of the key categories of cost takeout was travel. As you know, in this quarter, in the second quarter, travel just kind of ground to a halt everywhere. So we've got some assumptions about some of that coming back. We've got a little bit better assumption around some of the compensation categories that were dialed back in the first half of the year.

30:32 You know, that's probably the best way to describe it. It was down 5% in the second quarter. We're thinking 3% to 4% in the back half.

30:41 Yeah, much appreciated. Thanks, and good luck in Q3.

30:45 Thank you, Chris. Your next question comes from Ryan Connors from Benning and Scatter, your line is open.

30:56 Great, thanks for taking my question, guys. And congrats on a really great result in the environment, really strong. A couple bigger picture questions. Greg, you made a comment in the press release about the business being less cyclical. And I wonder if you can just kind of unpack that a little bit. I mean, obviously some businesses are longer cycle than others. For example, municipal, you know, four months falls really into the book shift time frame in municipal businesses. The CapEx cycles there really take a couple of years to play out. Can you discuss the portfolio in terms of what's shorter cycle versus longer cycle and how you see the things playing out over a year, 18-month time frame?

31:43 Talk about the different types of cycles you're playing into there.

31:47 Sure, Ryan. Thanks for the comments. Good to speak with you this morning. Let's talk about fueling first. Fueling Our people are in discussions with, you know, the U.S. market's about half, a little more than half of our business. And our people are in touch with the major marketers who tend to drive at the margin initiatives for capital spend and give us a good insight into kind of how the overall U.S. market is operating. And so, you know, they'll be talking to them throughout the year. They generally get, you know, kind of a year look at their spends and their planned station builds and rehabs. and then, you know, we'll get updates through the years. And those station bills and rehabs, you can think, you know, probably anywhere from a couple months to, say, a six-month, you know, advanced time frame.

32:35 You know, you've got to get a contractor on site and if you're going to do a whole scrape on the front, you're going to, you know, it's going to be a few months of lead time. So that's kind of the view there. You get outside the United States, we get pictures on state-operated oil companies and kind of, again, their multi-year plans Some of this stuff gets pushed to the right. We've seen some plans in India, for example, get pushed to the right. We've certainly seen in China the next regulatory initiative at ISD get pushed to the right. There's a little more opacity, a little less clarity in China. And then particularly this year has been difficult with COVID and now they've had flooding and they've had some other challenges. So it's a little less clear in that market, which is meaningful for us. and Station Builds. But again, if you start in the United States, you kind of say you've got a visibility of a few months to maybe six months out on planned builds.

33:27 Then we move over to the water business. And as John and I have talked about with you in the past, you're a largely watering pump line on a brand name Pioneer. Here again, we're talking to the rental companies and we've done a nice job diversifying into other areas, but the rental companies still drive that business that's oil and gas related. Again, we're looking at their capital cycles, and we can see where they're beginning to lay in orders now for, say, Q4. So we're seeing, again, kind of four months out, five months out, they're beginning to see some visibility to their plans in that business. Outside of that, we get to where our visibility is a few days. I mean, it's effectively, yes, we're talking to the end customers. We get to the large customers and some sewage effluent or plumbing and HVAC channels.

34:15 and some of the larger customers we do business with. They're going to give you some sense for their sell-through, but they lay orders on us and they're expecting delivery at a shift time of, say, five to seven days. So we get really short on that, and a lot of that's replacement business. I mean, yes, there's new home construction. Yes, we do see new installs. But we say, what, 80% of our business is replacement, so it's weather-related, it's economically related. and it's a very short cycle. Outside the United States, you'd say maybe there's a little bit more of a new inflation because you think about our platform and emerging markets. We want to be there because that's where all the people are. As people's standards of living increase, they consume more water and fuel.

35:01 So we tend to say the replacement percentage there is lower. But here again, our visibility, because of the nature of the product, is pretty limited to anecdotal or qualitative comments from our customers, and then they lay an order on us and expect it to be delivered in a relatively short period of time. Is that helpful? Is that what you're looking for? And then, excuse me, the last point is distribution. Distribution is you show up at the counter in the morning for a product you may have ordered the night before. So it's really, again, it's an emergency replacement type business. Is that touching on what you were looking for?

35:34 Thank you very much for having me. But there's also sort of increasing talk about unintended consequences of that. There's a lot of talk about that the herd's not getting thinned in terms of companies that were indebted in different spaces. And I wonder if you could talk about, you know, more an opinion, obviously, but what your perspective is on that, how that manifests itself in your industry. I mean, are there smaller players who would have been acquisition opportunities, you know, who took PPP and now they're going to get through, and now they're not going to be coming to markets?

36:28 or maybe other weaker players who are problematic in terms of pricing in the market who are limping along and survive now and don't get culled from the herd. I mean, what is your view on, yeah, we got saved short-term, but are there consequences now longer-term that could be negative?

36:45 Yeah, Ryan, it's an interesting question. I appreciate you asking. As you said, it's an opinion. Yeah, in the U.S., in the fueling business and in the water business, you know, This has been a lot of consolidation over the last two, three decades. And so, yes, there are still many family-operated businesses. I grew up in a family business, so I've enjoyed it. This is no disparagement of family businesses, but they tend to have lower capitalization, or they may have different expectations than, say, a publicly traded company or a large corporation. So to the degree that there are family businesses out there or smaller businesses that are under stress, then I suspect, to your point, there will be a fallout. But in the water business and the fueling business, they tend to be conservative businesses.

37:33 They tend to be pretty steady businesses. And so the ability for people to plan is a little bit easier, a little more transparent. and so I don't expect that you're going to see the kind of fall you might see, say, in the travel industry or hospitality industry or some of these other industries that have much more dramatic volume impacts in the service space than you'd say where we're in end markets that are basically human condition. People need water, people need fuel, so that end demand is not going away and I think that creates stability in the marketplace. Now, if somebody, you know, this precipitates a discussion by a family business to say, Look, we may want to look for a different strategic option and knock on our door, and that's why we are very pleased that we have a low-levered balance sheet and we have the ability to respond to those families as we have in the past.

38:22 Yep. Okay. That's very helpful. Thanks for your time. Thanks, Ryan. Thank you. Your next question comes from Walter Liptak from Seaport Global. Your line is open.

38:37 Hi. Good morning, guys.

38:39 Hi, Walter.

38:41 One on the cost side, what we're seeing from a lot of our industrial companies is that they're kind of rethinking cost structures and, you know, overhead levels. And, you know, I wonder if, you know, as we went through this, you know, the last six months or whatever, if you had a chance to rethink some of the way the company does business and if, you know, there's anything structural in cost that can come out. Because if I'm Not mistaken, it sounds like most of the cost reduction you've done been on travel, more temporary cost reduction.

39:19 Yeah, I would say the one clear thing that we've done, Walt, is we've accelerated some of our restructuring activities that we have on our fixed cost base. You know, our manufacturing or global product supply team kind of has a A multi-year plan as they think about our capacity and our needs around the world. And there's always some type of an effort or project going on. And one thing that we did this second quarter was to accelerate a couple of those projects that were in the United States that were actually planned out. So I would think as we think about the longer term and think about cost structure, it's that footprint both manufacturing and supply chain footprint where the biggest bang for the buck is, we believe.

40:15 Now, when you turn to SG&A, we absolutely took a critical eye, especially in our water business, towards headcount, toward other non-discretionary spend, and we took a fair amount of that out in the second quarter. Most of which will not come back. Now, some will clearly come back with volumes, but most of which will not come back. So I don't know that I would necessarily portray that as a different view of the company or a different view of the world. I think it was more a different view of where our top line was going and making some difficult decisions about short and long term and taking those actions.

41:05 I don't want to only imply that we did that in water. We did it in viewing. We did it all across the company. But I think it was more related to here's the current state versus having kind of a different two or three year look at what the company was going to be. That's my take.

41:29 Okay. Okay. And the supply chain, have you... I've been rethinking supply chain, and some companies are shortening the supply chain, trying to get a little bit more local. It doesn't sound like you've had too many challenges with supply, if I was reading that right, but I'm thinking about electronic parts or maybe motors or something like that that might come from the Asia Pacific region. Any thoughts there?

42:02 A couple thoughts. Well, I'd say that, you know, the analogy to a duck, you know, floating along the top of the water in a tranquil way, but their feet are going like crazy. I mean, our supply guys really, our team just really hustled, and there was a lot of what I would call whack-a-mole out there as issues popped up and having to deal with them. And they did a really nice job doing that. You know, that said, of course, you know, there's this natural... and a number of other people. So, I think we're going to have to wait and see what happens. I think we're going to have to wait and see what happens. I think we're going to have to wait and see what happens. So, I think we're going to have to wait and see what happens. So, I think we're going to have to wait and see what happens. So, I think we're going to have to wait and see what happens.

42:59 and a number of others. We've been doing a multi-year in-sourcing of electronics. For a company our size, we have our own electronics plant down in Guadalupe near Monterey. We continue to move more activity into that facility to shorten that lead time, which as you point out is one of the longer ones you have to deal with. We also are looking at our are regional manufacturing centers of excellence and how to effectively put more throughput into those centers that we're currently getting from third parties. So, yes, we're looking at this. It's certainly been a multi-year journey for Franklin. It's been one that heightened awareness with going through what we have been in the last four or five months.

43:50 With that said, I do think that we need to look at this over a long period of time. and there's some natural opportunities for us to do more but I'm not sure that necessarily a knee-jerk reaction to getting everything short is in the right way either.

44:06 Okay, great. I just wanted to ask one on the distribution part of the business. Last year, the weather, I think it was a tough year for distribution because of the weather really well and I wonder if you could talk about the timing of spend because I typically think of that business as spending in the spring and then tailing off. But with this hot season that we're having this year, could you see those trends continue maybe for a break-and-fix product?

44:41 Yeah, well, several aspects to your question. So as a reminder, last year was essentially like the wettest year recorded in the United States or the second-wettest year out of 125 that we tracked, something like that. This year, I think its number is right now we're kind of ranking 70. So it's kind of in the middle of the road from a standpoint of precipitation. To your point, we do see kind of second quarter activity. I believe you follow the center of the guys. I mean, there is definitely a spring aspect. You know, you do pre-watering of fields in Q2, and that's the first time in the ag piece of the business that you'll see some types of, you know, pumps failures and increased replacements. and then you get kind of a second wave in the later part of the season.

45:29 Again, you get equipment's been on or equipment's being used, kind of extend the moisture into the fall and you get kind of a second wave. That all relates to the ag piece of the business and to your point, I think we're going to have, because it's more of a normal weather, we should have more of a normal business cycle than we had last year. But you have to also keep in mind that a large part of the business is residential and they're We saw indications, as you may recall, we went out with our first quarter earnings call back on April 28th. We talked about how headwaters sales were down 4% in April, where the six weeks at the end of March through the beginning of April just kind of give an indication. But if you ignored Michigan, Washington State, and California, that the headwaters sales were up 6%. So it really showed the impact of these stay-in-place orders or these essential Business Definitions by the various governments.

46:24 And so, you know, that business caught up in May and June, and we expect that, you know, we indicated headwater in July is up 8% over last year. And so, you know, that's a part of it as well. So we think that, you know, while certainly there's going to be some second quarter business that's not going to get recovered, is that it is, you know, pretty much an emergency replacement. You know, we estimate, you know, 80% or so is replacement business. and so we would expect the back half in a normal weather year, as John pointed out, to be kind of similar performance relative to last year as the first half was.

47:01 Okay, great. Thank you. Your next question comes from Matt Somerville from DA Davidson. Your line is open.

47:13 Thanks. A couple questions. First, just with respect to China fueling, can you talk a little bit more specifically about around how we should be thinking about this transition from one environmental sort of initiative to the next. And if I'm not mistaken, I had thought you had said China previously would be down by roughly a third to maybe 30 million, and now you're saying maybe down 50 percent. So what has actually worsened in China fueling?

47:43 Yeah, good morning, Matt. What's worsened so far has been the slowdown in the double-wall pipe initiative, in part due to the flooding in China, in part due to the COVID. And then that's been pushing the ISD to the right. And I'll turn that over to John Haynes to give you more substance to that piece.

48:05 Yeah, so just, Matt, just at the highest level, you know, this was a revenue... China contributed about $53 million in fueling revenue in 2018. That dropped to $45 million last year. You're right, we had originally been thinking about $35 million or so for 2020. We thought 2020 anyway would, best case, be flat to 2019. And now we're thinking about something in the low 20s. So, as Greg points out, the pipe and containment initiative It seems to have accelerated and is starting to wind down faster than we had thought it would.

48:52 There's lots of factors, the pandemic, the flooding. I think it's fair to say there's also a competitive factor there for sure. And then the new one that we expected to come on board was this in-station diagnostic or the tank gauge for the vapor recovery, the ISD. We are starting to bid that. We're starting to get awards on that. But again, the pace of that is just not what we had expected it to be for all the same reasons. So it's a little bit difficult to parse out the individual impacts of those reasons. But we do like our position in ISD. We think it's a big opportunity. and we think we're in a very good position to compete there and we'll do that but we think some of these market factors and environment factors that are happening right now in that country are the biggest impediments.

49:56 Got it. And then just as a follow-up, John, can you quantify what your realized price was in water and fueling in Q2 versus last year?

50:06 Yeah, so in Q2, Our realized price in water was just under 2%, and in fueling, it was just under 3%, about 2.6%. Great. Thank you, guys.

50:26 Thank you, Matt. I am showing no further questions this time. I would now like to turn the conference back to Greg Sangstack.

50:39 Great. Thank you all for joining us for this conference call. We look forward to speaking to you after the Q3 in our normally scheduled conference call at that time. Have a great week. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.