Franklin Electric Co., Inc. (NASDAQ:FELE) Q1 2023 Earnings Call Transcript

Franklin Electric Co., Inc. (NASDAQ:FELE) Q1 2023 Earnings Call Transcript May 2, 2023

Operator: Good day, and welcome to the Franklin Electric Reports First Quarter 2023 Sales and Earnings Conference Call. At this time, all participants are in a listen only mode. After the speaker 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, Vice President of Finance and Investor Relations, Sandy Statzer.

Sandy Statzer: Thank you, Andrew, and welcome everyone to Franklin Electric’s first quarter 2023 earnings conference call. With me today is Gregg Sengstack, our Chairperson and Chief Executive Officer; and Jeff Taylor, our Vice President and Chief Financial Officer. On today’s call Gregg will review our first quarter business highlights, then Jeff will provide additional details on 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. These statements are subject to various risks and uncertainties, many of which could be caused — 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 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 Gregg Sengstack.

Gregg Sengstack: Thank you, Sandy, and thank you all for joining us. The Franklin team delivered a strong start to the year and solid results by achieving first quarter records for sales, operating income and earnings per share. Global demand for our manufactured products and distribution offerings remains healthy. All three of our segments delivered higher top line sales driven by elevated demand across many of our end markets, increased volume in our water and distribution businesses, and pricing all more than offsetting foreign exchange headwinds. We do, however, expect the year-over-year impact of pricing will moderate as we progress throughout the year. Further, we continue to see sequential improvements in our supply chain, giving us greater predictability and enabling us to increase shipments, while our open order balance remained elevated at approximately $230 million, the past due portion of this backlog has been reduced $60 million since the peak in the summer of 2022.

Our record first quarter performance benefited from operating leverage inherent in our business that drove enhanced operating margins for the quarter on a consolidated basis. Inventory for the quarter is up sequentially and in line with normal seasonal patterns, but still higher than we’d like. We are focused on reducing inventory over the course of the year by increasing shipments, continuing backlog conversion, as well as decreasing safety stock to more normal levels. Turning to our segments. Water Systems delivered record first quarter sales and operating income with revenues, growing 12% and operating income increasing 48%, driven by significantly higher volumes in large dewatering pumps as well as steady demand for groundwater and surface pumping equipment.

Large dewatering pump sales volumes and supply chain stability drove favorable operating leverage results and a 380-basis point improvement in operating margin to 16% for the quarter. Fueling systems similarly delivered record first quarter sales and operating income with revenue up slightly year-over-year on top of the 28% year-over-year revenue increase realized in Q1 last year. Operating income grew 18%, driven by strong end market demand in most of our key markets including the US, Latin America and India. Fueling systems’ first quarter operating margin came in at 28.6% and an increase of 420 basis points compared to the prior year period despite ongoing supply chain headwinds related to the availability of chips and other components. Looking ahead, we do not anticipate any major changes to the planned investments of major fueling marketers in the US.

We expect the business to continue to grow across product lines in a favorable Indian market. Although, distribution delivered record first quarter sales, segment was impacted by unfavorable weather across many parts of the United States that delayed the start of contractor installations. Commodity prices declining and some order patterns being reset to correspond to improve supply situations and shorter lead times. Sales increased 6% from prior year despite the increased headwinds for the business. While operating income decreased about 50%, due to a significant decline in the price of certain commodity-based products. Operating margin of 3.3%, which is 370 basis points lower than last year, was similarly impacted by those commodity-based products and higher operating expenses as the business continued to invest in growth via the six new branch locations announced in fiscal 2022.

Even with the cost of these investments, we are encouraged that the operating margin for distribution increased sequentially, 140 basis points from Q4 2022 on seasonally lower sales. Our sales team has line of sight to our contractor, customer’s project pipelines. And as a result, we feel confident that we will see improving performance in sales and margin as the weather improves and we enter the groundwater drilling season. We remain committed to a balanced capital allocation strategy. We continue to make internal investments focused on bringing additional production in-house and enhancing the integrity of our supply chain. We are also actively monitoring the M&A markets, and are well positioned to take advantage of our opportunities as they present themselves.

And finally, we remain committed to returning capital to our shareholders through the regular dividends and opportunistic share repurchases. Looking ahead to the remainder of this year, we are mindful of the continued macroeconomic and geopolitical pressures we may have to contend with. However, given the results in the first quarter, we’re increasing our full year 2023 sales guidance to be in the range of $2.15 billion and $2.25 billion and raising our EPS guidance to between $4.25 and $4.45. Before turning the call back over to Jeff, I would like to take a moment to recognize Franklin Electric and our employees for being named in Newsweek’s 2023 list of America’s most trustworthy companies for the consecutive year. The work that, we do is essential to people’s lives, advances global access to clean water and improves the safety and availability of fuel worldwide.

I’m also proud of the culture this management team is stewarded, one that balances focus across efficiency, sustainability and reliability, with the well-being of our employees. I encourage you to explore our 2023 sustainability report, when it’s made available in approximately a week. For an update on the progress, we made and what we still — are still working to achieve. I will now turn the call back over to Jeff. Jeff?

Jeff Taylor: Thank you, Gregg, and good morning, everyone. Overall, it was a record first quarter for Franklin Electric. We established new first quarter records for consolidated sales, gross profit, operating income and earnings per share. Our fully diluted earnings per share were $0.79 for the first quarter 2023 versus $0.63 for the first quarter of 2022. First quarter 2023 consolidated sales were a record $484.6 million, a year-over-year increase of 7% even with the 3% headwind due to foreign currency translation. Water Systems sales in the US and Canada were up 21% compared to the first quarter of 2022 due to price and volume. Foreign currency translation decreased sales by 1%. The sales growth in the US and Canada was led by sales of large dewatering equipment, which increased 144%.

Sales of groundwater pumping equipment increased 6% and sales of all other surface pumping equipment increased 7% versus the first quarter of 2022 due to strong end market demand. Water Systems sales in markets outside the US and Canada were flat overall. Foreign currency translation decreased sales 12%. Outside the US and Canada, excluding the impact of foreign currency translation, sales increases in EMEA and Latin America more than offset sales declines in the Asia Pacific markets. Water Systems operating income was $49 million in the first quarter of 2023, up $15.8 million or 48% versus the first quarter of 2022. Operating income margin was 16%, a year-over-year increase of 380 basis points. The increase in operating income was primarily due to higher sales.

Operating income margin improved due to fixed cost leverage from higher sales, price realization, and cost management. Overcoming weather-related headwinds during the quarter, distribution’s first quarter sales were a record $143 million versus the first quarter of 2022 sales of $134.9 million, a 6% increase. The distribution segment’s operating income was $4.7 million for the first quarter, a year-over-year decrease of $4.7 million. Operating income margin was 3.3% of sales in the first quarter of 2023 versus 7% in the prior year. The distribution segment’s operating income was 47 — $4.7 million for the first quarter, a year-over-year decrease of $4.7 million. Operating income margin was 3.3% of sales, in the first quarter of 2023 versus 7% in the prior year.

The distribution segment income was negatively impacted by weather. Income was also negatively impacted by margin compression from lower pricing, on commodity-based products sold through the business. Fueling Systems sales for our first quarter record of $72.7 million in 2023. Foreign currency translation decreased sales by 1% for the quarter. Fueling Systems sales in the US and Canada increased 4% compared to the first quarter of 2022, with strong sales in fuel management and pumping systems. Outside the US and Canada, Fueling Systems revenues decreased 10% due primarily to the divestiture of a small and up-ground storage tank business in 2022, and lower sales in China. Fueling Systems operating income was $20.8 million, a first quarter record driven by favorable product and geographic mix of net sales compared to $17.7 million in the first quarter of 2022.

The first quarter 2023 operating income margin was 28.6% compared to 24.4% of net sales in the prior year. Operating income margin increased primarily due to price realization and a favorable product and geographic sales mix. Franklin Electric’s consolidated gross profit was $162.3 million for the first quarter of 2023, a 12% year-over-year increase. The gross profit as a percent of net sales was 33.5% in the first quarter versus 32.2% in the prior year. The gross profit increase on a dollar basis was primarily due to higher sales. In the first quarter of 2023, gross profit margin was up 130 basis points due to price realization, cost management and operating leverage on higher sales. Selling, general and administrative or SG&A expense was $109.5 million in the first quarter of 2023 compared to $104.7 million in the first quarter of 2022.

The increase in SG&A expense was largely due to higher spending in marketing, selling and engineering to support higher sales growth. SG&A cost as a percent of net sales decreased to 22.6% in the first quarter of 2023 from 23.2% in the first quarter of 2022. Consolidated operating income was $52.6 million in the first quarter of 2023, up $12.7 million or 32% from $39.9 million in the first quarter of 2022, despite some unfavorable foreign exchange translational headwind of approximately $3 million. The increase in operating income is primarily due to higher sales. The first quarter 2023 operating income margin was 10.9% versus 8.8% of net sales in the first quarter of 2022. The increase in operating margin was primarily due to leverage on higher sales volumes and SG&A spending.

Other non-operating expenses were higher in the first quarter of 2023 compared to the prior year. First interest expense was higher due to higher average debt outstanding and higher interest rates. Foreign exchange losses were higher primarily due to the stronger US dollar, and our operations outside the US particularly in Turkey and Argentina. The effective tax rate was 21% for the quarter compared to 20% in the prior year quarter. The company purchased approximately 162,000 shares of its common stock in the open market, for about $14.1 million during the first quarter 2023. At the end of the first quarter, the remaining share repurchase authorization is approximately 1.1 million shares including, the recent increase to our stock repurchase program.

Last week the company announced a quarterly cash dividend of $0.225 that will be paid on May 18 to shareholders of record as of May 4. This concludes our prepared remarks. We’ll turn the call over to Andrew for questions.

Q&A Session

Operator: Thank you. Our first question comes from the line of Bryan Blair with Oppenheimer.

Bryan Blair: Thank you. good morning everyone.

Gregg Sengstack: Good morning.

Bryan Blair: It doesn’t sound like there’s much to call out here if anything, but wondering if you would note any real changes in macro assumptions channel inventory? Any other critical factors relative to a few months ago? And if there is anything to call out there how that influences any kind of pivot and strategy you’re positioning for the remainder of the year?

Jeff Taylor: Bryan this is Jeff. We I don’t see any real shifts in our view there from a macroeconomic perspective overall as we look at 2023. I think our view is pretty consistent with where it was just one quarter ago when we initiated our guidance for the year. And obviously we’ve reflected the strong first quarter performance and our updated guidance, but as we look at the remainder of the year I think our view is pretty consistent.

Bryan Blair: Okay. Understood. I was wondering if we could drill down on the water treatment results in Q1. You had called out a little bit of caution there at least over the near-term given more new resi exposure and macro sensitivity for the business. Just wondering how the first quarter shook out what you’re seeing in order patterns into the early part of Q2 and what sales expectations are for the full year?

Gregg Sengstack: Yes, Bryan this is Gregg. In the back half of last year when rates started to rise new housing permits start to fall off, we saw the business demand fall off some. It looks like that’s pretty much behind us. I’d say that as we are entering Q2 that there’s a sense of buoyancy and that the business now is moving forward with and will be growing and that’s our expectations for the balance of the year.

Bryan Blair: Okay. Good to hear. And sticking with water treatment. Is the outlook still for margin expansion? You’ve owned the assets for a while so integration at least the heavy lifting is behind you. You’ve called out ERP on that front. Just wondering if you can speak to the run rate profitability and how your team is thinking about operating leverage going forward?

Jeff Taylor: Yes, Bryan, when we first put that business together through multiple acquisitions, the business was running at margins slightly less than the Water Systems segment average. They’re in the high single-digits when we initially started in over the last year, year and a half, we’ve got those margins up to low double-digits, low teens, above 10% operating margin. I think as we move forward our expectation is that we’ll continue to grow those margins. Having said that, we will invest in the business. We’re looking for expansion of our footprint there as well as development of new products. And so that will put a little bit of pressure on the operating margins, but we do expect it to stay in that low double-digit range I believe for the year as we go through this growth we expect.

Bryan Blair: Understood. Appreciate the detail. Thanks again.

Jeff Taylor: Thank you, Bryan.

Gregg Sengstack: Thank you, Bryan.

Operator: Thank you. Our next question comes from the line of Matt Summerville with D.A. Davidson.

Matt Summerville: Thanks. Gregg I was wondering if you could put a little more commentary and color around the weather impact you experienced in Q1, maybe adding a geographic overlay to an extent did that impact the manufacturing business or just distribution? I mean as we’re sitting here one month into the second quarter, is your sense that that picture is getting better for Franklin Electric?

Gregg Sengstack: Matt, good morning. The answer to your first question is yes in both manufacturing and distribution. Distribution probably took a more on the chin just from the standpoint that contractors just were able to get into the field. We saw a delay this year and a slow down because if you compare to the first quarter last year, which was dry, warm this year, it’s been wet cold. If you watch your weather channel you see all the weather tsunamis come across the western half of the United States in the northern part of the United States. And so it’s a reminder that we are a seasonal business. And if we are seeing it improve, we were talking about this just earlier this week that D. Davis who runs our Headwater distribution company was talking about how contractors you get now they can see order inflows picking order demand picking up.

So the indication of season is getting underway and that’s certainly positive for us. And then on the manufacturing side again it’s likely to put a little bit dampening impact on the — from our other distributors restocking. But overall the biggest impact was on distribution.

Matt Summerville: And then just as a follow-up with respect to pricing maybe can we talk about year-over-year realization in the first quarter and where you see that moderating down team as you move throughout 2023? And I just — I would assume that’s just a function of when you put in price increases in last year and the absolute price isn’t coming down per se, but the magnitude of incremental realization of decelerating? Do I have that correct?

Jeff Taylor: Yes. Good morning, Matt. This is Jeff. We’ve seen year-over-year pricing in the first quarter. I would say generally in the mid single-digit range to — we have locations where it’s approaching high single-digits. Those are before the impact of FX. When you include foreign exchange there it really puts us in that mid single-digit range to slight high single-digit range on what we’re seeing there. As we go through the year we’re going to give — we’re going to lap a lot of those price increases that we did last year. And so that will moderate the year-over-year price impact that we see, but we continue to see it to be positive and we expect it to be kind of low to mid single-digits as we get to the back half of the year.

Matt Summerville: Got it. And then just maybe one final question. Can you guys maybe comment on what you’re seeing from an M&A standpoint specifically as it pertains to the build-out you’ve been doing in water treatment? You’ve been pretty quiet on that front since the end of 2021 if I remember correctly.

Gregg Sengstack: Yes, Matt the challenge you have in the M&A environment inventory give us from other companies to cover is price expectations from sellers and what buyers like us are willing to pay. As you can imagine from middle of last year when everything was still pretty hot to now there’s been a separation and to be a readjustment of expectations of sellers to get deals done as interest rates have risen and as general macro environment has been a little bit more unsteady or at least people’s concern about the unsteady. So we’re interested, we’re active. We have the capital to do it, but it asks us to be a willing seller as well. So we’ll continue to look for opportunities. We’ll continue to believe there are opportunities out there and continue to talk to people and I suspect that we will be able to continue our acquisitions and more treatment and elsewhere too.

I mean we’re certainly looking at expanding our water helping product lines and also looking at acquisitions and the — we’re looking at critical asset monitoring equipment. So we’ll continue to look, but since water treatment I think because of private sellers maybe there is a little bit of a gap in expectation going on right now.

Matt Summerville: Got it. Thank you, guys.

Gregg Sengstack: Thank you, Matt.

Operator: Thank you. And our next question comes from the line of Mike Halloran with Baird.

Mike Halloran: Good morning, everyone. So can we start on the Water System margins really strong particularly for first quarter. I read the commentary about strength of dewatering and some of the mix side of things feel like that mix might have been a headwind for you. So make those margins maybe look even better. Maybe talk through some of the puts and takes on that side what drove the strength. And also as we think about the remainder of the year is there anything in that number that we can’t just kind of build the normal seasonal margin progression on?

Jeff Taylor: Yes. Good morning, Mike. This is Jeff. I’d say a couple of comments about Water Systems margin. I mean, obviously, strong sales in the business. And we get I guess nice flow-through of leverage when we have strong sales. And despite having high sales of large dewatering equipment, which we typically say are on the low end of Water Systems margins when sales are as strong as they are that drives strong operating leverage through the business for us. So that’s certainly a piece of it. We had nice sales in groundwater and other surface pumping equipment. So those contribute and are accretive to the overall margin pattern. We’ve had nice pricing on a year-over-year basis in the Water Systems business. And so that’s been favorable overall.

I would say that as we move through the back half of the year, we continue to expect Water Systems margins to be strong but be in the normal range that we expect and we said for a while that Water Systems margins are expected to be in that 15% to 17% range. The other thing I would point out in terms of the year-over-year improvement there, I think it was 380 basis points is last year’s operating margin was very low for us. And so we’re comparing to a very low number from where we were last year with the operating margin in the 12%, 12.5% range. So it was a pretty easy comp when you look at it from that perspective as well.

Mike Halloran: Yes, true. But also very, very strong for you from a first quarter perspective. So if you think about the demand perspective on the water systems side maybe some of the more traditional products on the submersible pumps, surface pumps. Maybe talk about what you’re seeing from an underlying trend perspective on that side. It sounds like channel inventory is in a reasonable spot but would like to understand how you’re thinking about cadencing from here? What kind of visibility backlog gives you any kind of nuance?

Gregg Sengstack: Yes, Mike. So I called out that our past due is getting better still not zero. So we have some work to do there. So that will be some – a bit of a tailwind. Because of our visibility in the US groundwater business through our Headwater Distribution company, again out-the-door sales for them, looks good it is picking up as it would seasonally and contractors from talking to our Headwater team have got plenty to do and so we see a good year there in the US with commodity prices up and metal prices up. We expect that the dewatering – groundwater and dewatering pumps will be good kind of across the globe in industrial and mining applications. The surface pump business was somewhat supply constrained more last year than maybe our other businesses.

So to your point about channel inventory has been I think fairly thin. And as our supply chain continues to improve I think that business should do well. The balance of the year, the large dewatering pumps that I mentioned just a couple of seconds ago. Again, we’re seeing robust demand. And we’re not – you may recall back in the middle of last decade when oil prices collapsed, we took on a chin in our Pioneer product line. But now we – when we were probably two-thirds exposed to oil and gas or more seven, eight years ago and now, it’s flip-flop. So we’re much more exposed than municipal industrial. And there’s pretty good capital flowing into that from the government, Inflation Relief Act and so on. So we’re seeing that to be good. And then outside the United States I think Europe came through the year-end and the winter a little better than I think people were expecting.

On the margin, we’re seeing product flowing back into Egypt, which is a small market but important for us and showing that cash is moving a little bit better. Latin America, certainly went through a shock with a couple of changes in governments and particularly in Brazil, it seems to be – that’s settling down now and we would expect that those markets to return and Southern Africa is good. We haven’t tagged a little bit in Southeast Asia. I think there is – it’s been a little bit of share loss on availability and also with the economy being tough people move in to maybe some more product coming out of China. But as availability improves, I suspect we’ll recover some of the share loss in Southeast Asia. So that’s generally kind of the view on the water business across the globe unless I missed something for you.

Mike Halloran: Sounds great. Thanks, Gregg. Thanks, Jeff.

Gregg Sengstack: Thank you, Mike.

Jeff Taylor: Thank you, Mike.

Operator: Thank you. And our next question comes from the line of Ryan Connors with Northcoast Research.

Ryan Connors: Good morning. Thanks for taking my question.

Gregg Sengstack: Hi, Ryan.

Ryan Connors: Yes. So I wanted to actually talk about distribution for a moment. And you called out a couple of times in the release and on the call here the commodity-based products kind of bigger in the mix and not hurting the margin. Can you give any more granularity on what exactly that is in terms of what types of product lines?

Gregg Sengstack: Sure. So Ryan, a big pass-through product for distribution in this end market is pipe. This is both plastic pipe, fiberglass and then it’s also steel pipe, and that’s one that is — goes through this channel and is one that has a lot of price volatility to it and has big availability challenges. So, where contractors were loading up last year and distribution was able to get price, we only get price on that. Now it’s just the opposite is happening. So now that the supply chains improve, pipes available, those commodity prices are coming down. And so that gives us — if you’re holding inventory, you get margin compression on that inventory. That would be separate from say, the non-commodity products, which we define would be motors, pumps, tanks, filtration equipment, that type of value-add product that distribution delivers.

So, we’re — it’s interesting and quickly rising inflationary environments, distribution does well, not just Franklin but other distribution and manufacturing probably suffers a bit. And then as you see price stabilization and supply improve, manufacturing does a little bit better typically and distribution gets squeezed on margins for until it kind of works its way through the system. So, that’s the macro of this distribution segment.

Ryan Connors: Yes. No, that’s very clear. Thanks for that. And then I wanted to actually a quick one on Fueling. The US, Canada strength was — if that comes a positive surprise, where is that coming from? Is that still sort of these convenience store build-outs with some of the suburban development, or is that resetting of existing equipment, or what exactly is driving that North — US, Canada strength in Fueling?

Gregg Sengstack: Ryan, the short answer is yes. The longer answer is a couple of things. One is that, back up 25 years ago and there were the initiatives to replace all the underground tanks and the vast majority of underground tanks in the United States through an EPA mandate to double wall construction. So, there was a massive upgrade across the US in 1997, 1998, 1999. I think it tripled in the 2000. So all our equipment is 25 years old station lines are 25 — 20, 30 years, you’re kind of going to do something with the station. You’re going to do some level of upgrade to the station or you’re potentially going to — to your point, you’re going to close the station or rebuild a new station as populations move during that 25-year time period.

So that’s kind of — there’s that going on I think in the background. The other thing is that station ownership has changed over the last couple of decades. It used to be, I’d say, the majority of stations whether in the United States and Canada — more I can say about the United States maybe that’s much I can, were owned by single store or operators have operated one, two, three stores something like that. Those stations are now being bought up by major marketers. And those locations are being bought or those people are closing, those single store operations are being closed, as I pointed out just from an age and new stores are being replacing them nearby by these major marketers. I mentioned major marketers many of them are — some of them are publicly traded, there is private equity coming in here because of the real estate play.

And so what you’re seeing is investment in this industry because of the returns. And that’s I think driving kind of a secular growth in the market. And we are also — we’re working hard to gain share on product lines that we’ve developed for this market over the years and we have a good reputation in those markets. So, I think that’s helping us as well. So, it’s just a — it’s a good market to be in. There are good returns on capital. Capital is available and people are investing.

Ryan Connors: Got it. Thanks for your time.

Gregg Sengstack: Sure, Ryan. Thank you.

Operator: Thank you. I would now like to hand the call back over to CEO, Gregg Sengstack for any closing remarks.

Gregg Sengstack: Thank you, Andrew. We appreciate you all listening in on our call today. We look forward to speaking to you in July after our second quarter results release. Have a good week.

Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for participating and you may now disconnect.