Franklin Electric (NASDAQ:FELE) Q3 2021 Earnings Call

0:00 Good day and thank you for standing by. Welcome to the Franklin Electric Reports Third Quarter 2021 Sales and Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised, today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Jeff Taylor, our chief financial officer. Please go ahead. Thank you, Mary, and welcome everyone to Franklin Electric's third quarter 2021 earnings conference call. With me today is Greg Singstack, our chairperson and CEO.

0:49 On today's call, Greg will review our third quarter business highlights, and I will review our third quarter financial results in more detail. When we are through, we will have some time for questions and answers. Before we begin, let me remind you that as we conduct this call, we'll 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. With that, I will now turn the call over to our chairperson and CEO, Greg Singstack.

1:49 Thank you, Jeff, and thank you all for joining us. I am pleased to report that we delivered another record quarter, which included the highest consolidated net sales, operating income, and EPS for any quarter in Franklin Electric's history. Demand across our end markets remains robust, fueling our sustained growth and sizable open order balance. This strong performance reinforces that we have the right strategy in place, which is laying the groundwork to grow as a global provider of water and fuel systems through geographic expansion and product line extensions, leveraging our global platform and expertise in system design. Supply chain constraints continue to persist. Our team remains focused on managing these ongoing challenges to meet our customers' needs, as we expect this volatility to stretch into 2022.

2:38 From a supply chain perspective, it is one of the most challenging environments that I have experienced during my career, and I want to recognize the continued relentless focus of our global team to minimize the level of disruptions for the company and our customers. As we anticipated, during the quarter, inflationary pressures were a more substantial headwind. We experienced high material, component, and logistics cost increases in addition to the continuing impact of tariffs. In response to these cost increases, we continued to implement price increases to maintain an appropriate margin, recognizing the highly competitive nature of our end markets. Turning to our segments, in water systems, we achieved record sales with overall revenue growth of 28%, including organic revenue growth of 11%. Robust demand continues, driven in large part by a strong housing market domestically, drier weather, healthy commodity prices, and strong ongoing demand in developing regions.

3:37 In the U.S., groundwater pumping systems revenue increased 12% in the quarter, supported by strong housing and agricultural demand. Overall, organic growth in the U.S. for water systems is 10%. Outside the U.S., organic water systems growth was 12% led by our business in Latin America, seeing substantial success with 22% growth, as well as strength in Europe, the Middle East, and Africa, all of which continue to see post-lockdown recovery demand. Notably, our business in Brazil and Turkey continues to be strong. During the quarter, we continued to execute on our inorganic strategy as well. We completed a small acquisition in Australia, MindTough, which is a line of electric submersible pumps principally used in mine and construction site dewatering.

4:22 We intend to manufacture and distribute these pumps across our global footprint. With MindTough, we have completed three water segment acquisitions this year. The other two are in the U.S. water treatment market. Speaking of water treatment, the integration of our recently announced water treatment acquisitions, Puronix and AquaSystems, is progressing according to plan. Within water treatment, we are making steady progress on our goal of establishing a leading position in the U.S. and Canada as the market continues to consolidate, and we believe the marketplace is recognizing our enhanced capabilities in the space. Our U.S. distribution business, Headwater, delivered record performance for any third quarter in Franklin's history, with overall revenue growth of 43%, operating income growth of 92%, and operating margins of 8.8%, continuing to underscore the segment's role as a catalyst for future growth of our company.

5:12 This tremendous growth has been anchored by sustained demand over recent quarters, reflecting Headwater's superior product and service offerings. We believe this established leadership position in the marketplace will drive future success and opportunity. Our fueling systems business followed suit in the third quarter, producing overall revenue growth of 18%, operating income growth of 26%, and operating margins of 29.5%. This growth was led by sustained strength in the U.S., continued improvement in Latin America and Asia Pacific outside of China in favorable mix as well. Across the globe, growth in the middle class leads to increased use of motor vehicles, growing demand for energy and energy infrastructure. Recognizing this opportunity, our fueling team is leveraging and extending our success in monitoring the critical assets of fueling station to monitor other critical assets, including electric utility transformers, circuit breakers, and Rail, Telco and Server Farm battery backup systems.

6:12 During the third quarter, we maintain our strong free cash flow of the generation. Combined with our strong balance sheet, this allows us to proactively reinvest capital back into our business while at the same time returning cash to shareholders. In addition, we are continuously evaluating new M&A opportunities that will enhance our portfolio through product line extensions and geographic expansion building upon our ongoing organic growth across all of our segments. Looking forward, overall demand continues to be strong as evidenced by our record third quarter performance and significant open order balance. Open orders at the end of the third quarter were approximately $145 million, up significantly from a typical $35 million pre-COVID run rate. Turning to our outlook for the fourth quarter, as I mentioned earlier, we expect global supply constraints, logistics issues, and inflation to continue into 2022.

7:05 However, based on how we have managed through these challenges, we are updating and increasing our current 2021 earnings per share guidance. Our new 2021 full-year earnings per share before restructuring guidance is $2.99 to $3.07 per share, reflecting an increase in the midpoint of our prior range of $2.95 to our current range with a midpoint of $3.03. I will now turn the call back over to Jeff. Thank you, Greg. Our fully diluted earnings per share were a record for any quarter in the company's history at 98 cents for the third quarter of 2021 versus 82 cents for the third quarter of 2020. Third quarter earnings per share before the impact of restructuring expenses was also 98 cents compared to the 2020 third quarter EPS before restructuring of 83 cents.

7:57 Restructuring expenses in the third quarter of 2021 were 0.1 million and were related to various manufacturing realignment activities in the water segment and had no impact on earnings per share. Restructuring expenses in the third quarter of 2020 were $0.4 million and were primarily related to various manufacturing realignment activities in the water segment and resulted in a one cent impact on earnings per share in the third quarter of 2020. Third quarter 2021 consolidated sales were a record $459 million. compared to the 2020 third quarter sales of $351.2 million, an increase of 31% year-over-year. The increase from acquisition-related sales was $47.4 million, while organic growth contributed 17%.

8:50 Sales revenue increased by $1.1 million, or less than 1% in the third quarter of 2021 due to foreign currency translations. Water system sales in the U.S. and Canada were up approximately 41% compared to the third quarter of 2020 due to acquisition-related sales, volume, and price. In the third quarter of 2021, sales from businesses acquired since the third quarter of 2020 were $33.7 million. Water system sales in the U.S. and Canada grew 10% organically in the third quarter. Sales of groundwater pumping equipment increased by about 12%, and sales of dewatering equipment were up about 60%, both due to strong in-market demand.

9:36 Sales of surface pumping equipment increased by about 3% versus the third quarter of 2020 as supply constraints with certain utility pumps and lower overall sales of sump pumps limited our ability to grow at a faster rate. Water system sales in markets outside of the U.S. and Canada increased by about 12% overall. Foreign currency translation had essentially no impact on sales in the quarter. Outside the U.S. and Canada, water systems organic sales increased by about 12%, driven primarily by higher sales in Latin America, Europe, the Middle East, and Africa markets. Water systems operating income was $36.8 million in the third quarter 2021, compared to $36.6 million in the third quarter 2020.

10:25 while operating margin decreased by 390 basis points compared to the exceptionally strong margin in the prior year quarter. The decline in operating margin was due to higher SG&A expenses, primarily higher variable compensation, and other operating expenses related to increased commercial activity. Additionally, we experienced cost inflation in materials components, freight, and tariffs, all of which we strived to fully offset with pricing. as well as a higher mix of water treatment sales at a lower margin also contributed to the lower operating margin. Distribution achieved record third quarter sales of 140.2 million this year versus the third quarter 2020 sales of 98 million.

11:11 In the third quarter 2021, sales from businesses acquired since the third quarter of 2020 were 13.2 million. The distribution segment organic sales increased 30% compared to the third quarter 2020. And revenue growth was driven by broad-based demand in all regions and product categories. The distribution segment operating income was a record for the third quarter at $12.3 million compared to the third quarter of 2020 operating income of $6.4 million. Operating income margin increased to 8.8% of sales in distribution primarily because of revenue growth and improved operating leverage, but was negatively impacted in the quarter by higher SG&A costs, which included variable compensation and other operating expenses.

12:03 Fueling system sales were a record $81 million in the third quarter 2021 and increased 18% versus the third quarter 2020, which was entirely organic growth. Fueling system sales in the U.S. and Canada increased by about 27% compared to the third quarter of 2020. The increase was due to higher demand for fuel management systems, piping, and pumping systems. Outside the U.S. and Canada, fueling systems revenues decreased by about 1% as sales increases of 11% in the rest of the world outside of China were offset by lower sales in China. Fueling systems operating income in the third quarter was $23.9 million, a new record for any quarter, compared to $18.9 million in the third quarter 2020 driven by higher sales.

12:57 The third quarter 2021 operating income margin was 29.5% compared to 27.6% of net sales in the prior year. Operating income margin in the third quarter increased in fueling systems, primarily due to higher sales volumes, favorable product and geographic sales mix. The company's consolidated gross profit was $163.1 million for the third quarter of 2021, an increase from the third quarter 2020 gross profit of $124.3 million. The gross profit as a percent of net sales was 35.5% in the third quarter 2021 versus 35.4% in the third quarter 2020. and was essentially flat due in most part to material inflation costs that were offset by price increases.

13:50 Selling general and administrative expenses were $106.4 million in the third quarter 2021 compared to $75.5 million in the third quarter 2020. SG&A expenses from acquired businesses were approximately $12 million. Excluding acquisitions, SG&A expenses were higher by $18.9 million, about $11 million of which is variable compensation expense and commissions on higher sales. The effective tax rate for the third quarter of 2021 was 18%, essentially flat with the prior year quarter at 17%. The effective tax rate for the full year 2021 is projected to be between 18.0% to 18.5%. The company ended the third quarter of 2021 with a cash balance of about $76 million and generated $93.9 million of net cash flow from operations during the first nine months of 2021 versus $133.7 million in the same period of 2020.

14:54 The decrease was primarily due to higher working capital requirements in support of higher revenues, including higher inventory to compensate for supply issues. Yesterday, the company announced a quarterly cash dividend of 17.5 cents that will be paid November 18th to shareholders of record on November 4th. The company purchased about 98,000 shares of its common stock in the open market for about $7.9 million during the third quarter of 2021. At the end of the third quarter, the total remaining authorized shares that may be repurchased is roughly 742,000. As previously disclosed in our SEC filings, the company's fourth quarter results will include an estimated 12-cent EPS gain related to an approximately $6 million one-time income gain on a bargain purchase price transaction that will be presented in the income statement on the other income and expense section.

15:55 Although it is our practice to not call out items as non-GAAP adjustments in our reported results, We are mentioning this gain due to its size and since we do not consider it to be operational in nature. This $0.12 EPS gain is not included in our updated EPS guidance. As Greg mentioned, the company is raising its guidance for full year earnings per share before restructuring expenses to a range of $2.99 to $3.07. This concludes our prepared remarks. We'll now turn the call over to Mary for questions. Thank you. As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster.

16:47 Our first question comes from the line of Jake Jarnigo from Baird. Your line is open. Morning, everyone. Yeah, you got Jake here filling in for Mike. Yeah, I guess first question would be the price-cost cadence here moving forward. I guess, you know, one, can you kind of remind us or quantify how much price you've gotten in the quarter or year to date, and then how you're thinking of price implementation going into next year? I mean, how much inherently carries over? You know, I guess if you could kind of cadence that out for us qualitatively, that would help. Yeah, Jake, let me start that, and then Greg can certainly chime in here. So in terms of our pricing actions, we've been active throughout the full year.

17:36 As you know, we started price increases late last year. We've continued those throughout this year. There have been multiple price increases across both of our manufacturing businesses as well as distribution throughout the year. At this point in time, we've had three, four, or more price increases and all of those businesses. We did have price increases in water and in fueling, which both took effect in the third quarter. If we look at the current third quarter versus prior year, price is up in the low double-digit range. So we're seeing the cumulative effect of the price increases that we have implemented throughout the year up to this point.

18:21 We're also evaluating and working on additional price increases as we continue to see inflationary pressure flow through for the fourth quarter. We'll continue to monitor that as we move into 2022 as well. Yeah, Jake, you may recall from our second quarter that we try to get price to offset inflation. First quarter, we were ahead. Second quarter, we got a little behind. Third quarter, a little bit ahead again. But we're mindful that the inflation tsunami continues to roll forward here and We're mindful of that. At the same time, when we do price changes, they do take some time to get into effect. So we should see some additional price lift here going forward, but we're mindful that we're also going to see continued inflation going forward as well.

19:07 Great. Super helpful. And then focusing again on water systems here. You know, it looks like now dewatering, you know, it's starting to come back inherently against an easy calm. So I guess remind us how mix works in this segment. You know, going forward, it would appear, you know, the stronger residential and ag groundwater. will start to give way to some of the industrial and dewatering exposures you have. I guess a reminder on how that flows through from a mixed perspective, and is it meaningful? Is that something we should be keeping in mind? Thanks. Sure, Jake. I'll give a qualitative response, and Jeff can weigh in a little bit more on the quantitative side. So you may recall that with the groundwater systems, that's where we're most vertically integrated, so that's where we see typically a higher margin profile.

20:00 To your point, dewatering, because we're buying larger components and assembling them into packages, will typically see a slightly lower margin profile. And so you're correct that to the degree that dewatering, particularly the large dewatering pumps, become a larger portion of our business, that will put some gross profit pressure on the mix. But, you know, overall, we've done well. The team's done well at getting to a lower fixed cost base in our larger key watering pump business. So that's helped offset some of the lower gross profit margin we'd see. So it still kind of blends through. And I believe, you know, we've talked about margins in the, you know, 15% to 17% range for water.

20:51 Certainly the current pressure relates also to the fact that, you know, we've We're having more of a drag related to water treatment because these are businesses that have lower profit profiles currently. We expect over time that they'll get up to more of the median of our water business, but that takes a little time. So that's, I think, going to be more of a near-term drag on OI than necessarily the large-scale watering pumps. Great. Very helpful. I'll drop back in the queue. Thank you, Jake. Our next question comes from the line of Matt Somerville from DA Davidson. Your line is open. Thanks. A couple questions. Just sticking with water for a second, when you look at year-over-year all-in revenue up, I'm rounding a little bit, but $60 million OP flat, I know you mentioned maybe some dilution from treatment, but I guess I'm curious, is treatment not profitable then? Help me understand on a year-over-year basis why you're not getting any incremental OP dollar flow-through on all that revenue, especially if you're a little bit ahead on the price-cost side of things.

21:59 Yeah, thanks, Matt. And the quick answer to the first part of that is water treatment is profitable, but the operating margins are slightly below the operating margins we would see for the core business. Given the growth that we've seen in Water Treatment and how it's grown to be a bigger portion of the overall segment there, then it's having a bigger impact on a weighted basis. The margins there we would expect to be in the low double digit range, whereas water segment system is in the mid double digit range over time. We do expect water treatment margins to continue to grow and expand. eventually reaching similar, if not better, margin profile than the overall business.

22:49 But we've recently completed those acquisitions. We're going through that integration phase. We want to continue to grow that business. And for the time being, it's meeting our expectations, but it is pulling down the overall segment margins a little bit. And then how about maybe talking through on an OP dollar basis, again, why we're not seeing any income dollar fall through on a $60 million revenue increase? Yeah, I would say overall, when you look at segment margins in total, those margins are down about 390 basis points on a year-over-year basis. So let me just kind of walk through that bridge, if you will. First thing I'd say is that 18% margins that we saw last year were exceptionally high margins, certainly some of the highest margins we've seen in recent history.

23:42 I think you have to go back almost seven years to see margins that were in that range. So the third quarter of last year, we were getting strong demand recovery coming out of the COVID lockdowns and the pandemic. That period was also before we saw a lot of the inflation that has flowed through to us. So we had certainly exceptional margins in the prior year quarter. That's certainly a piece of it. As I said, we would expect normal water systems margins to be in the 15% to 17% range. We were at 14%. So when you look at the bridge, SG&A is up on a year-over-year basis. That's certainly a significant piece of it.

24:28 That's about 50% of the overall impact on the operating margin. That's driven largely on variable compensation bonus. As you know, the business is performing well on a year-over-year basis. Growth is nice. Profitability is up. And as the business performs well, then typically variable compensation follows that. In addition, We also have higher business activity and commercial activity there. It's related to, you know, we were locked down pretty much third quarter last year. There wasn't a lot of travel entertainment. There weren't a lot of shows. That activity is beginning to resume. We're seeing more activity in trade shows, more customer visits. As a result, we're investing more in marketing and advertising dollars, and that's also contributing to the higher year-over-year SG&A.

25:16 The remainder of the change in operating income for the year-over-year comparison is really split between some inflationary cost pressure that we're seeing in the water segment. They're working really hard to keep up with that on a pricing basis, but they have seen some inflation flow through versus price. So they've got some pressure there. And then the other piece of it is the mixed piece from the water treatment that we've talked about already. Just one follow-up, Greg. I think you mentioned in your prepared remarks your backlog, I think you referred to it as open orders, stood at 145 million. How did that compare on a sequential basis, and at what point do you think you'll be able to start biting into that number, or do you see it still increasing sequentially for the time being?

26:11 Matt, I appreciate the follow-up. We were actually down from Q2. I recall I think Q2 was about 170. 175. 175. So flat on the fueling piece, the fueling demand and recovery of the North American market has been really strong, and we see it continuing that way as there's further consolidation in the industry and investment by major marketers. Water piece, we knocked down probably about 30 million. So we're beginning to dig into that. on the water side as we speak. And I think, you know, fueling will come along a little further along just because of the strong end market demand. Got it. Thank you, guys. Thank you, Matt. Thank you. Our next question comes from the line of Walter Liptak from Seaport Global.

27:00 Your line is open. Hey, thanks. Good morning, guys. Hey, Walter. One last one from 50,000 Feet with the talk of selling price increases and more coming. Is there any demand destruction that's coming in? How are these conversations going with customers? Is everybody just in the same boat or at some point do you think you're going to get more pushback? Walter, as you know, it's tough to talk about the future with great clarity, but I will say right now that people need the product, and as quickly as we can get it through the supply chain, get it through our facilities, and get it out the door, the demand is there. So there's not a whole lot of conversation about pricing right now. It's all about availability.

27:51 And until you see some abatement in supply chain, and material costs, I suspect that this continued focus on availability is going to be what's top of mind for customers. Okay, that sounds great. And, you know, kind of thinking of that, when you look at the distribution business, how much of that is that volume growth or that organic growth is volume versus price? Again, Jeff, looking at that, it's one of these things where we continue to price to the market. Some of our products that we get, like pipe and others, are more commodity-based, and so it's spot pricing. And the price-cost mix and distribution isn't quite as clear as it is on the manufacturing side. Jeff, you've got some additional thoughts?

28:43 Yeah, we're seeing strong pull-through on pricing in the second half of the year. on a year-to-date basis, I would estimate that the balance there is about 50-50 between price and volume, Walt. Okay. All right, great. So it's great to see the profitability come up again in the Headwaters business. You know, is this something that's sustainable, though, or is it just that you're getting good SG&A leverage? I guess maybe the better way to ask it is, you know, are those gross margins going to be sustainable? Yeah, well, fair question. Look, rising tide lifts all ships, and right now I think distribution generally, not only Franklin but other distributors that are publicly traded where we've got information, we're all seeing some lift in their numbers because of strong demand. Margins are holding.

29:40 We're getting some operating leverage. We had a couple of charges in the quarter that reduced it sequentially from Q2. But I'd say generally right now, the distributions business is robust, and so therefore we're getting good financial performance. You may recall that our original goal was to get this business in the 4 to 6 range. There's some seasonality, so we're doing better in the second and third quarters than that. But we are performing and a step function better than where we were in prior years. Okay, yeah. I guess the question is, do we think that that's, is there something structurally that's changed or do we think that that four to six range is where we should think about this business over the long term?

30:29 I think we've reached a new level of maturity of the business where it would be at the upper end of that range, maybe a little bit higher. Okay, great. If I can switch over to fueling systems, one of your competitors reported and they had a little bit of a slowdown in their business during the quarter and had some margin pressure and you guys seemed to come through it okay. I wonder if you could give us a little bit more color on what's going on in fueling systems with the rollout from the major fueling retailers. Sure. Well, again, being mindful that the two public companies that are fueling both Vontir and Dover are both in the dispensing side of the business.

31:20 We are not. There's been this multi-year upgrade of the EV upgrade and dispensers. I think they both called out that they were going to maybe face some headwinds. From my memory, they were because of the pretty much completion of that upgrade in the first quarter of this year. We operate principally in the below-ground equipment, but also with the brains of the outfit, the tank gauge, and the back office. And with dollars now freed up by major marketers, we're seeing those dollars potentially being redeployed in areas that we benefit from. And also, we may be getting some share gains. That's always difficult to discern. But our marketers are building, and they're investing with Franklin.

32:08 Okay, that sounds great. Thank you. Thank you, Walt. Our next question comes from the line of Chris McInnis from Cdoty & Co. The line is open. Yeah, good morning. Thanks for taking my questions in the next quarter. I was just wondering if you could just maybe dig in a little bit on the recent acquisitions and around water treatment, just maybe their growth rates. I may have missed it if you did talk about it earlier, but just wondering how they're being integrated in the Organic Growth, you're seeing from that business. Thanks. Sure, Chris. From a qualitative point of view, we didn't discuss it earlier in detail, but the water treatment organic growth profile from what we've seen in the industry and what we've learned over the last couple years when we first stepped into this business with our acquisition of First Sales a couple years back is that the organic growth rate looks to be higher than, say, the growth rate of water generally because You're seeing housing demand recovering.

33:09 You're seeing people not only just in the United States but across the globe being much more focused on water quality. And so that's lending to a higher growth rate. The other opportunity for Franklin is that while we bought well-established businesses, one in California, one in Canada, and one here in the Midwest, which are strong markets, hard water markets, that these businesses were fairly regional. and we now have given them the capital and resources to go national. So I think that's another good thing for Franklin is that we've got businesses that have relatively small footprints that can grow relatively quickly just by expanding their business models across the U.S. and then we're going to look outside the United States as well.

33:58 The margin profile and the bar treatment business, I think as you cover and other significant public companies or companies that have significant investments in large treatment. They're certainly kind of mid-teens margins would be or even better. But we're sub 10% right now in those businesses because of with acquisition costs, amortization costs, which we don't break out. But we expect those operating margins to increase with operating leverage and with consolidation into our Franklin business over time. currently dilutive to our operating margins for water, but we expect them to be equal to and potentially accretive over time as we get these businesses digested and they can get operating leverage from expanding across the U.S. and then, you know, to a larger footprint globally.

34:46 Great, Matt. Thanks for taking my questions. Good luck in Q4. Great. Thank you, Chris. Thank you. We have no further questions at this time. Now I turn the call back over to Greg Sainzbeck. We appreciate your joining us on this conference call and look forward to speaking to you after the end of the year with our full year results. Have a great week. This concludes today's conference call. Thank you everyone for participating. You may now disconnect.