Franklin Electric Q2 2023 Earnings Call Transcript

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July 25, 2023

There are 7 speakers on the call.

Operator

Welcome to the Franklin Electric Reports Second Quarter 2023 Sales and Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded. It is now my pleasure to introduce our Vice President of Finance and Investor Relations, Sandy Statzer.

Speaker 1

Thank you, Andrew, and welcome everyone to Franklin Electric's Q2 2023 earnings conference call. With me today is Greg Stenstack, our Chairperson and Executive Chief Executive Officer and Jeff Taylor, our Vice President and Chief Financial Officer. On today's call, Greg will review our Q2 business highlights, then Jeff will provide an overview of our financial performance. We will then take questions. 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.

Speaker 1

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 ks and 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 Greg

Speaker 2

Thank you, Sandy. The Franklin team delivered another strong quarter of performance, which included record sales and earnings per share results for any quarter in Franklin's history. These record top line results were driven by our Water Systems and Distribution segments. Throughout the quarter, we saw solid demand continue across our core end markets and geographic regions, even as each business continued to face weather related headwinds. Strong execution and disciplined expense management by our global teams enabled us to deliver solid margins in all of our businesses.

Speaker 2

This was especially notable in our Fueling Systems segment, which reported 2nd quarter record operating income and year over year operating income growth on lower year over year sales. The 2nd fiscal quarter is the start of the busy season for our core Northern Hemisphere markets and when we typically build inventories to meet demand. However, as the performance of our supply base continues to improve, during the quarter we focused on reducing inventories to more normalized levels. This operational focus and agility allowed us to accelerate shipments and convert backlog, sequentially decreasing inventory by $26,000,000 reducing our backlog to $186,000,000 As a result, our year to date cash flow improved by $105,000,000 over the prior year. We still have some work ahead of us, but we continue to make progress on our commitments to improve our cash flow generation.

Speaker 2

Turning to our segments. Water Systems delivered record sales and operating income for any quarter in its history with revenues and operating income each increasing Approximately 4%, driven by robust sales of our large dewatering pumps and year over year growth in other surface pump products. Our groundwater business was solid despite being negatively impacted by weather weather in the U. S. And other regions in previous few years and our intentional reduction of intersegment sales.

Speaker 2

As our lead times are improving, we are reducing transfers to our Headwater Distribution segment to right size their inventory of our products. We expect that other customers are right sizing their inventories as well. We believe these weather and destocking headwinds to be transitory and we continue to see healthy end market demand across our business. For example, in our water treatment business, our direct sales to consumers this quarter were up about 10% sequentially as we are lapping the housing market slowdown that started last summer. Overall, Water Systems reported an operating margin of 16%, flat year over year as leverage from sales growth was offset by the mix impact from largelyewatering pump volumes.

Speaker 2

Fueling Systems reported revenue decrease of 7% compared to the prior year period, while delivering strong operating margins and record second quarter operating income. Half of the sales decrease was due to us exiting our tank manufacturing business located in the United Kingdom. Fueling Systems record 2nd quarter Operating margin of 33.2 percent, an increase of 290 basis points compared to the prior year period, was driven by robust demand for our higher margin Critical Asset Monitoring, Fuel Management Systems and Grid Solution Products. During the quarter, we experienced further supply chain improvements, Both ship and certain component availability continue to be a challenge. While we understand that major convenience store marketer customers are not reducing their Several programs have slowed such that it appears that several planned 2023 new and industry builds are now likely to be completed in early 2024.

Speaker 2

We expect that higher interest rates, weather and the availability of construction labor have all had an impact on the timing of these new builds. We believe we are gaining market share in fuel management systems and continue to build momentum with convenience store marketers. Further, the well documented stress in the electrical grid is This investment appears to be accelerated. Distribution revenue increased 1% in the prior year Despite unfavorable weather impacting the start of contractor installations, commodity pricing continued to decline and customer inventories trending to more normalized levels. Operating income decreased about 24%, primarily driven by lower commodity prices.

Speaker 2

The segment delivered an operating margin of 9.2%, Historically strong margin was 300 basis points below last year's record operating margin, which was aided by last year's strong inflationary environment. More importantly, the operating margin increased sequentially by 5.90 basis points, reflecting a normal seasonal pickup in the 2nd quarter. The team remains focused on executing our strategy to grow and leverage the foundation we built in the distribution business for the last several years. Our balanced capital allocation strategy remains unchanged. We evaluate each opportunity on its economic and strategic merits and continue to return capital to shareholders through dividends and share repurchases, invest in our business and explore M and A opportunities.

Speaker 2

While we are mindful of the macroeconomic pressures that continue to persist And the transitory issues of weather and the impact of channel inventory rightsizing across all three of our reporting segments, we're optimistic about the underlying demand in our core markets. Our Q2 results keeps us on track with the full year 2023 guidance, which was raised last quarter. As a result, we are reaffirming Our 2023 full year sales and EPS guidance range of $2,150,000,000 to $2,250,000,000 in revenue and $4.25 to 4.45 percent in earnings per share respectively. Before turning the call over to Jeff, I'd like to mention our 2023 sustainability report, which was just published in June and has expanded from previous years. This year's sustainability report provides an update on the progress we have made on several ESG initiatives as well as various focus for the next few years.

Speaker 2

I'm proud of the progress we have made in our ESG performance as reflected in this year's sustainability report. As I said earlier, we have more work to do. With that, I'll now turn the call over to Jeff for the financial highlights.

Speaker 3

Thanks, Greg, and good morning, everyone. Overall, it was a record 2nd quarter for Franklin Electric. We established new quarterly records for consolidated sales and earnings per share. 2nd quarter 2023 consolidated sales were a record $569,100,000 a year over year increase of 3%, despite the 2% headwind due to foreign currency translation. Our fully diluted earnings per share were $1.27 for the 2nd quarter $2023 versus $1.26 for the Q2 of 2022.

Speaker 3

Water system sales in the U. S. And Canada were up 4% compared to the Q2 of 2022 due to price and volume. Foreign currency translation decreased Canadian The sales growth in the U. S.

Speaker 3

And Canada was led by sales of large dewatering equipment, which increased approximately 100%. Wet weather across most of the U. S. In the first half of the year and some destocking in the U. S.

Speaker 3

Pro channel led to lower sales of groundwater pumping equipment. Water system sales in markets outside the U. S. And Canada were up 3%. Foreign currency translation decreased sales outside the U.

Speaker 3

S. And Canada by 10%. Sales increases in EMEA and Latin America more than offset slightly lower sales in the Asia Pacific markets. Water Systems operating income was $50,800,000 in the Q2 of 2023, up $1,800,000 or 4% versus the Q2 of 2022. Operating income margin was 15.8%, flat compared to last year.

Speaker 3

The increase in operating income was primarily due to higher sales. Distribution 2nd quarter sales were a record $193,100,000 versus Q2 2022 sales of $191,100,000 a 1% increase. The Distribution segment's operating income was $17,800,000 for the 2nd quarter, a year over year decrease of 5,500,000 Operating income margin was 9.2 percent of sales in the Q2 of 2023 versus 12.2% in the prior year. The Distribution segment was negatively impacted by wetter weather consistent with our prior comments relating to Water Systems. Income was also negatively impacted by margin compression from lower pricing on commodity based products sold through the business.

Speaker 3

Fueling system sales were $80,400,000 in 2023 versus Q2 2022, sales of $86,000,000 a 7% decrease. Fueling system sales in the U. S. And Canada decreased 6% compared to the Q2 2022 due to lower demand from destocking and general inventory as supply availability and lead times improve. We experienced growth in our fuel management systems and pumping systems as well as our grid solutions business.

Speaker 3

Outside the U. S. And Canada, fueling systems revenues decreased 8%, primarily due to the divestiture of the tank business in 2022 and lower sales in the Asia Pacific region. Fueling Systems operating income was $26,700,000 a second quarter record compared to $26,100,000 in the Q2 of 2022. The Q2 2023 operating income margin was 33.2% compared to 30.3% of net sales in the prior year.

Speaker 3

Operating income and margin increased primarily due to price realization, favorable product and geographic sales mix shift and disciplined expense management. Franklin Electric's consolidated gross profit was $188,500,000 for the Q2 2023, down slightly from last year's Q2 gross profit of $189,300,000 The gross profit as a percentage of net sales was 33.1% in the Q2 of 2023 versus 34.3% in the prior year. Gross profit margin was negatively impacted by weather margin compression from unfavorable pricing of commodity based products sold through the business. Selling, general and administrative Our SG and A expense was $107,400,000 in the Q2 of 2023 compared to $108,300,000 in the Q2 of 2022. The decrease in SG and A expense was largely due to disciplined expense management, including lower spending in marketing and advertising in the quarter.

Speaker 3

SG and A cost as a percent of net sales decreased to 18.9% in the Q2 2023 from 19.7% in the Q2 2022. Consolidated operating income was $80,900,000 in the second in the Q2 2022 despite an unfavorable foreign exchange translational headwind of approximately $1,000,000 2nd quarter 2023 operating income margin was 14.2% versus 14.7% of net sales in the Q2 2022. The decrease in operating income and operating margin was primarily due to the decrease in operating income from the Distribution segment. Other non operating expenses were higher in the Q2 2023 compared to the prior year. First, interest expense was higher due to higher interest rates.

Speaker 3

Next, foreign exchange losses were higher primarily due to the stronger U. S. Dollar and our operations outside the U. S, particularly in Turkey and Argentina. The effective tax rate was 19% for the quarter compared to 22% in the prior year quarter.

Speaker 3

We generated approximately $43,000,000 of operating cash flow in the first half of twenty twenty three compared to using or negative $62,000,000 in Higher levels of working capital to support our growth. In 2023, we expect working capital to continue to return to more normal levels, leading to improved cash flows. The company purchased approximately 9,000 shares of common stock in the open market for about $900,000 during the Q2 of 2023. At the end of the Q2 of 2023, the remaining total shares of the company's ownership authorization is approximately 1,100,000 Yesterday, the company announced a quarterly cash dividend of $0.225 that will be paid August 17 to shareholders of record as of August 3rd. This concludes our prepared remarks.

Speaker 3

We'll now turn the call back over to Andrew for questions.

Operator

Thank And our first question comes from the line of Matt Summerville with D. A. Davidson.

Speaker 4

Thanks. A couple of questions. Can you maybe just put a finer point on what you saw from a destocking standpoint? When in the quarter it started, if you're still seeing a lingering impact into the Q3 and maybe is there a way to quantify How much of an impact it had on Q2? So maybe just start there and then I have a follow-up.

Speaker 2

Yes, Matt, this is Greg and I'm Sure, Jeff will have a follow on to this. It's a little tough for us to parse it out because of the we Look, we had a couple of years of really dry weather. We've seen the housing slowdown from last summer. So sales in the quarter in Groundwater, we probably have the most visibility in the United States. You can see that The Edgewater sales were out the door were up 1%, and actual units are up a little bit more than that because the value of the commodity piece was lower in dollars for commodity that we sold like pipe or wire.

Speaker 2

So that's kind of our best indicators that the That business was actually up the door and yet we reduced our transfers by about $10,000,000 into the business, Intentionally reduced their inventory. So that's a bogie. I must say that that's 40% of kind of our Sales from that channel, so you can maybe extrapolate from that. So it's and it was kind of throughout the quarter. I really Maybe you couldn't put a finer point.

Speaker 2

Jeff may have a better a different point of view better point

Speaker 3

of view. No, I don't have a hard number on the to quantify the amount of As Greg said, it's really hard to kind of separate how much was weather related versus how much was destocking. What I can tell you is that we are seeing supply chain improve. Our delivery times to our customers Our delivery times from our suppliers improved in the quarter. We think that others are seeing that as well, which is allowing them to normalized or right size their inventory levels.

Speaker 3

And so that certainly has an impact. I also think that Higher interest rates are playing a role here, so people are realizing that the cost of carrying inventory is higher today than it was a year ago. And because of that, we're also looking to pull down those inventory levels. Obviously, it was we think it's a little more prevalent in fueling than we've seen on the water side As they've had some delays in starts on those new to industry installations, but Hard to separate the effect between weather and destocking. We do believe it's transitory.

Speaker 3

I do think that we'll see some impact Carryover into Q3, once again, hard to quantify what that is at this time.

Speaker 4

Got it. And then as a follow-up, can you talk about What price realization look like on a year over year basis for Franklin Electric and if there's a material difference in the businesses. And one of the things I'm trying to get at is how much did lower commodity pass through weigh on the distribution segment? And then maybe, Jeff, if you can comment on what you expect free cash conversion to look like for Franklin in 2023? Thank you, guys.

Speaker 3

Yes, certainly, Matt. So I would say that pricing realization that we're seeing on a year over year basis Take the commodity piece out of Headwater for this comment. And I think we're seeing mid single digits generally Pricing across the board and that's water is kind of mid to high single digits at this point in time. We've talked about that we expected as we progress through the year with price increases being less frequent this year And being more stable, more of a return to normal pricing environment that we've seen in the past, that those will continue to contract as we move through the year and we lap those price increases from last year. On the headwater side, on the non commodity products, so the pumps, the motors, controls and drives those type of products.

Speaker 3

They're seeing good price realization, still seeing something consistent with what Otter Systems is In mid single digits pricing and but on the commodity product side, they're seeing price decreases and that's Really what's driving a big part of the margin compression that Edgewater has seen in their business in the first half of this year. And then the fueling business has seen kind of low to mid single digits pricing. So everybody is positive on pricing at this point in time. For free cash flow conversion, our target is and continues to be 100%. Based on Our current view for the rest of the year, we expect that we'll be able to exceed that and by A reasonable amount as we go through the back half of the year and we typically generate very strong cash flow in the back half of the year.

Speaker 3

And so when we turned the quarter in Q2, as you know, we had very strong free cash flow in the quarter And certainly compared to the prior year and sequentially as well. And so we expect to see pretty normal recovery of cash, Strong free cash flow generation in the back half of the year.

Speaker 4

Understood. Thanks guys.

Operator

One moment please for our next question. And our next question comes from the line of Mike Halloran with Baird.

Speaker 5

Hey, good morning everyone.

Speaker 3

Hey Mike. So

Speaker 5

a couple of questions here. First, I think probably goes with part of Matt's first question a little bit. When you think when I hear what you're saying, which is lead times are normalizing, But you had a destock in the quarter, those 2 kind of make sense. But at the same time, you're talking about a pretty healthy backlog level as you look in the environment. So Maybe you can just find a way to rectify those for me.

Speaker 5

They seem contradictory on the surface, but obviously it's what you're seeing So I'd love to understand how those all fit together.

Speaker 2

Yes, Mike, a couple of things are going on. To your point is that Again, this is the Q2. I think as people are coming into the season, both the compared to prior year, a little bit Tougher comp from the standpoint of weather and then also I think people are just kind of burning through what they have on hand, our customers. So we're seeing that. At the same time, our large pump business, that's a different Business in that, we work off the backlog.

Speaker 2

So there's a meaningful portion of our backlog, which relates to large which are going to be delivered over a series of months. We're even seeing now some POs going to 2024. So we have good visibility on that, which is different than our short cycle business. The short cycle business is more as we go into Q3, which used to be Q2 is our largest revenue quarter as a manufacturer. Now with a more meaningful distribution business, Q3 tends to be Maybe a little bit bigger than Q2.

Speaker 2

So we just we're in that part of the season. Yes, California has We've got a lot of rains, they're using a lot of surface water and that's one micro market and we had decent results in Northern Latin America, Europe Did well. Southern Africa did well. Asia looks like it's coming back. So we have a sense that's where we have a sense it's a short cycle business, but our people are Confident right now, it's in the back half of the year.

Speaker 6

Yes. That's helpful. Thank you. Go ahead. Sorry,

Speaker 5

I was

Speaker 3

going to say that the comment I would add there is Greg talked about our large pumps and they're more of Longer order cycle versus our short cycle business. A big part of the decrease we saw in our backlog was in our past dues. And so we've made great progress In the quarter, in catching up on past dues. And some of the decrease was on the large pumps, but a big chunk of it was also in the short So we're very pleased with how we're seeing the backlog in this environment and we're making, like I said, great progress in terms of Reducing past dues and past dues are getting almost getting back to what we would say is a normal level for us. So we're Once again, pleased with that.

Speaker 5

That makes sense, Jeff. Thanks for that add on. And second question relates to something, I think, Greg, you touched on briefly. Just how to think about what seasonality now looks like through business? I understand the headwater piece probably a little bit more sequential improvement.

Speaker 5

But obviously, you pointed out a bunch of things going on in 2Q from a destock perspective, weather perspective that Maybe changes how that cadencing looks from 2Q to 3Q, so more on the water side cumulatively. But Any help you can give to how you think that should play out as we look through the back half of the year, how it compares to normal seasonality, any kind of context would be great?

Speaker 3

Yes. So obviously, the middle part of the year is generally the strong season for us. In the Northern Hemisphere, It's the drilling season in the groundwater business. And so, those are going to be our strongest periods of time. Every year is a little different.

Speaker 3

And You kind of take it year by year. I would say, Greg can confirm or correct me if I'm wrong, but I think Typically, historically, maybe Q2 has been a little bit of a stronger quarter for us. But in the last couple of years, We've certainly seen that strength continue into Q3. And I think this year in particular with the wet weather that we saw in the first half of the year, I mean, the U. S.

Speaker 3

Was really much wetter this year than the prior couple of years that we've seen in the first half of the year, and I think that's going Hopefully, we see things dry up here, and I think we've started to see that already. And that will lead to some Pickup in activity in the back half of the year. And then I would say the other thing that can impact that seasonality and it's a little early to be talking about 4th quarter and the end of the year, but certainly how long the season goes into the Q4. And so if winter weather Kind of holds off and we have a long season that will obviously will play into the full year seasonality.

Speaker 5

Thanks, gentlemen. Appreciate it.

Speaker 3

Thank you. Thank you, Mike.

Operator

Thank you. One moment please for our next question.

Speaker 3

And our

Operator

next question comes from the line of Walt Liptak with Seaport Research.

Speaker 6

Hey, good morning guys. You're answering the question, But

Speaker 3

I wanted to ask it in

Speaker 6

a different way. With the guidance for maintain for 2023 And the weaker second quarter, what are your key assumptions for maintaining that guidance?

Speaker 3

Yes, Walt, I would say that our outlook really hasn't changed materially for the full year. Obviously, we're maintaining our full year guidance. And so from that perspective, really little to no change from the last quarter. I'll Echo a couple of points that I made last quarter. I mean, we are expecting to see more of a return to normal in 2023 versus what we saw in 'twenty one and 'twenty two, we see inflation continuing to moderate.

Speaker 3

We see generally organic growth in kind of mid single digits, certainly depending on our business and our region. And then obviously, if we get that kind of growth, we get good Leverage on it and flow through for our bottom line results as well. We expect supply chain is going to continue to improve. And our base demand has been very solid and very, very healthy. We have a high component of replacement demand in our core business, And that's generally very stable.

Speaker 3

And so that plays into our outlook and our view for The rest of the year, we continue to see FX translation continuing to be a headwind. It was about 2% in the second quarter. We would generally view it to be about 1% to 2%. We have started to see some areas where the dollar is stabilizing And starting maybe even to weaken versus a couple of currencies. On the macro level, we're not economists.

Speaker 3

We're not, I would say predicting where the economy is going, but I don't think we see a recession built into our outlook. I think we see The economy continuing to kind of move along at the current level through the end of the year and into 2024.

Speaker 6

Okay, great. And with the destocking issue and maybe the timing issue that you just spoke about in the previous question, Is some of that related to the agricultural irrigation markets? And I wonder What kind of visibility you have into things firming up in the Q3?

Speaker 3

Yes. For our business, we saw the ag side kind of hold up. It was positive on a year over year basis, but kind of Low single digits. So we didn't see as much on the ag side. I would say that More we've seen a little more on the residential, the resi side, in both our base water business but also at water treatment.

Speaker 3

And we've talked about AltaWater treatment has a little more exposure or sensitivity on the resi side than the base water business does.

Speaker 6

Okay, great. Okay, thank you.

Speaker 2

Thank you, Walt.

Operator

Thank you. I would now like to hand the call back over to CEO, Greg Stankstack for any closing remarks.

Speaker 2

Thank you for joining us this morning for our conference call. We look forward to speaking to you after the end of the

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