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Edited Transcript of FELE earnings conference call or presentation 20-Feb-18 2:00pm GMT

Q4 2017 Franklin Electric Co Inc Earnings Call

BLUFFTON Oct 3, 2018 (Thomson StreetEvents) -- Edited Transcript of Franklin Electric Co Inc earnings conference call or presentation Tuesday, February 20, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gregg C. Sengstack

Franklin Electric Co., Inc. - Chairman & CEO

* John J. Haines

Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer

* Robert J. Stone

Franklin Electric Co., Inc. - Senior VP & President of International Water Systems

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Conference Call Participants

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* Edward James Marshall

Sidoti & Company, LLC - Research Analyst

* Matt J. Summerville

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

* Ryan Michael Connors

Boenning and Scattergood, Inc., Research Division - MD & Senior Analyst of Water and Environment

* Walter Scott Liptak

Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Franklin Electric Fourth Quarter and Fiscal Year 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mr. John Haines, Chief Financial Officer. Sir, you may begin.

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [2]

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Well, thank you, Brian, and welcome everyone to Franklin Electric's Fourth Quarter and Fiscal Year 2017 Earnings Conference Call. With me today are Gregg Sengstack, our Chairman and CEO; and Robert Stone, our Senior Vice President and President of our International Water Systems Unit. On today's call, Gregg will review our fourth quarter and full year business results, and I will review our fourth quarter and full year 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. 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'll turn the call over to our Chairman and CEO, Gregg Sengstack.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [3]

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Thank you, John. Our fourth quarter unfolded pretty much as we had anticipated. In the U.S. and Canada Water Systems business, Pioneer brand dewatering pump sales remained strong, more than double the fourth quarter of last year, driven by recovery in the market for oil and gas as well as the expansion of our business into other end markets. Backlog in the business is strong. Revenue from other surface pumps as well as groundwater pumps declined for a couple of reasons: end market demand appeared to be flat, we elected to reduce promotional activity to smooth demand; and our Distribution business, focusing on their working capital, reduce purchases from our manufacturing business. So compared to the very strong finish in 2016, U.S. and Canada water revenues were lower.

Outside the U.S. and Canada, we had single-digit revenue growth in Europe, Africa and Asia. Our business in Turkey continues to do well. And while small, our business in India grew nicely. However, in each of these end markets, we saw margin contraction due to rising input costs. After several years of strong growth in sales and profits, for the last 3 quarters, our business in Brazil has had lower quarter-over-quarter sales and profits. Favorable market conditions have been replaced by weak demand and margin compression, particularly this last quarter. Brazil is an important market for us and is the second-largest underground aquifer in the world. At the same time, our team is adjusting the cost structure to address the current realities of the market.

Our Fueling Systems business turned in another record quarter. Our business outside the U.S. was very strong. Revenue in China doubled. Revenue in every other international market grew double digits, except for India. While we continue to be bullish on a long-term business in India, the market to retrofit fuel transport trucks for stage 1 vapor recovery has yet to materialize. We decided to cut our losses and shut down our Wadcorpp JV that produces this product line. At the same time, we're beginning to move some Fueling Systems production into our Water Systems factory located in Gujarat province. Fueling revenue in the U.S. and Canada declined 2%. Gains in pumps and fuel management were more than offset by a decline in containment and dispensing product lines.

Our U.S. Distribution business lost money in the quarter. The groundwater Distribution business is seasonal. That fact, combined with additional integration, logistics and promotion costs led to the expected loss. No one wants to have a loss, particularly in a recent acquisition. However, the 2017 pro forma operating income margin in the Distribution segment was 3%. Our leadership team has a line of sight to move into the post-integration range of 4% to 6% as we originally guided.

As we close the books on 2017, I wanted to take a moment to reflect upon the year. We made a strategic decision to create a new company, Headwater, as an investment vehicle to acquire groundwater distributors in the U.S. We saw this as opportunity to both maintain the access to this market; move us closer to the end user, the contractor; and to make money. For the year, even with all the disruptions, our Distribution business was profitable, and our manufacturing profitability in this important end market improved as well.

Outside the U.S., Water Systems revenue grew but profitability suffered across the globe, principally in Asia Pacific and Brazil, where demand was weak and input costs continued to rise. Our Fueling business delivered another record year driven by converting customers' specification to Franklin products, market growth and the strength of our business in China. In both our Water and Fueling businesses, we continue to turn out an increasing number of innovative new products to address customer needs.

So as we turn to 2018, in our Water Systems business, we currently expect to see revenue growth in the 4% to 5% range. We have taken pricing actions to offset the inflation that we're seeing, such that we expect Water Systems operating income to increase double digits. In our Fueling Systems business, we currently expect a year like 2017 with sales and operating income growth in the high-single digits. In addition, I want to point out that the upgrade of underground piping systems in China, which is currently accelerated, may provide additional growth. With our product offering reset, we expect our Distribution business to see organic sales growth with a modest expansion in operating income margin. Please note that the Distribution segment will have greater seasonality and reported revenue earnings in our Water Systems businesses. We continue to look at acquisitions in our core markets and adjacencies but remain disciplined around the multiples of cash flow that we're willing to pay. Overall, we're very optimistic about 2018 and expect our earnings per share before restructuring charges to be between $2.16 and $2.28 for the full year.

I'll now turn to call over to John to discuss the numbers in more detail. John?

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [4]

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Thank you, Gregg. Our fully diluted earnings per share were $0.17 for the fourth quarter 2017 versus $0.37 for the fourth quarter of 2016. In the fourth quarter of 2017, the company incurred $0.04 of restructuring expenses and $0.21 of tax expenses related to the U.S. Tax Cuts and Jobs Act of 2017. So before the impact of restructuring and the U.S. Tax Cuts and Jobs Act of 2017, we were able to grow our fourth quarter earnings per share by about 14%, primarily related to the Fueling Systems performance and the pretax benefits unrelated to the new tax law in the United States. I'll say a bit more about the new tax law in the U.S. in a couple of minutes.

Fourth quarter 2017 sales were $288.2 million compared with 2016 fourth quarter sales of $239.6 million, an increase of 20%, primarily from acquisitions. Organic sales increased about 2% when excluding the impact of foreign currency translation.

Water Systems sales were $181.5 million in the fourth quarter 2017 versus the fourth quarter 2016 sales of $177.8 million, an increase of 2%. Water Systems organic sales were about 1% in the quarter when you exclude the impact of foreign currency translation. Water Systems sales in the U.S. and Canada declined by about 3% compared to the fourth quarter 2016. Sales of Pioneer branded dewatering equipment increased by about 80% in the fourth quarter when compared to the prior year, resulting from the continued diversification of customers and strengthening in the U.S. oil and gas end markets. Sales of groundwater pumping equipment decreased by about 9% on weaker residential and agricultural system sales, lower sales to Headwater and due to a difficult sales comparison in the fourth quarter 2016. Sales of other surface pumping equipment decreased by about 4%, primarily in irrigation and agricultural-related products.

Water Systems sales in markets outside the United States and Canada increased by about 6% overall. The impact of foreign currency translation increased sales by about 2%. International Water Systems sales were led by improved sales in Europe, the Middle East, Africa and Asia Pacific but were offset by lower sales in Latin America when compared to the fourth quarter 2016. Sales in Brazil declined by about 8% in the quarter.

Water Systems operating income was $19.5 million in the fourth quarter of 2017, down $3.1 million versus the fourth quarter of 2016. Water Systems operating income before restructuring was $20.6 million in the fourth quarter 2017, down $2.2 million or about 10% versus the fourth quarter of 2016. The decline in operating income is primarily related to higher raw materials and freight costs, products sales mix shifts and lower revenue in Brazil.

Fueling Systems sales were $67.9 million in the fourth quarter 2017 versus the fourth quarter 2016 sales of $61.8 million or about 10% higher. Fueling Systems organic sales were about 7% when excluding the impact of foreign currency translation. Fueling Systems sales in the U.S. and Canada declined about 2% compared to the fourth quarter 2016. The decrease was in piping and dispensing products. Outside the U.S. and Canada, Fueling Systems revenues grew by about 26%, led by strong sales in China, Southeast Asia and Europe. Fueling Systems operating income was $17 million in the fourth quarter of 2017 compared to $15.4 million in the fourth quarter of 2016. Fueling Systems operating income before restructuring was $18.6 million in the fourth quarter of 2017 compared to $15.5 million in the fourth quarter of 2016.

Distribution segment sales were $49.5 million in the fourth quarter 2017. We estimate that fourth quarter Distribution sales declined by about 11% from the fourth quarter of 2016, primarily driven by supply chain disruptions and weak end market conditions in the West and Southeast regions of the United States. The Distribution segment recorded an operating loss of $2 million in the fourth quarter of 2017.

The company's consolidated gross profit was $94.6 million for the fourth quarter, an increase from the fourth quarter of 2016 gross profit of $81 million. The gross profit increase was primarily due to higher sales. The gross profit as a percent of net sales was 32.8% in the fourth quarter 2017 versus 33.8% during the fourth quarter 2016. The decline in gross profit margin percentage is primarily due to product and geographic sales mix shifts and higher raw material costs in Water Systems.

Selling, general and administrative expenses were $69.4 million in the fourth quarter of 2017 compared to $55.5 million in the fourth quarter of the prior year. The increase in SG&A expenses from acquired businesses were $16.3 million. Excluding the acquired entities, the company's SG&A expenses in the fourth quarter of 2017 were $53.1 million or about 4% lower than the 2016 fourth quarter.

Restructuring expenses for the fourth quarter of 2017 were $2.7 million and reduced fully diluted earnings per share by approximately $0.04. During the fourth quarter of 2017, the company approved a plan to close the Wadcorpp India Private Limited joint venture and took a charge of $1.6 million. The company purchased the controlling interest in the Wadcorpp entity during the third quarter of 2014 and included the entity as a fully consolidated subsidiary in the Fueling Systems segment. As part of this action, the company will continue to sell fueling product in the Indian market while the Wadcorpp manufacturing operations will cease. The closure began in the fourth quarter 2017 and is estimated to be -- to conclude by the end of 2018. Charges for the closure are expected to be in the range between $2 million and $4 million and will include severance expenses, asset write-offs and other closure expenses. The balance of the fourth quarter 2017 restructuring expenses, about $1.1 million, were primarily related to continuing realignment efforts in Brazil. Restructuring expenses in the fourth quarter 2016 were $0.2 million.

In the fourth quarter ended December 31, 2017, the company recorded a net tax expense of $10.2 million or $0.21 per share related to the enactment of the U.S. Tax Cuts and Jobs Act of 2017. This expenses was primarily derived from the recognition of a U.S. tax liability for the deemed repatriation of foreign earnings, partially offset by the revaluation of other deferred tax liabilities. In 2018, the company estimates its effective tax rate will be 13% to 17% or about 10 percentage points lower than the effective tax rate of 25% in 2017, which includes the $10.2 million onetime charge in the fourth quarter. The lower tax rate in 2018 is primarily the result of the U.S. and Tax Cuts and Jobs Act of 2017.

The company ended 2017 with a cash balance of about $67 million versus about $104 million at the end of 2016, down primarily due to acquisitions and increased working capital. Inventory levels at the end of 2017 were $312 million versus the prior year end 2016 of $203 million. About $65 million of the inventory increase is due to the Distribution segment acquisitions.

The company had $67 million in borrowing on its revolving debt facilities at the end of the year and no borrowing at the end of 2016. These borrowings were primarily to fund the distribution acquisitions made during the year and for working capital needs. The company did not purchase any shares of its common stock in the open market during the fourth quarter 2017. As of the end of the fourth quarter 2017, the total remaining authorized shares that may be repurchased is about 2.2 million.

This concludes our prepared remarks. We'd now like to turn the call over for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Edward Marshall from Sidoti & Company.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [2]

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So I'm curious on the Distribution side, I'm wondering did you potentially lose share in those regions because the OEM wasn't able to supply the channel fast enough?

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [3]

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Yes. Edward, we had some disruptions.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [4]

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Yes, Ed. In Q3 and Q4, once -- we were cut off by a couple of OEMs, and we had to go and get other OEMs established. And so yes, at that time, we lost some share, and then we got the new [supplier] base. We haven't fully recovered that share, but that's where we're seeing this opportunity going into 2018.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [5]

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Got it. And I thought a big portion of that increased supplier was coming from Franklin OEMs themselves. And looking at the revenues in the 2 businesses, groundwater and Distribution, as it relates to the U.S., I'm not seeing the restocking that I might have thought that I would see. Can you kind of clear that up for me?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [6]

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Sure. We -- no. There was clear pass-through between Franklin Manufacturing and the Headwater distribution company in the last 6 months. The -- what we're looking at was more of the disruption on the that Franklin is, not the default submersible pumps, but other pump lines, submersible -- surface pump lines is where we're looking to gain traction to replace product lines that Franklin Electric doesn't have.

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [7]

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Yes. The other way just to think about that, our sales are transfers, I guess is what you should call them, between our manufacturing business in the United States and Headwater were down 11% in the fourth quarter. Part of that is because the fourth quarter 2016 was a pretty strong quarter before we owned the Headwater Companies. The other part of it, as Gregg pointed out, is there's really not an economic benefit to do that and just to transfer inventory or sell inventory to them and then have them not do anything with that in terms of selling it on to their end markets. So instead of doing that and taking what would be a working capital penalty, if you will, in Headwater, we didn't make those sales, and that was part of the decline.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [8]

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Got it. And I shouldn't infer from what you're saying here today that there's a issue obtaining certain suppliers or anything. It's just a matter of timing, and they just haven't gotten the product to you.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [9]

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Yes. It was more the latter because we picked up 9 pump companies in the last 6 to 7 months and some were a new customer and were looking for water products. They're looking for training. They had to get out with our people, so it's just that natural friction that occurs in switching vendors on a pretty short notice.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [10]

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Got it. And the fourth quarter on profitability in the segment versus that, is that typical for that business line? And second, was there loss of potentially rebate activity due to the loss of certain suppliers?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [11]

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I would say that there's as much gain in rebate activity from new suppliers as there is potential loss from those suppliers. I don't have the exact numbers. John maybe will expand about that. This is a business where we knew that there -- you'd see losses in the winter months. And so this is not, as we said, this was not -- in my prepared remarks, this is not unexpected for this business.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [12]

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Got it. And I look at the guidance for next year in 2018. I guess any onetime items? Or are there acquisitions baked into that line that's all other EPS growth? Or is that a clean number?

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [13]

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No. As we -- the $2.22 midpoint, the only acquisition that's in there is the small Valley Farms acquisition that we did in January, all in Headwater as I know you thought. And that's accretive, but it's not accretive by a significant amount. And then as we point out, we believe our effective tax rate in 2018, the basis for that guidance, will be about 15%, or 13% to 17%, the midpoint being 15%. And that, of course, includes all of the new benefits, if you will, the rate benefit of the new tax law in the United States. So that's all in there. There's no assumption of other really other onetime items in that guidance.

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Operator [14]

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And our next question comes from the line of Ryan Connors from Boenning and Scattergood.

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Ryan Michael Connors, Boenning and Scattergood, Inc., Research Division - MD & Senior Analyst of Water and Environment [15]

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Great. Just first off, continuing on this discussion of the guidance. It seems like there's so many divergent moving parts here, some things like dewatering up dramatically, others down significantly. How do you get comfort, I mean, with the top line guidance or modeling number internally in that environment? Do we expect some kind of normalization here? Or how should we think about getting to the core of what the consolidated -- the rate of growth is when we've got so many things, it seems like, jumping around pretty dramatically?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [16]

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Sure. Ryan, I'll say this. Broadly, we develop our plans, they're developed from the ground up from the business units, and they're rolled up to a corporate number. And to your point, there has been disruptions in the North American market, and we see 2018 to be a more kind of normal year quarter-to-quarter and year-to-year growth. When you get outside United States, we have seen weakness. Again, we've talked about this with Brazil. That one is one, you may recall last quarter I talked about that we thought it was going to push into 2018. It looks like it's going to even push out a little farther. I'm not saying 2019, but we just don't have visibility to when we're going to see business in Brazil start turning north. We do think that Asia Pacific, which is the other business, and Robert is here, he can talking about it as well, is that Asia, we had a really strong '16 on weather. We have tough comp on 2017. We see that stabilizing. So we go around the globe and build that up. We also build up your fueling model the same way. We did point out in my comments that we have this potential option on the China market that could come in stronger than what we have planned. And then with our Distribution business, again, we did a roll-up for the various branches right up through the top. And based on having the products we have in place today, we went with the number we went with. So that's how we come about with '18, and it's -- there's been some variability '16 to '17, and there'll be some variability '17 to '18. I guess '18 we expect to be kind of a more "normal" year. Robert, do you want to talk about Brazil and APAC?

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Robert J. Stone, Franklin Electric Co., Inc. - Senior VP & President of International Water Systems [17]

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Sure. As Gregg mentioned, in terms of Asia Pacific, we had a couple of markets where we had a really strong comp. 2016, pick one market. Thailand, we came off of basically 5 years of drought in that market. That ended. 2017 was a very wet year, unusually wet off of -- compared to unusually dry conditions. So we saw that market contract significantly. Brazil is -- there's a combination of things. The economy still sputters. They still have some political instability. That seems to be getting better, but significant competition as the markets (inaudible) shrunk over the past 1.5 years, and we see a lot of discounting, which has put a lot pressure on margins, and there's the lack of confidence in the distribution channels to take on inventories. So basically everything is almost a spot price transaction in Brazil these days. That looks to get better. We can't say when, but we're still confident that Brazil is a very good market for us and one where we continue to invest.

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Ryan Michael Connors, Boenning and Scattergood, Inc., Research Division - MD & Senior Analyst of Water and Environment [18]

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Okay, got it. That's really helpful detail. My other question just had to do with raw material costs. You did cite that repeatedly in your prepared remarks as a margin headwind, albeit maybe a less of a headwind than mix. But can you just unpack that for us a little in terms of the outlook? Are raw materials going to be a headwind again in '18? And if so, what does the price cost dynamic look like?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [19]

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Raw material, we look at ground up throughout our whole supply chain network and we build up incoming price expectations or price -- and also with our commodities as well. And John can take you through the detail how that roll-up translates into inflation '18 and what we're doing with that pricing offset. John?

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [20]

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Yes. Ryan, when we think about raw material increases, they obviously vary by commodity groups, products around the world. But generally, we're thinking about 150 to 200 basis points of raw material inflation. Now that's on a comparable basis, on a net sales basis. Obviously, if you did that on a raw material basis, it would be much higher. And then when we think about pricing around the entity, each business unit is a bit different. But our pricing assumptions right now going into 2018 are between 200 and 300 basis points. Some business is higher than 300 basis points on a comparable basis. So all of our water businesses -- all of our businesses, but our water businesses, probably more especially, are competing in very intense end markets. And if there's an opportunity later to get new suppliers, we'll take advantage of that. But right now the assumptions going in are that we will be priced 200 to 300 basis points with something in the range of the same basis of 150 to 200 basis points of inflation.

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Ryan Michael Connors, Boenning and Scattergood, Inc., Research Division - MD & Senior Analyst of Water and Environment [21]

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Got it. Now maybe one last one, if I might. In terms of the new business, the Distribution business, how does being in that part of the supply chain impact your ability to manage that price costs relationship? I'd assume that's a positive in that respect. But can you just kind of discuss that a little bit?

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [22]

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The Distribution business has its own P&L, and these guys are focused on making money in their business. And so as all of distribution businesses within Franklin, outside of Franklin tend to not object too harshly to price increases from manufacturers because that inflates the value of their on-hand inventory in a positive way and allows them to move price along into the marketplace. So to your point, generally, I mean, is modest price increases are typically well received within Distribution and again if they're reasonable would be passed through to the marketplace.

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Operator [23]

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And our next question comes from the line of Walter Liptak from Seaport Global.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [24]

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Just as a follow-on to the price cost. I wonder if we could get a little bit more detail on when it was that you took prices up. And do you have flexibility to take prices up further throughout the year? And then just as a follow-on to that, any color on the different parts of the business in pricing and where the pressure is coming from or if there is any pressure. And I'm thinking of in oil and gas, are you able to pass along prices? In Fueling Systems, are you able to pass along prices, et cetera?

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [25]

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Yes. Walter, as Gregg said, generally in our water businesses, which is where I think there's the most pressure, there's some pressure between inflation and achieved price, we are able to get price because we're selling primarily through distribution. So business units around the world depend on the end market and other competitive actions. But generally, we'll take price actions between November 1, and let's say, March 1. They're generally centered around the end of the year. And for our water businesses globally, including in North America, those price increases are kind of 200 to 300 basis points. The fueling business performed a little bit different. It doesn't have nearly the fragmented competition base in the end market that you see perhaps on the water side, and -- but they basically take the same approach where they assess the inflation and then go forward with price action that they think is necessary to grow margin. So that's kind of the view of it right now. We can do -- as I said, we do have the ability and we have in previous years. If we get into the June, July time frame and the inflation curve ticks up or the input costs are going up in a way that are more dramatic than we had assumed, then we have the ability to go back through and raise prices. We have done that in the past, we just prefer not to do that for the benefit of our customers.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [26]

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Okay, great. And then if we could just turn to Distribution and I wonder if we could just take a step back and think of the Distribution business, just the core business that you bought, Headwaters. And I wonder if we can get an idea of how the sales ended in 2017 either on a dollar or percentage. Distribution was down 11%, but maybe there was M&A that was in there, too. I don't know. And then in 2018, are you thinking Distribution starts to grow next year? Or is there still more supply chain disruption and revenue declines in 2018?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [27]

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Okay, helpful questions there. So for 2017, we had the 3 businesses that we acquired in the second quarter. And John was giving indication of relative pro forma to what we knew were 2016 results. That's where we said the revenues were down in the West and in the Southeast. Some of that was weather. Some of it was loss of some customers because of the product line disruption. We think that has now stabilized, and we're beginning to see we're regaining customers with our new suppliers to Headwater. So when we talk about 2018, we will have inorganic growth because we didn't own the company the first 4 months of the year or it wasn't consolidated with the Franklin the first 4 months of the year. So inorganic growth because of the acquisition of Valley, but we're expecting organic growth. That was the guidance I was giving of mid-single digits, and that would be just year-over-year. That's again share recovery. And the weather in the West Coast, particularly California, was less than ideal last year for the market. If it's more kind of "normal year", we would expect that to be a little bit of a help as well. So that's our thinking around the Distribution businesses top line for 2018.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [28]

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Okay. And if I can just ask another one on Distribution. You've had it now for a little while. I wonder outside of the supply chain changes, have you made investments into the business? I'm thinking of how many salespeople you have now versus before. Are there any profit improvement programs that you can put in place to increase profitability in 2018?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [29]

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Absolutely. And some of those programs would create some drag, but what we're doing is we're getting the back office all in one common platform, so we have visibility across the national network that's going to allow for better supply optimizations. It's going to allow for better communication on orders between Headwater and one of the largest suppliers, Franklin Electric. We are also weaning out various branches and getting them organized into a consistent model across the branches to improve productivity at the branch level and to reduce the risk of excess obsolete and just to have a general one look and feel under the different flags within the organization. We are continuing to expand some roles for some people in management oversight training, additional sales training and incentives. So we're doing all those things to help grow the business that you would do with any business that you acquire and want to get the leverage out of assimilating out into these common platforms and have common programs.

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Operator [30]

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Our next question comes from the line of Matt Summerville from D.A. Davidson.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [31]

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First, can you comment on your inventory position heading into the year? And how that -- I mean, adjusting for the Distribution businesses, I get that aspect. But if you kind of remove that from the equation, how are you feeling about your inventory position? And I guess I would imagine you want to bleed that down a little bit, how much do you need to bleed it down in your mind, Gregg?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [32]

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Yes. That is a great question. We have comfortable levels of inventory going into the year. That is clear. And I think that when you look at some of our historical numbers, stripping out the Distribution company, as you pointed out, to see a $25 million decline in the inventory in the year I think would be a reasonable expectation. We want to do this over time. We've now kind of -- we've moved some inventory out of our Distribution business into Franklin. We're understanding better some of the relationships. We're matching demand more to market demand than to quarter end activity, which is more the behavior of this industry in the past and so if we're just going to keep squeezing that back into the plants and then into reducing raw material acquisition. So we'll see that inventory bleed over time. Let's put a number out there, let's call it $25 million at this point, and we will see where we go from there. I think that we have the opportunity to improve upon that again over time.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [33]

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I want to make sure I understand Brazil a little bit better. Can you talk about -- I think you said water overall, up 4% to 5% organically in '18. What is the assumption you have baked in for Brazil specifically? Can you talk about the competitive dynamics in the business? Is this a price cutting you're seeing being brought on by other local OEMs? Or are Asian competitors starting to come into the market? And I guess does it make sense to think about having more of a roll-up strategy in Brazil? Or are you positioned how you need to be positioned?

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Robert J. Stone, Franklin Electric Co., Inc. - Senior VP & President of International Water Systems [34]

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Well, Matt, we're positioned pretty well. And so we have some growth forecast again in Brazil in this coming year. The situation is that the primary price cutting is coming from domestic players, and there aren't so many but there are a handful to a dozen domestic players, and everybody is trying to find business. And so they're cutting their margins to the bone. EBARA made an acquisition last year, and we could see that, that business is suffering, and we see that in their price cutting as well. There is definitely some encouragement from outside suppliers, namely from Asia, but that hasn't been the bulk of the challenge as yet. It's been mainly domestic suppliers who are desperate for volume.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [35]

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Got it. And then just one follow-up on Fueling. Gregg, you mentioned perhaps some upside to the fueling outlook in 2018, at least from a top line standpoint. I was wondering to the extent you can comment a little bit on what the flow-through of that business looks like. Obviously you had very good margins in the fourth quarter. So I guess maybe top line upside, what the read-through is to margins. And maybe what inning we're in, to use a baseball analogy, with the underground piping initiative there, please.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [36]

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Yes. So what's going on in China is that there is a very large initiative to upgrade the underground piping equipment to double-wall piping, and Franklin has a very strong position in the double-wall piping market. We saw the business begin to pick up in '17. It gained and accelerated in the fourth quarter. And then going into '18, its -- we could see it accelerate even further. I'm always -- you know I hesitate in putting out numbers out there, but it could be another 3, 4 points of growth on the fueling business margins in China are reasonable. They'll be a little bit less on piping relative to our kind of contribution margins on all of our products, but we should get some decent leverage. But we're already operating this business in a mid-20s OI. So I'm just saying we're going to get a lot operating leverage. We have -- pipe's expensive to move around the globe. We are increasing manufacturing in China to support the initiative locally. But I mean, there are other costs, so I just caution you to do too much of a leverage calculation on the sales opportunity.

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Operator [37]

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(Operator Instructions) Our next question comes from the line of Edward Marshall from Sidoti.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [38]

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Just a quick follow-up. I went back to the transcript from last year, looked like 200 basis points in '16 in price and 250 in 2017. I'm just curious we're kind of in line with the historic ranges of price increases. Are you capturing all the raw material price inflation in that 200 to 300 that you're seeing? Or is there additional room for upside there?

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [39]

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The raw material inflation, Ed, that we were talking about is the 150 to 200. The price to offset that, that we're assuming, again depends on the business unit, is between 200 and 300. And yes, so the assumption on the raw material inflation would be basically a bottoms-up kind of roll-up, looking at commodities, purchase components. There's also an assumption that goes into that relative to value improvement opportunities. So how much can we take out of those costs from a sourcing perspective, that's all in our thinking right now or our current thinking is the way we do that. Done basically in a roll-up that happens in the November time frame, and then we update that roll-up in the January time frame

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [40]

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So it seems consistent with prior years. Is this in addition to other like traditional just normal increasing in pricing aside from what you're seeing on the input cost side? I mean, it just seems like it's your typical 200 to 300 on an annual basis kind of increase for water.

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John J. Haines, Franklin Electric Co., Inc. - VP, CFO & Principal Accounting Officer [41]

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Well, the -- yes. The price achieved in 2017 was about 200 basis points on the consolidated entity. The assumption for 2018 is to achieve something higher than that, net. And that's primarily because we're expecting higher raw material inflation than we saw in 2017.

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Operator [42]

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And I am currently seeing no further questions. I would now like to turn the call back to Gregg Sengstack, Chief Executive Officer, for any further remarks.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman & CEO [43]

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Thank you for joining our conference call today. We look forward to speaking to you after the first quarter results are out.

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Operator [44]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the conference, you may all disconnect. Everyone, have a great day.