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Edited Transcript of FELE earnings conference call or presentation 23-Jul-19 1:00pm GMT

Q2 2019 Franklin Electric Co Inc Earnings Call

BLUFFTON Jul 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Franklin Electric Co Inc earnings conference call or presentation Tuesday, July 23, 2019 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, President & CEO

* John J. Haines

Franklin Electric Co., Inc. - VP & CFO

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Conference Call Participants

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* Edward James Marshall

Sidoti & Company, LLC - Senior Equity Research Analyst

* Matt J. Summerville

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

* Ryan Michael Connors

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

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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 Reports Second Quarter 2019 Sales and Earnings Conference Call. (Operator Instructions) Also, as a reminder, this conference call is being recorded.

At this time, I would like to turn the call over to your host, John Haines, Chief Financial Officer. Please go ahead.

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

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Thank you, Bill, and welcome, everyone, to Franklin Electric's Second Quarter 2019 Earnings Conference Call. With me today is Gregg Sengstack, our Chairman and Chief Executive Officer. On today's call, Gregg will review our second quarter business results, and I'll review our second quarter financial results. When I'm through, we'll allow 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, President & CEO [3]

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Thank you, John. Second quarter 2019 results were below our plan and expectations. Continued record precipitation in the U.S., political uncertainty and social unrest in EMENA, economic weakness in other developing regions and a slowdown in China, all contributed. That said, second quarter revenue, operating income, net income and earnings per share were records for any quarter in our company's history.

In the U.S. and Canada Water Systems business, large dewatering pump sales were up over last year but below expectations, again due to customers pushing out a couple of million dollars of orders into the second half of 2019. Backlog remained steady. Sales of other categories of surface pumps were up as well in the quarter.

U.S., Canada groundwater pumping systems sales declined 12% on the back of lower sales through our Distribution segment. With much of the back office integration complete, we are focusing on reducing inter-segment inventory. Sales of groundwater pumps to third-party distributors were up 5% over last year.

Moving outside the U.S. Our Water Systems business in EMENA declined organically mid-single digits. As we supply components to other European pump companies, we view this slowdown as industry wide. The Middle East is an important export market for European companies, and the political uncertainty and social unrest are impacting the pump business in this region. In addition, business in Turkey is slow, particularly in the ag market. Farmers have not recovered from the dramatic devaluation of the lira that began last summer.

Our Water Systems business in Latin America outside Brazil declined organically as well. Throughout Latin America, political instability and fragile economies still trade the headlines. One bright spot is Asia Pacific where like quarter 1 our Water Systems business was up meaningfully. John will get into more details, but weakening currencies reduced our International Water reported revenue by 8% as compared to the second quarter of last year.

Our Fueling Systems business delivered another record quarter with operating income up double digits. Sales were, again, up double digits in the U.S. and Canada. Business in China is back on track, but we see growing evidence that the economic environment in China is impacting our business in 2 ways: First, state-owned oil companies are scaling back their capital plans; and second, a "buy local" initiative is growing. At this point, we believe we will achieve our 2019 planned revenue of approximately $50 million in the country. However, we now believe that 2020 revenue will be between $40 million and $50 million.

Sales in EMEA continue to be below expectations, principally due to uncertainty around Brexit impacting underground tank sales and credit issues in Africa delaying build programs in the back half of 2019. Sales in Asia were down after a strong Q1. Sales in India recovered nicely and are back on plan. Our Fueling business in Latin America continues to grow.

Turning to Distribution. Like Q1, this end-customer-facing business was the one most dramatically impacted by the extreme weather and high levels of precipitation experienced in many regions of the U.S. We had expected, hoped maybe, that precipitation would have normalized in Q2. That didn't happen. However, the team did a great job of selling more non-water well products and delivered 1% organic growth in the second quarter. As expected, the overall weak demand in the water well market compressed margins, although they improved sequentially through the quarter. With many Headwater branches located in the Midwest and West, the record precipitation resulted in sales of F.E.-brand products through Headwater being 5% lower in Q2 of last year.

That brings me to our outlook for the balance of the year. I will start with Distribution. End demand is there. We believe that the more normal weather conditions we're now seeing will lead to recovery in our Distribution business. July has started well. We believe our groundwater manufacturing business will also recover. Our sense is that inventory channel is about average for this time of the year.

The outlook for our U.S. surface pump business is good as is the demand for our large watering pumps where we continue to focus considerable attention on expanding and diversifying our customer base both by end markets and geography. Overall, the business climate in the U.S. is robust. We are encouraged by the positive feedback we've gotten from the field.

Even with the turmoil in EMENA, we're somewhat optimistic about the second half of 2019. We're getting more traction with our expanding line of pressure boosting systems. We are seeing an increase in tender activity for North Africa and believe we will see some improvement in the Middle East, albeit from a low base. We believe our European Water business is doing as well or better than most. Given our second quarter results, we expect Turkey to continue to be weak. We see Argentina stabilizing and Brazil getting a little bit better as well.

We are encouraged by our results in Australia, Southeast Asia and in China where we have introduced a new booster system that is gaining some traction. In our Fueling business, the outlook remains positive. The team is positioned to carry forward the strong start in the U.S., and our China revenues are recovering back to planned levels.

Despite these positives, looking forward, our first half results did not meet our expectations, and we do not believe we will be able to achieve our original earnings per share guidance. We now believe our full year 2019 earnings per share before restructuring charges will be between $2.15 and $2.25, which at its midpoint, would result in the second half 2019 earnings per share before restructuring charges of $1.29, [an 11%] increase over the second half of 2018.

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

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

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Thank you, Gregg. Our fully diluted earnings per share were $0.70 for the second quarter of 2019 versus $0.64 for the second quarter 2018. Second quarter EPS before the impact of restructuring expenses was also $0.70 compared to 2018 second quarter EPS before restructuring of $0.65. Restructuring expenses in the second quarter 2019 were $0.2 million and were related to branch consolidations and other asset rationalizations in the Headwater Distribution segment.

Restructuring expenses in the second quarter of 2018 were $0.6 million related to various manufacturing realignment activities and resulted in a $0.01 impact on earnings per share in the second quarter of 2018.

Second quarter 2019 sales were $355.3 million compared to 2018 second quarter sales of $344 million, an increase of 3%. Sales revenue decreased by $10.3 million or about 3% in the second quarter of 2019 due to foreign currency translation, and we estimate this revenue decline lowered our earnings per share in the second quarter by about $0.03 versus the second quarter 2018.

Water Systems sales were $205 million in the second quarter 2019 versus the second quarter 2018 sales of $211.4 million. In the second quarter of 2019, sales from businesses acquired since the second quarter of 2018 were $3.3 million. Water Systems sales decreased about 4% in the quarter due to foreign currency translation. Water Systems organic sales were flat compared to the second quarter of 2018.

Water Systems operating income was $30.9 million in the second quarter 2019 compared to $32.2 million in the second quarter 2018. Water Systems operating income was lower in the second quarter, primarily due to lower sales volume, the result in lost leverage on fixed costs and adverse product sales mix.

Fueling Systems sales were $78 million in the second quarter 2019 compared to second quarter 2018 sales of $73.1 million and were a record for any second quarter. In the second quarter 2019, sales from businesses acquired since the second quarter of 2018 were $1.7 million. Fueling Systems sales decreased about 2% in the quarter due to foreign currency translation. Fueling Systems organic sales increased about 7% compared to the second quarter of 2018.

Fueling Systems operating income was $21.7 million in the second quarter of 2019 compared to $19 million in the second quarter of 2018. Fueling Systems operating income was higher in the second quarter due to favorable mix and operating leverage.

Distribution sales were $87.1 million in the second quarter of 2019 versus second quarter 2018 sales of $79.5 million. In the second quarter of 2019, sales from businesses acquired since the second quarter of 2018 were $7 million. The Distribution segment sales grew about 1% organically compared to the second quarter of 2018.

The Distribution segment operating income was $4.5 million in the second quarter of 2019 compared to $4 million in the second quarter of 2018. Operating income before the impact of restructuring expenses was $4.7 million. Distribution's operating income was higher due to acquisitions.

The company's consolidated gross profit was $119.7 million for the second quarter of 2019, an increase from the second quarter of 2018 gross profit of $116.1 million. The gross profit increase was primarily due to higher Fueling Systems sales. The gross profit as a percent of net sales was 33.7% in the second quarter of 2019 and 2018.

Selling, general and administrative expenses were $75.8 million in the second quarter of 2019 compared to $75 million in the second quarter of 2018. SG&A expenses from acquired businesses was $2.8 million, and excluding the acquired entities, the company's SG&A expenses in the second quarter of 2019 were $73 million, a decrease of about 3% from the second quarter 2018, partially due to the effect of foreign currency translation in the second quarter of 2019 versus the prior year.

During the first quarter of 2019, the company changed the management reporting for certain transfers of manufactured products between the Water and Fueling segments. This change was made to better align the production of certain products by reportable segment and sales to third-party customers. To consistently compare 2019 results with the prior year, certain 2018 net sales and operating income reclassifications were made. These reclassifications resulted in lowering second quarter 2018 results of Fueling Systems and increasing second quarter 2018 results of Water Systems net sales by about $1 million and operating income by $0.1 million versus what was reported in this period last year. There's no impact on the company's previously reported consolidated financial statements.

In 2019, we believe our effective tax rate, net of discrete events, will be about 20%, significantly higher than the 2018 effective tax rate of about 12%. This higher tax rate is primarily due to the inclusion of 2018 of discrete tax events that effectively lowered our tax expense for the full year. We do not believe these events will reoccur at the same level in 2019.

The company ended the second quarter of 2019 with a cash balance of $41 million, which was $18.2 million lower than at the end of 2018. Cash decreased primarily due to acquisitions and debt repayments. The company had $123.3 million in borrowings on its revolving debt facility at the end of the second quarter of 2019 and $133.8 million in borrowings at the end of the second quarter of 2018.

As of January 1, 2019, the company adopted the new lease standard and has recognized additional operating liabilities of about $26 million for its outstanding operating leases with corresponding right-of-use assets of the same amount. The impact of this new accounting standard is noncash in nature and does not affect the company's cash position. The company does not consider the impact of this standard to be material to the consolidated results of operation or to the cash flows.

The company repurchased about 93,000 shares of its common stock for approximately $4.1 million in the open market during the second quarter. As at the end of the second quarter 2019, the total remaining authorized shares that may be repurchased is about 1.3 million. On July 22, the company announced a quarterly cash dividend of $0.145. The dividend will be paid August 15 to shareholders of record on August 1.

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 Edward Marshall from Sidoti & Company.

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

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So I understand your comments regarding the Distribution and the inventory being what you thought was or what you think is average for this time of the year. I guess, I have a question on that. If I look at your own inventory, it seems a little bit higher than normal for this period in the second quarter. Can you talk about maybe what your own inventory looks like maybe outside of the Distribution and what that might mean for pricing as we move forward?

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

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Yes. Our inventory levels, Ed, for sure ended the quarter higher than we have expected. That's in most part because of inventory buildup in anticipation of sales that did not take place in the quarter on the manufacturing side. When you look maybe just one level below that, we had some inventory in Pioneer anticipating the backlog in the sales in the back half of the year.

The buildup -- we had some buildup in our U.S. manufacturing plants in the 6- and 8-inch product that is often used for agricultural purposes, which, as you know, because of the weather were depressed in the second quarter. So those were 2 of the primary reasons why we had the inventory buildup in the manufacturing entities. Our inventory in total is up about $17 million from the same period last year. That's about 7% when you're excluding Distribution.

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

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And Ed, getting maybe to your question about pricing, we don't see this as having any impact on pricing. Just to John's point, we had a stronger forecasts internally. We built that forecast. It didn't happen. So we will have some -- we'll be running inventories down in the back half comparable basis, create some drag on the margins, but we think we got some offsets.

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

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Got it. And as I think about kind of the way you might plan your manufacturing, I mean, you're anticipating a stronger second half than maybe the first half. Do you plan to kind of build at the same manufacturing rate? I know last quarter you talked about some restructuring. Was there another round of restructuring announced in 2Q as we kind of look to the back half of the year?

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

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Yes, again, we'll be running our plants at lower than planned levels -- planned levels planned at the beginning of the year to bring down our inventories to be more in line since we do have this strong position here, and that will create some negative absorption in the back half, Ed.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [7]

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Got it. And then you mentioned that you saw some slowdown in China. Is that more driven by the economics? Or is that maybe trade war tensions or both? Or any comments that you can kind of relate to that? I'm specifically talking on the Water segment. I understand the Fueling is quite a different scenario.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, President & CEO [8]

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Water segment actually, Ed, maybe I didn't make it clear in my prepared remarks. Actually, Water segment -- again, we have a small business in China, sub-$10 million, but we're sort of seeing -- we're seeing some pick up there because of the introduction of this new Inline Delta product, which is a substitute for Vertical Multi-Stage boosting products in the lower medium rise residential buildings in China. So we're getting some traction on that. We have a very small base in the Water. And so I wouldn't say that there's any impact related to trade or economy. The comments that I made were more directed to your point about the Fueling business and the capital spend rates of the public oil companies and then in general kind of those which may be related to trade tensions, I didn't put that in my comments, but this idea of, well, buy locally is a way of immunizing -- well, I say we -- China will buy locally in a way to immunizing from the trade tensions with the U.S. in general.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [9]

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Got it. Have you seen the weakness -- have you seen the capital investments from some of the other larger kind of global players outside of Chinese-owned pumping stations? Have you seen the same decline in the rate of capital spend as you've seen with the local agencies, by the local pumping ownership?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, President & CEO [10]

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Well, the -- yes, in China, the bulk of the gas stations are owned by the national oil companies. The number of gas stations owned by major oil is a smaller subset, and I would expect that their programs are pretty much their programs. They do this, and they do their upgrades on their capital spend rates and their plans, not so much, I think, related to the Chinese government's decision.

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Operator [11]

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Our next question comes from Ryan Connors from Boenning and Scattergood.

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Ryan Michael Connors, Boenning and Scattergood, Inc., Research Division - Director of Research and Senior Analyst of Water & Environment [12]

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Actually, I want to stick with the China theme for a minute. This issue of buy local, Gregg, is that something -- I mean, is that anecdotally you've heard that from some of your people there? Or are there like specific announced programs you are aware of in terms of procurement and then moving toward this buy local?

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

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Yes. What I'm hearing is from our leadership team, our Fueling leadership team on the ground in China and through the senior leadership of Fueling is that we saw some reopening of specifications to allow more local Chinese players to be qualified and so we've seen evidence by the government of making it easier for local companies to compete because their products stay in the ground and work as well as Western product. We'll let the market decide that, but that's the evidence we're seeing and that's what I'm hearing from our teams.

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Ryan Michael Connors, Boenning and Scattergood, Inc., Research Division - Director of Research and Senior Analyst of Water & Environment [14]

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Got it. Okay. That's good clarification. And then just on this issue -- I apologize, if the question is somewhat elementary. But I mean, can you just kind of refresh us on how the wet weather, the puts and takes in your business? Because on the one end, you would think it'd be good for dewatering; ag, you mentioned bad. Just how do we think about Franklin Electric as an entity as a whole and wet weather and why such a pronounced negative impact of that when you've kind of got -- it would seem you've got product lines that can play either side of that?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, President & CEO [15]

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That's a great question, Ryan, and it's a great reminder about how our business operates. We're -- again, we're more groundwater-centric, we're water-well-centric than any other product line. It's the one where we had the highest margins because we're more vertically integrated. That said, when you look at our surface pumping equipment, clearly, in the Midwest, massive run on getting some pumps and that's why our surface business is up because of that. But those are relatively smaller pumps, lower margins than our submersible.

The watering pumps from Pioneer are more event-driven, and so it will be -- you think that if there's a hurricane or you think if there was some type of flooding in a specified area where you see some of that dewatering, but that's still a relatively small part of our overall business, even within Pioneer. Pioneer has been a big -- a lot of our activity from Pioneer has gone into our rental fleets, and so there's a tail -- we're the tail of that dog and some of the other buying for these rental fleets and you might see upticks with URI or Sunbelt or other rental companies higher utilization because of flooding, but we wouldn't necessarily see that. And their capital spend with us, their capital spend has been laid out months and maybe years in advance.

So what happens to us is that, when we get the weather we saw in the -- going throughout the country in the first half of the year is people aren't running their submersible pumps, their groundwater pumps as frequently or even at all, and so they're just not replacing them. We have a large replacement part of the business. Anywhere, we estimate it's around 80%. And so if you're not turning the pumps on or run them, you're not replacing them. And so that's where we saw the weakness. So yes, we did see some uplift in demand in the Midwest, particularly with the flood events with pumps for homes. But we certainly -- that did not offset the decline that we've seen -- in my 10 years with Franklin, this has been the wettest year in history as it's been a tremendously soft market out there.

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Ryan Michael Connors, Boenning and Scattergood, Inc., Research Division - Director of Research and Senior Analyst of Water & Environment [16]

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Yes. Okay. That's really helpful. I guess my follow-on to that is just, you mentioned that after the first quarter, things were a little soft, but you maintained the guidance and it's kind of see how second quarter played out. So now you've trimmed it, but what's baked in there in terms of the second half? I mean what if we do continue to get wet weather in the third quarter? I mean, is that -- are we conservative relative to that? Or is it built in that we're going to get a sequential recovery and then potentially in that scenario like a shoe to drop again?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, President & CEO [17]

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Yes. So I think the way we're looking at it -- actually, the way we looked at it back in April is we said, okay, things normalized and we should then see more normal revenue and more normal profitability. Back half, we're looking at kind of a 5% plus or minus organic growth rate in Water, to give you some kind of guidelines around that. So we're just expecting the second half just -- now it seems dried out. People that did get their crops in ground will be irrigating, usage of submersibles will be increasing, and so we should see a kind of a more normal run rate. So think about in mid-single-digit organic growth terms.

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

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Got it. And then just one last one, if I could, I guess, just to more bring John in, but it seems like ForEx has really exacerbated the volatility of the results the last couple few years here. Can you just kind of refresh us on your thinking around hedging and just philosophically around whether you could or would or should ever do anything to kind of help smooth some of that out?

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

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Yes. Ryan, before I turn over to John for the numbers of U.S.A., since 2014, the U.S. dollar has strengthened, what, some 25%, and so that impacts. Obviously, there's math on the translation side. And then we also get a little bit more volatility because if you look at the stock markets, the developing regions certainly has been a tale of 2 cities relative to the U.S. market, which is, I think, more reflective of this kind of the weak economy. So we have a meaningful, strategic exposure to the developing regions, and developing regions have been weak economically, which is also why their currencies have been weak. And so that's come back with impacting our short-term results. Long term, we think, it's where we need to be from a performance point of view because that's where all the people are. John can take you through some of the philosophy around how to immunize this?

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

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Yes. Ryan, you'll recall that the bulk of the FX exposure that our company faces is translational FX exposure where we have operating units around the globe, doing business in reals, doing business in Turkish lira, in euro, South African rand and other currencies, and then we're translating those results back. We think the best immunization for that is to match revenues with supply chains, which we do in most part around the globe.

So for example, our business in Brazil primarily sells in reals and their supply chain is primarily a reals supply chain. For the most part, that's true in euro and that's true in South Africa and other places. So our real issue is the translation back of those entity's earnings. And our view is that other than that kind of natural matching in country of those operations or in market of those operations, there's not a ton we're going to do on the translation side, but it is significant. So in the first half of 2019, FX has cost us about 3.5% on the top line, about 5% in Water and about 2.3% in Fueling.

Where we have true transactional FX exposures, in some cases, we do deploy hedging strategies. We have those in several places around the world, not significant positions, but where we can predict a balance sheet position and then hedge that successfully, trying to get predictions around cash flows and predictions around AR balances and other things like that. It's a little bit difficult in a volatile revenue environment as you might guess that we see as well. So that's the short on the FX and kind of how it impacts our company.

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Operator [21]

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Our next question comes from Edward Marshall from Sidoti & Company.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [22]

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I just wanted to jump back in and follow up on the margin if I could. It doesn't go unnoticed I think 2 points. One, Headwater had a pretty good quarter. Wonder if you'd might comment there. I know the second quarter is generally strong, but this seems to kind of hit your targets for what you expect at Headwater. So maybe you could just make a comment about what's going on there and the success you might be having?

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

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Sure, Ed. Again, the margin that we talked about were range of 4% to 6% on an annual run rate basis, second and third quarter being seasonally stronger. So appreciate the observation about Headwater's performance in Q2, and we expect to see kind of similar margin activity in Q3, but Q4, it will slow down. And so we're still not where we think it should be, but we are continuing to now work more on the supply chain and cost side as we have a very more integrated platform. All the Headwater branches that were acquired last year before are all on one system. The acquisition we did this year will go on that system in about 6 months. So that'd begin to help us on the backside as well.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [24]

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Got it. And the second point, I guess, was on Fueling. I mean it looks like it might be the one of the stronger margins I have seen in that business in a while, maybe ever. Based on the comments and specifically around China and how big of a department -- business that is for you, is this -- and I understand it can be lumpy and volatile. Is this a high watermark for that business? I mean do you expect that to kind of moderate as we move through the remainder of the year or do you expect to see that kind of repeat into the end of the year and maybe even into 2020?

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

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Yes. One of the key drivers, Ed, of the Fueling margins is in fact the U.S. business and the product mix that we have there. This team's also done a really nice job of leveraging their fixed costs, so adding fixed costs at a much lower rate than the revenue growth that's happening in the business. So as I've warned you before and others, I wouldn't get real comfortable with high 20s Fueling operating income margins. I think something in the mid-20s is doable. As you point out, it can be influenced quite dramatically by product, mix shifts and geography mix shifts. And this quarter, we just had -- we had a favorable mix in the United States where growth was up, as Gregg pointed out, and that favorably impacted our operating income margins.

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Operator [26]

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Our next question comes from Matt Summerville from D.A. Davidson.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [27]

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Couple of questions. First, just talk about the North America groundwater business. Can you parse out a bit how you think your business did in the second quarter on the ag side versus the resi side year-over-year?

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, President & CEO [28]

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Matt, I guess, what I can say is that the ag was hurt the most because of where the majority of rain fell. And when we look at some -- pattern of some of the Headwater stores and where we saw dramatic fall off of revenues at stores -- at locations that typically are ag-based and had a really strong 2018. Beyond that, I don't have much detail. It's more qualitative. I don't know, John, you got any more quantitative data?

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John J. Haines, Franklin Electric Co., Inc. - VP & CFO [29]

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I mean as we said, Matt, groundwater in the U.S. was down 12% in the quarter, as Gregg's pointing out, more severe in ag than in residential. The surface pumps that are not the dewatering pumps that Ryan was asking a little about, those were up 8%, dewatering was up about 12%. So when you look at that surface nongroundwater other category, we saw some lift there. A big percentage of that is residential. So if you're thinking residential nongroundwater, that was impacted by the surface increase, which is wastewater, water transfer, sump pumps, those kind of things that you might expect to be up in a very wet environment.

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

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And Matt, again on the pro channel side, what we say is, because our sales to third-party distributors non-Headwater were up 5% and net sales basis kind of more Midwest East, which tends to be a little bit more resi, it says the residential market was maybe less impacted than the -- again the ag market, which is more Midwest West and more where we have Headwater exposure, and Headwater's outdoor sales of Franklin pumps were down about 5%. Does that help?

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

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Yes. That's very helpful. I appreciate that. And then on the pricing environment. What was realized price for Franklin in Water and Fueling in Q2? And with steel costs rolling over, copper prices coming down a bit, I guess, what's your outlook in price versus cost in the back half of the year?

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John J. Haines, Franklin Electric Co., Inc. - VP & CFO [32]

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Yes. Our chief price in the first half of the year was -- excuse me, in the second quarter was about 3.1% in Water and about 2% in Fueling, Matt. We have seen some reduction in steel prices and other commodity prices as we have trended this. But I would also say that on an input basis both our raw materials -- our commodity materials and all other raw materials that we're buying are still higher than last year's average price paid. So we right now for the most part are not anticipating new price actions in the back half of the year, but we are still seeing inflation flowing through our -- raw material inflation flowing through our cost of goods sold. So right now, I would say that we're basically assuming a neutral for the back half of the year that our price will offset that inflation and that may get a little bit more favorable for us as we get toward the end of the year, but right now that's our base assumption.

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

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Got it. And then, I guess, just sticking with pricing. I think, Gregg, last quarter, you'd indicated some concern that you're going to experience, given the demand environment, increased price pressure in Q2. Given the realization John just cited in Water, I guess, it's hard for me to maybe think that happened. But can you comment around what you're seeing kind of currently and what you saw in Q2 with respect to accounting specifically in North America?

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

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Yes, Matt, to your point, I think you got to figure it out. We did not see as much pricing pressure in Q2 at the manufacturing level that I may be cautious about in my prepared remarks for last quarter. I would say that it calls out that at the Distribution level, at Headwater, that we saw some margin compression, but margins improved, pricing improved throughout the quarter. So I think it got really tough in April and then we saw sequentially May and June seeing some lift. So that's what we're seeing. And I'd say right now we're kind of in a "normal pricing environment." We all run promotions. They all seem to be similar in size and percentage terms that we have seen in prior years.

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

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And then just one follow up on the -- sort of the comments you made on buy local in China. And I just want to be clear on something. This is in no way a government mandate that is saying that these oil companies have to buy local. This is not a -- you're not seeing this at the central government level, correct?

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

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No. We're not seeing a mandate. You are in command of the economy, and we've seen some evidence I mentioned earlier on the call where tentative specifications have been reopened to help others get -- excuse me, they've been reopened. And as a result of them being reopened, we've seen more local suppliers being qualified. I'm not saying that they get to buy -- to sell or not saying that they are getting picked up by the major oils, but they are now on the list.

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John J. Haines, Franklin Electric Co., Inc. - VP & CFO [37]

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Matt, I think what we see frequently in these type of regulatory mandates that we and maybe a couple other of our U.S. multinational competitors take early leads from a market share perspective and then it becomes more common that local competitors start to catch up on that. I think that's what's happening here as well that there's just more local companies now that have caught up and are able to be certified in this product and therefore serve the market. So I'm not sure that this is -- that this like other regulatory opportunities we've had in the developing world before.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, President & CEO [38]

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And Matt, as a follow on to John's comment, you may recall back in 2008 when the mandate for vapor recovery in China came out, and Franklin with our Healey product line, we took a commanding initial lead and we had, I don't know, 50%, 60%, 70% of market in Beijing and then I think overall maybe 30%, 40% share of the market, but we did see that there are more local competitors that came in later. Now the issue is that some of these products, once it gets installed, you find out it doesn't work, or doesn't work the way it was designed, and so the opportunity you got to follow up is that, that product gets taken out and we eventually get the sale. So as John pointed out, we did see this happen with the vapor recovery initiative back in the '08, 2010 time frame.

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Operator [39]

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This concludes our Q&A session. I would now like to turn the call over to Gregg Sengstack, Chairman and CEO, for closing remarks.

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Gregg C. Sengstack, Franklin Electric Co., Inc. - Chairman, President & CEO [40]

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Thank you for participating on our earnings call. We look forward to speaking to you after the third quarter. Have a good day.

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Operator [41]

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Thank you, ladies and gentlemen, for attending today's conference. This concludes the program. You may all disconnect. Good day.