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Edited Transcript of FELE earnings conference call or presentation 27-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Franklin Electric Co Inc Earnings Call

BLUFFTON Apr 30, 2017 (Thomson StreetEvents) -- Edited Transcript of Franklin Electric Co Inc earnings conference call or presentation Thursday, April 27, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gregg C. Sengstack

Franklin Electric Co., Inc. - Chairman, CEO and President

* John J. Haines

Franklin Electric Co., Inc. - CFO and VP

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Conference Call Participants

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* Edward Marshall

Sidoti & Company, LLC - Research Analyst

* Matt J. Summerville

Alembic Global Advisors - MD and Senior Analyst

* Ryan Curtis Cassil

Seaport Global Securities LLC, Research Division - Director of Flow Control and Engineering and Construction and Senior Industrials Analyst

* Ryan Michael Connors

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

* Spencer Everett Joyce

Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. I'd like to introduce your host for today's conference, Mr. John Haines, Chief Financial Officer. You may begin.

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John J. Haines, Franklin Electric Co., Inc. - CFO and VP [2]

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Thank you, Amanda, and welcome, everyone, to Franklin Electric's First Quarter 2017 Earnings Conference Call. With me today are Gregg Sengstack, our Chairman and Chief Executive Officer.

On today's call, Gregg will review our first quarter business results, and then I will review our first 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. 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 Chief Executive officer, Gregg Sengstack.

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

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Thank you, John. Outside of the U.S. groundwater business, we had a good start to the year with organic sales growth of approximately 5% led by our Fueling Systems business and our Latin America Water business. Our fueling business continues to grow globally. Organic sales increased 7% in the U.S. and Canada and 11% internationally. Our strategy of focusing on safety and lowest total cost of ownership continues to be in traction.

The development of our Site Builder website and FFS PRO University, we are winning business in North America, with major marketers as well as distributor discretionary business. With a stabilization of oil prices outside of North America, we are seeing pockets of increased demand for our products and systems as well. For example, during the quarter, we had a definite uptick in demand with China market, which we see carrying on through the balance of the year.

We are also seeing strength in our water business in developing regions. Latin America growth accelerated to over 10%. Southern Africa, while still soft, had better results from last year, and even with a particularly tough comp, Asia Pacific eked out an increase. We had another record quarter to local currency in Turkey, although Europe and net balance of the Middle East remain relatively flat.

Focusing on the U.S., our dewatering equipment business is up about 12% as we are seeing increased backlog in coating activity. Revenue of our other surface pumping equipment declined by 3%. In our U.S. groundwater business, we saw about $7 million decrease in sales as compared to the first quarter of 2016. Excluding sales to the Headwater Distribution entities, still the groundwater pumping systems were down about $1 million. Weather in the Western Canada was great, and we had a very strong finish to last year in this channel with the year-end price increase, and as 2016 was a better year than 2015, many distributors stretched for volume rebates and we expect channel inventory to be healthy.

As John will explain in a minute, the Headwater distributors that we're acquiring this quarter had different matters to consider. But in short, there is nothing to gain by increasing the purchases from Franklin Electric in the quarter, and we had no incentives to promote more sales to them. So our U.S. water sales were down and those margins on groundwater pumping systems are higher than our corporate average due to vertical integration, our operating income for the quarter suffered.

One other data point. On a pro forma basis, the first quarter revenue of the 4 entities that we are acquiring to form the Headwater Company, overcame a 10% decline in sales in the West Coast and we're up 4% on consolidated basis in the quarter.

So as we look forward to the balance of 2017, despite a slow start in the U.S. and Canada groundwater markets, we remain positive about our ability to achieve organic top line growth in the 5% to 7% range for our preacquisition segments. This growth allows us to reaffirm our 2017 adjusted earnings per share guidance range of $1.77 to $1.87.

I will now turn the call back over to John.

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John J. Haines, Franklin Electric Co., Inc. - CFO and VP [4]

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Thank you, Gregg. Our fully diluted earnings per share were $0.33 for the first quarter 2017 versus $0.28 for the first quarter of 2016, an increase of 18%. First quarter 2017 sales were $220.3 million, an increase of 1% compared to 2016 first quarter sales of $218.4 million. The company's organic sales growth was 1% as the impact of foreign currency translation was not significant.

The company is not reporting non-GAAP adjustments in the first quarter 2017 as we are now reporting the first quarter 2016 operating income in the same format. The $0.3 million of restructuring expense reported in the first quarter is related to the ongoing restructuring efforts in Brazil.

Water Systems sales were $167.2 million in the first quarter 2017, a decrease of $1.6 million or about 1% versus the first quarter 2016 sales of $168.8 million. Water Systems organic sales were also down about 1% compared to the first quarter 2016.

As Gregg already mentioned, sales of Groundwater pumping equipment in the United States and Canada declined in total about $7 million. However, about $6 million was due to reduced sales to the Headwater Distribution entities that the company announced the acquisition of on April 10. There was no incentive for these entities to buy up inventory from Franklin in the quarter, especially considering their large fourth quarter purchases in weak end-market conditions in the Western United States.

Likewise, due to the deferral of profit recognition on sales between the Water Systems segment and Headwater until the product is sold to the Headwater customer, there was also no rationale for the Water Systems segment to incentivize or promote higher sales for these customers in the first quarter.

The profit recognition deferral is elongated by the amount of Franklin inventory, the Headwater Company has on hand at that time the acquisitions were completed. We estimated the lower sales of groundwater pumping equipment to the Headwater companies explains about $0.04 difference in EPS from the first quarter of 2016 to the first quarter of this year.

Water Systems operating income was $21.4 million in the first quarter of 2017, down $2.8 million or 12% versus the first quarter 2016. And operating income margin was 12.8%, a decline of 150 basis points from 14.3% in the first quarter of 2016.

Water Systems first quarter 2017 operating income and operating income margins, before restructuring expenses, were $21.7 million and 13%, respectively. The decline in Water Systems operating income and operating income margin is primarily attributable to lower sales volume and higher marketing and selling expenses, which increased about $2.7 million from the first quarter of the prior year.

Fueling Systems sales were $53.1 million in the first quarter 2017, an increase of $3.5 million or about 7% versus the first quarter of 2016 sales of $49.6 million. Fueling Systems sales decreased by $0.8 million or about 2% in the quarter due to foreign currency translation. Fueling Systems sales increased about 9% after excluding foreign currency translation.

Fueling Systems operating income was $11 million in the first quarter of 2017, up about $0.8 million or about 8% compared to $10.2 million in the first quarter of 2016. And the first quarter operating income margin was 20.7%, an increase of 10 basis points from the 20.6% of net sales in the first quarter of 2016.

The company's consolidated gross profit was $75.8 million for the first quarter of 2017, an increase of $1.6 million or about 2%, from the first quarter of 2016 gross profit of $74.2 million. The gross profit as a percent of net sales was 34.4% in the first quarter of 2017 and increased about 40 basis points versus 34% during the first quarter of 2016. The gross profit margin increase was primarily due to favorable pricing and lower direct material costs, partially offset by higher fixed costs.

Selling, general and administrative expenses were $57 million in the first quarter of 2017 compared to $52.3 million in the first quarter of the prior year, an increase of $4.7 million or about 9%. Sales related support cost, including marketing and selling-related expenses increased by about $3.3 million, and transaction and other costs associated with the recently acquired distribution companies were about $0.8 million. Additionally, foreign currency translation increased SG&A about $0.6 million in the quarter.

The company realized discrete income tax benefits related to foreign net operating losses and currency exchange losses in the first quarter of 2017, which lowered the consolidated effective tax rate to about 1%. The effective tax rate in the first quarter of 2016 was about 27%.

The company ended the first quarter of 2017 with a cash balance of about $71 million versus about $104 million at the end of 2016, down due primarily to increased inventory. Inventory levels at the end of the first quarter of 2017 were $236 million versus year-end 2016 of $203 million. Inventory increase is primarily due to seasonal demand and due to lower-than-anticipated sales of groundwater pumping equipment in the United States and Canada markets.

The company had no borrowings on its revolving debt facilities at the end of either Q1 2017 or year-end 2016. The company did not purchase any shares of its common stock in the open market during the first quarter of 2017. As of the end of the first quarter of 2017, total remaining authorized shares that may be repurchased is about 2.2 million.

This concludes our prepared remarks. And we would 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 of Sidoti & Company.

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

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So I wanted to ask, in the original guidance was, did you plan on the discrete tax item at that point? And is there anything else that you can see in the financials that would lead you to think that, that will continue throughout the year?

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

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Yes. A portion of it certainly was planned, a portion was not planned. So the discrete benefits that we got in the first quarter was a little bit better than we had originally believed it would be. But when we reaffirmed the guidance today, the $1.82 midpoint, we're considering several different pluses and minuses. So yes, we're going to get a bit of a plus on the tax side we think, but there's a few other minuses that get us back to that [$1.82]. So the answer to it is, part of it was assumed, but part -- a portion of it was not as well.

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Edward Marshall, Sidoti & Company, LLC - Research Analyst [4]

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And so following on that, what do you think the tax rate for the year is going to be?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [5]

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I think, in our best view right now, before the impact of discrete items is still in that 26%, 27% range. After the impact of discrete items, it is more in 20% to 22% range.

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Edward Marshall, Sidoti & Company, LLC - Research Analyst [6]

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Okay. And last -- couple of weeks back, when you had the acquisition call, you confirmed your outlook and said that it was going to be neutral to earnings. Now what they mean -- looking at the kind of the first quarter and some of the other items that are flowing through, is there language to change there or do you still expect it to be kind of neutral for 2017?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [7]

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Yes. It's all part of that same math, Ed.

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

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Okay.

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

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When we were trying to estimate -- we're trying to estimate several moving pieces here as it relates to the distribution acquisitions, the amount of income they'll will generate on their own kind of from May 1 on when we own them. The added costs, we had some costs in the first quarter. We're trying to think through the amount of reduced sales that we have in the first quarter to them, which obviously, impacted our first quarter results. And then the most important thing is this deferral, the recognition of profit that will take place when these are fully owned subsidiaries. So we won't -- as we've explained a couple of times, we won't be able to recognize profit on sales from the Water Systems segment to the distribution segment until the distribution segment completes the sale of that Franklin product all the way through to their end customer that their contractor installed. So while all those variables are in play, and what we're trying to do is -- okay, based on all that, based on our first quarter results that had pluses and minuses in it, we still think the $1.82 midpoint is where it'll be for '17.

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

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Got it. Sounds like you have a tough job to help us out, so we appreciate it. I guess let's talk about the core business and then add in the acquisitions on. You had relatively higher SG&A in the first quarter. On the core business itself, is that kind of the run rate for the year? Or was there something specific that drove that higher? And that's absent acquisitions, because I know that number is going to change.

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

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Yes. Ed, I guess (inaudible). Yes, the SG&A was up $3.3 million in the quarter related to specifically to sales and marketing related activity globally and across those segments. So that was true for water, it was true for fueling. Fueling is up. But when you think about it, we had 4% water organic growth outside of the U.S. and Canada, and we had 9% organic growth in fueling in the first quarter. And we're also reaffirming the belief that our core entities, the core Franklin before acquisitions is going to achieve between 5% and 7% organic growth for the full year. So we're hanging on to that guidance as well. So in retrospect, we have some higher sales and marketing expense from our perspective is to be expected now. The good news about SG&A is that we can kind of turn that down and turn that off if we proceed through 2017 here and see that some of these growth rates are not materializing the way that we want them to. So the entire $3.3 million was related to sales and marketing stuff. We would say there was a lot of onetime stuff, about $600,000 that was related to FX. So that was the driver in our total SG&A as well. Does that answer it for you, Ed?

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

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No, it does. I appreciate the comments.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [13]

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Thanks for recognizing John and his team's efforts. So there are a lot of moving parts, and they've done a fine job trying to keep this all in front of everybody.

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Operator [14]

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Next question is from the line of Ryan Cassil of Seaport Global.

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Ryan Curtis Cassil, Seaport Global Securities LLC, Research Division - Director of Flow Control and Engineering and Construction and Senior Industrials Analyst [15]

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I was wondering if you could just parse out, I guess, some of the higher selling costs between the segments. Just looking at fueling, really nice volume growth as you pointed out. The incremental margins just sort of low-double digits, is sort of lower than we expected. Was that mix related? Or did you have -- was more of that selling costs in fueling perhaps? If any color that would be great.

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

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Yes. I think there is a portion of it that was mix related, Ryan. As I said, the marketing and selling was up and fueling as well. The other thing, I guess, I would point to in fueling is, they didn't have higher price realization in the quarter as what we would expect. It was sub 200 basis points. So the other thing that we're trying to balance this year with our pricing increases is, the balance of raw material inflation coming at us offset by price. And I think that gross profit margin is probably the best place to look at how that's working. And we did incrementally improve our gross profit margin. So I think that might be the only other factors along with mix in fueling. And you'll recall, I hope, from prior conversations that when fueling is kicking around in mid-20 kind of operating income margin, we always said, hey, that's pretty high. There's a lot of factors that are going really well for them. And that -- I don't know, 22% to 24% might be a more reasonable point for fueling.

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Ryan Curtis Cassil, Seaport Global Securities LLC, Research Division - Director of Flow Control and Engineering and Construction and Senior Industrials Analyst [17]

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Right. That's kind of where I was going. You guys have always -- it seemed like this segment was sort of out-earning. So to like we're sort of normalizing, maybe -- or it's -- is it maybe a change in the competitive landscape that we see it going to the 22, mid-to-low 20s margin rate over the longer term? And I guess how quickly do you think that might...

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [18]

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Ryan, there is enough different factors that will move in around quarter to quarter. We don't see a fundamental underlying change in the competitive landscape. Over the last 1.5 years, I guess, it has been now -- there's been some consolidation in the dispensing space, but that has not impacted our business. It's a function of where in the world is sold, what product line is sold. There are -- there's different market characteristics with different product lines in the different regions. And so that's why when we're out talking with people, we say, as John pointed out, low 20s is kind of what you expect. If it's better than that, it's been a good quarter. And here again, this idea is turning on and turning off fixed costs. We need to continue to invest in our fueling business to continue to get top line growth as in the high single-digit. So we're going to do that where it's appropriate, then we'll get leverage on that as we go.

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Ryan Curtis Cassil, Seaport Global Securities LLC, Research Division - Director of Flow Control and Engineering and Construction and Senior Industrials Analyst [19]

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Understood. Appreciate it. And then just lastly on the water side. You guys reiterated your confidence in the organic outlook 5% to 7%. Have you seen things kind of snapback? Or could you give any commentary just respect to groundwater systems early here in Q2?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [20]

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It's -- this is always kind of the critical time or tough time to call that because it's still late April. The second quarter is when things start moving along, but it is -- we don't want to overplay weather, but the weather is a component when this business starts in the U.S. Outside the U.S., the groundwater business has been, as we pointed out, pretty solid. It's been not particularly strong in Europe, but outside U.S. and other parts of the world, it's been -- continue to be very strong. But to look at your question in the U.S., we're seeing good order flow rates. We're seeing -- there's kind of normal seasonality, but if you start calling the second quarter that would be premature.

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Operator [21]

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Our next question is from the line of Ryan Connors of Boenning.

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Ryan Michael Connors, Boenning and Scattergood, Inc., Research Division - MD and Senior Analyst of Water and Environment [22]

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My question has to do with just trying to get better understanding of this destocking by your -- to be acquired entities and exactly how the tactical dynamics of that work? So they're -- I mean, they're going to destock, how does that impact their ability to meet demand in the very near term? And is there other competitive dynamics that arise there, and how quickly do you sort of scale up your own inventory to meet that demand? If you can kind of just walk us through how that dynamic works.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [23]

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Sure, Ryan. Again, in Q1, people or companies like Franklin here are promoting to move parts on the shelves of distribution in anticipation of seasonality in North America. And that was kind of the normal Q1 cadence that didn't occur once it was clear of these owners that we were going to proceed with purchasing them. You'll notice that Franklin's inventories are up. Availability, we talk to you about it as a strategic imperative for Franklin only next to quality. And so we've got deep inventory. We can deliver on a relatively short basis. We see an opportunity logistically with these entities to work on that supply chain aspect, to increase service levels, maintain our increased service levels with less overall inventory. And John can take you through again the math of this -- how inventory at closing has this intercompany profit aspect to it in more detail. But from the standpoint of the business, there is no incentive for you guys to buy. We knew we can deliver as necessary to supply the markets as Franklin Electric manufacturing. We're confident we can do that for our piece of it. We're obviously going to continue to buy from other suppliers as well. And then on the math, if you have some specific questions you have for John. You can sort of chew on that piece.

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Ryan Michael Connors, Boenning and Scattergood, Inc., Research Division - MD and Senior Analyst of Water and Environment [24]

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Great. Great. That's very helpful. And then just one another quick one. I did notice -- and you may have mentioned this, but I might have missed it, but there is a line in the press release about a 12% increase in dewatering, which looked actually pretty positive. Wonder if you can kind of just talk to us about some of the drivers behind that? And how that change the outlook for that business?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [25]

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When we talk about dewatering, we're talking about the Pioneer product line. And you may recall that, that business back in 2014 was $100 million top line. With a falloff in oil prices, that business is dropped to about half and more than half in '15, it's recovered a little bit. And we've now repositioned that business and are growing with customers not only in the oil and gas channel, but other channels as well. We're just seeing a nice little tick-up in demand there. So we're very pleased to see that the team is working hard. We've got more feet on the street, not only in the U.S., but around the globe and the business is beginning to grow nicely.

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Operator [26]

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Our next question is from the line of Matt Summerville of Alembic Global.

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Matt J. Summerville, Alembic Global Advisors - MD and Senior Analyst [27]

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John, to get to this Headwater acquisitions and, I guess, what is your top line assumption in terms of your sell into the Headwater companies during the period you own them in 2017? So let's call it, 7 months, 7.5 months, whatever the right figure is. So you have a sell-in assumption, and I would assume, you have a sell-through assumption as well, if you could help us from a modeling standpoint. How you're thinking about those figures, that would be helpful?.

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John J. Haines, Franklin Electric Co., Inc. - CFO and VP [28]

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Yes, Matt, as we said, the volume that we sold to the Headwater companies in 2016 is about $50 million. Given the first quarter results here, I think what we'll sell into them in 2017 is probably more in the mid-40s. I think there's going to be some growth, but I think the first quarter is what it is, and there was -- there's certainly a decline there. In terms of their sell-through of Franklin product only, I'm not sure that I have a real current estimate of that. What we're trying to do is understand more of the timing of that, Matt, than -- really more than anything because the timing is what's going to influence the ultimate recognition of our profit. So the factor in the first quarter that is most meaningful was that, that our sales down by $6 million, which is obviously very meaningful to groundwater and to the U.S. results. That was a little bit more than we had expected. We expected them to be down. And we attribute that little bit more to kind of the underlying market conditions along the West Coast, which is where hydro and to a large extent (inaudible) operate. They were not very favorable during the first quarter.

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Matt J. Summerville, Alembic Global Advisors - MD and Senior Analyst [29]

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And then, I guess, maybe Gregg, as you're out speaking with other distributors, which you do not own and will be directly competing with them given the footprint you are acquiring. What kind of feedback are you getting from your other distribution folks that you deal with?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [30]

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We're getting the range of feedbacks one would expect in this equation. We have -- again, for Franklin's piece of this, we have selective distribution. And so -- but for an ownership change, nothing else fundamentally has changed there. I think -- but I said, you get the range of reaction of "cautious" and "wait-and-see" to "we can go if you guys are doing it, " and it's somewhat comforting for some of these guys to know there's potentially somebody out there that has now created an entity that they may be able to sell their business to at some point in the future. So we've got the range you'd expect.

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Matt J. Summerville, Alembic Global Advisors - MD and Senior Analyst [31]

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I guess, thinking longer term recognizing, you've just now, kind of, gone this route from a vertical integration standpoint into distribution. But again, thinking longer term, what is the next logical acquisitive step for Franklin in North America distribution? Is it a geographic play? Is it a product set play? Talk about that a little bit. And then also, Gregg, is this model that you are moving forward within North America, does it fit anywhere else geographically speaking outside of the U.S.?

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

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Okay, Matt. Several questions buried there, see if I can pick them off one at a time. If you look at the footprints that we have, there are logical geographies where we could expand if there was appropriate to do so, keeping in mind as you pointed out, we're doing this business for 2 weeks. And so we've got a lot to do just to integrate these 4 businesses under one platform and move forward. But you can look at it, there is a logical look in saying, there are geographic opportunities to expand. The other point is very well taken, which is that, if you look at each of these entities, they all had niche businesses that are adjacent to the core groundwater. Hydro is strong in commercial in California. You've got very strong in turf irrigation. DSI has got some strength in the wastewater or green water space. So these are all kind of logical adjacencies for us to look at cross-selling and then for us to also potentially look at as manufacturer of increasing our footprint in those situations. So it really does give us, as we said, back 12 years ago, before we integrated pumps giving us more headroom for growth, this also gives us more headroom for growth. Your question about outside the U.S. is really interesting, because it's a little bit market-to-market. The core groundwater channel is rather unique to the U.S. market. But as we look around the world and as we've expanded through our acquisitions and developing platforms, I could take you to the example of Brazil, which has worked out very well for us. But the Schneider acquisition was principally a surface pumping business. They had sold submersibles in the past, they had sold Franklin Electric motors and fuels pumps. So they had access to the channel, but they, I think, had 5,000 customers. So in effect, we're going to Brazil, we're buying a really strong brand with a really strong reach. But their average customer buy is just a few thousand dollars or tens of thousands of dollars a year or not, hundreds of thousands of dollars. It's a much more fragmented customer base. But going into Brazil and having that distribution reach allowed us, again, to accelerate the penetration in the market with the groundwater side, which kept us -- put pressure on a couple of competitors who kept the dialogue (inaudible) and then we (inaudible) which is kind of right in Franklin groundwater throughway, so -- and you look at Turkey. Turkey, there are a couple of ways people that are market for us. We have about 300 distributors. Other competitors in Turkey have less -- few distributors that are more like master distributors. So we've been steadily kind of pushing down our position in each of these markets to be closer and closer to the end customer. But the U.S. is really kind of most unique platform in the ground and the submersible space in the world.

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Matt J. Summerville, Alembic Global Advisors - MD and Senior Analyst [33]

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Got it. And then you mentioned pricing, I think, pertaining to the fueling business. What was your realization in the Water Systems segment in Q1? And what would your full year expectation be for [Feili] overall?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [34]

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Water was about 280 basis points, Matt, in the first quarter. Our expectation is slightly below that for the full year.

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Matt J. Summerville, Alembic Global Advisors - MD and Senior Analyst [35]

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Got it. And then just to follow-up and get back to the organic guidance of 5% to 7% for the whole company. I assume that water is squarely in kind of down the fairway, in (inaudible) place if you will. You're starting out the year down one. You face -- I'm going to call a normal comps in Q2 and 3 and a big comp in Q4. I guess, what helps -- give me comfort that the math sort of works there to get to the midpoint of that fairway given what I sort of articulated with how you come into Q1? And then how your comp works in Q4?

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

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Yes. Again, I think, Matt, when you're looking outside the U.S. and Canada, it was reasonable organic growth story on the waterside of about 4%. And I think, when you consider this Headwater, call it inventory adjustment or reduction in buy that happened in the first quarter, we think that, that was more of a onetime kind of impact in the first quarter that's not likely to repeat in the subsequent quarters. So I would say those are the primary factors that give us confidence. I think fueling at 9% and is off to a good start, and most of the indicators on the fueling side are positive. So we have a lot of confidence that, that will be above that range, which is what our assumption was all along.

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Operator [37]

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(Operator Instructions) Our next question is from the line of Spencer Joyce of Hilliard Lyons.

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Spencer Everett Joyce, Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities [38]

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To piggy back a little bit of both Ryan and Matt's questions earlier, I want to talk a little bit about the Headwater acquisitions here. So the delays in the destocking, I thought you all did a good job explaining that to us, but I guess my question is, we should see a little bit of that phenomenon play out in the second quarter as well, is that right? Or were those inventory levels substantially alleviated kind of before these deals close?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [39]

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What I'm understanding, Spencer, your question that the phenomena of profit recognition by the consolidated entity will start -- the deferral of that profit recognition will start in the second quarter. It is impacted by how much inventory these units have on hand to start with, right? So as we said, when we announced on April 10, that -- and we said, again, this morning, if they're selling inventory or selling Franklin products if they have an inventory that we've already recognized profit on because we've already sold it to them, right. Then Franklin consolidate is not going to recognize any profit on sales to these entities until all that inventory is sold, they'll buy new inventory and sell that. So that's what giving rise to this period of deferrals. So certainly, from Franklin's perspective, and that was the point we were trying to make up this morning. From our perspective, it's better that they have lower inventory because they'll sell that faster and then buy more and then we'll get back to the profit recognition more quickly, right? And as we also said, they really didn't have a financial or closing or proceeds advantage of building more inventory in the first quarter, either. So that was part of the thinking there. So that is -- that's basically what we're facing up against. But if your question is, is this going to start to impact us in the second quarter, the answer is absolutely, yes. It is.

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Spencer Everett Joyce, Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities [40]

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Okay. That's very helpful. Sticking with Headwater here for a second, so we have the 3 acquisitions here right off the bat, which I'm assuming still leaves us with a segment that's even much smaller than fueling and, presumably, at lower operating margins. And I'm just wondering what the plan is kind of over the next 6 to 12 months, or perhaps 6 to 18 months as far as getting that up to kind of critical mass, whether it be perhaps an escalation of organic CapEx? Or is there still a pretty robust pipeline of another 4, 5, of other tuck-in type deals that you could do here?

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John J. Haines, Franklin Electric Co., Inc. - CFO and VP [41]

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Well, the run rate of this business, we fear, is going to be around $275 million on an annual basis. That's going to be actually a little bit larger than fueling, although to your point, the operating margins in distributions are lower. And that we discussed on their call couple of weeks ago. We've got plenty to do with these businesses. The scale -- the opportunities we have is getting everybody on a single platform and really working on the -- on both the input value streams, and so we're getting really good flow of inventory from all suppliers into the entity and also increasing service levels so that we continue to win customers on the sales side. So this is the largest entity that we believe by branch count, by employment. We think our revenue run rate -- we know this is visible to everybody in this space. So we think we've got a scale. We've just got plenty of work to do to get these entities all integrated in one platform and increasing service levels throughout the supply chain. So that's really the focus for the next period of time.

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Spencer Everett Joyce, Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities [42]

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Okay. That's helpful as well. I guess a couple of kind of housekeeping questions, and I apologize I've had to kind of jump on and off here a little bit. John, did you mention or give us any kind of guidance to tax items for the balance of the year? Are the NOL items from Q1 -- contained to Q1, we should be modeling fairly normal over the balance of the year?

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

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Yes. I would -- when we talk about our tax rate expenditure in 2 pieces before the discrete items. So that's the 26%, 27% range. And then we have from time to time these discrete benefits, sometimes they are not benefits, sometimes they go the other way. But we have these discrete items that lower our effective rate. So what we're saying, I don't know, if it was Ryan or somebody asked the question earlier, the 26% to 27% before the discrete items, we think with the discrete items, it's 20% to 22%, and that assumes not only the first quarter discrete items that we've already recognized, but then some estimate of what the balance of the year might be. So those are -- that's how we're currently thinking about it. Some of these things are really hard to predict, as you might guess. You don't really know if you're going to get them until you actually get them. So that's what makes kind of putting some of these into the forecast and talking confidently about them difficult.

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Spencer Everett Joyce, Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities [44]

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Okay. So we're looking at 20% to 22% for the full year, including the discrete items?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [45]

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Including, yes.

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Spencer Everett Joyce, Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities [46]

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And is some of the discrete items we might see related to the new share-based compensation accounting guidance, I know we've seen that pop-up for a lot of companies kind of across sectors. Are you all dealing with that at all? Or is that...

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [47]

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No. That's certainly playing into it, Spencer. I would not say that were the -- those were the critical drivers in the first quarter. In the first quarter, we realized a foreign currency translation loss on the repayment of an intercompany loan that gave us a permanent tax benefit. The other thing that happened in the first quarter is, we completed a international tax jurisdiction restructuring that we leased a valuation allowance on our deferred tax asset that gave us a big benefit in the first quarter. So the answer to your question is, yes. The share-based comp is impacting the tax rate, but the bigger impact in the first quarter were these 2 items that I just mentioned.

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Operator [48]

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Thank you. And at this time, I'm showing no further questions. I'd like to turn the call back over to Mr. Gregg Sengstack for closing remarks.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, CEO and President [49]

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Thank you, Amanda. We appreciate everybody joining us on this first quarter conference call. We look forward to speaking to you all after the second quarter. Have a good day.

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Operator [50]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everybody, have a great day.