Good day ladies and gentlemen and welcome to the Franklin Electric Reports First Quarter 2019 Sales and Earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. If anyone should require operator assistance, please press star and the zero key on your touchtone telephone. As a reminder, this call will be recorded. I would now like to introduce your host for today’s conference, John Haines, Chief Financial Officer. Please go ahead.

Thank you, Chris, and welcome everyone to Franklin Electric’s first quarter 2019 earnings conference call. With me today is Gregg Sengstack, our Chairman and CEO. On today’s call, Gregg will review our first quarter business results and I’ll review our first quarter financial results. When I’m through, we’ll have some time for questions and answers. Before we begin, let me remind you that as we conduct this call, we will be making forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to various risks and uncertainties, many of which could cause actual results to differ materially from such forward-looking statements. A discussion of these factors may be found in the company’s annual report on Form 10-K and in today’s earnings release. All forward-looking statements made during this call are based on information currently available and except as required by law, the company assumes no obligation to update any forward-looking statements. With that, I will now turn the call over to our Chairman and CEO, Gregg Sengstack.

Thank you, John. 2019 started slightly ahead of our expectations; however, midway through the quarter business conditions deteriorated meaningfully, particularly in the North America groundwater market. The resulting poor sales both in our manufacturing and distribution segments negatively impacted mix, de-levered our fixed cost base, and reduced our year-over-year operating income by over 40%. In the U.S and Canada water systems business, large de-watering pump sales were up over last year but below expectations due to customers pushing out about $2 million of orders into the second quarter. Service pumping sales were up as well. While groundwater pumping sales declined 5% on the back of lower inter-segment transfers to our distribution segment, sales at third party distributors were up over last year. Outside the United States, we experienced somewhat of a reversal of last year’s Q1 with better than expected growth in Brazil and the Asia Pacific region, partially offsetting weak conditions in Europe, the Middle East and Central America. Europe is slow and the Turkish market is working through the dramatic devaluation of the lira that began last summer. In Central America, political instability and changes are negatively impacting local market demand, in particular in Mexico. John will get into more details, but weakening currencies reduced our international water reported revenue by 11% as compared to the first quarter last year. While our reported top line for water systems was down 2%, the mix shift resulted in operating income down over 20% in this segment. Our fueling systems business delivered solid results. Sales were up double digits in the U.S. and Canada and would have been even higher but for the inclement weather delaying planned station builds. We believe we continue to gain share. Our business in China recovered more slowly than expected after the Chinese New Year; however…

Thanks, Gregg. Our fully diluted earnings per share were $0.19 for the first quarter of 2019 versus $0.45 for the first quarter of 2018. Restructuring expenses were $1.1 million and were related to branch consolidation and other asset rationalizations in the Headwater distribution segment, and continued miscellaneous manufacturing and realignments in the water systems segment, and had a $0.02 impact on the earnings per share in the first quarter of 2019. First quarter EPS before the impact of restructuring and expenses therefore was $0.21 compared to 2018 first quarter EPS before restructuring of $0.45. Specifically related to the first quarter of 2018, the company recognized about $5 million of discrete tax benefits related to certain deferred tax positions which lowered our effective tax rate and created a tax benefit of about 9% in that quarter. The discrete tax benefit and lower tax rate improved earnings per share in the first quarter of 2018 by about $0.11, and without it our first quarter 2018 earnings per share would have been $0.34. First quarter 2019 sales were $290.7 million compared to 2018 first quarter sales of $295.6 million, a decrease of 2%. Sales revenue decreased by $12.9 million or about 4% in the first quarter of 2019 due to foreign currency translation, and we estimate this revenue decline lowered our earnings per share in the first quarter by about $0.03 versus the first quarter 2018. Water system sales were $188.4 million in the first quarter 2019 versus the first quarter 2018 sales of $192.6 million. In the first quarter of 2019, sales from businesses acquired since the first quarter of 2018 were $4.3 million. Water systems sales decreased about 6% in the quarter due to foreign currency translation. Water systems organic sales increased about 2% compared to the first quarter of 2018.…

[Operator instructions] Our first question comes from the line of Mike Halloran with Baird. Your line is now open.

Hey, morning guys.

Morning, Mike.

Let’s talk about that ramp from 1Q to 2Q. Prepared remarks made it very clear you were expecting what seems to be a bigger ramp from 1Q to 2Q than normal. Other than some normalization in weather, can you help line out some of those other factors that are driving that?

Sure, Mike. Again, I think the normalization of weather gives us seasonality. The distribution business is more pronounced than before we had distribution. Also, with the fueling business ramp from 1Q to 2Q with China and also with the North America business, again there’s been some delay in construction activity, so it gets back to your normalization. Sense is, again as we commented in the prepared remarks, when you look at Europe, I think that’s going to be kind of sideways, so we’re not seeing--we’re not banking on much ramp there. We are thinking that we’re going to see some continued strength in Asia Pacific and areas of South America that I didn’t specifically call out. We’re seeing--you know, the slowdown in Mexico, we think that’s going to recover. Argentina, a little bit more cautious on, but Brazil seems to be doing overall better. Then also back to the North America, the de-watering space, we had some push out which we expect will be delivered in Q2, so those are some of the smaller items that add to why we see the ramp--or where we’re expecting to ramp in Q2.

Is the 1Q shortfall being essentially consumed in 2Q, or is it going to take 2Q, 3Q to normalize out at this point?

I’d be careful about saying all of Q1 is going to magically come back in Q2. If we get some normalization, then there hasn’t been a lot of lost time in the field. If we don’t, there’s going to be some days where people--these will be lost contractor days, but we expect that this is going to be picked up through Q2 and Q3.

Then a question on profitability, more of a longer term thought process. Distribution side and water side, the margins have been a little pressured lately, so could you just lay out some thoughts for both segments, how you’re looking at those long-term margins at this point for distribution for fueling?

Yes Mike, it hasn’t changed on the distribution side. We’ve kind of said from the beginning that we expect an operating income margin of 4% to 6% in distribution. We have not achieved that. Many of the efforts that the team has underway around branch rationalization and other fixed cost rationalizations that are occurring this year and will continue to occur are all directed at the idea of operating income margins being below our expectations. Now the business unit, as you know from kind of the get-go has had a difficult volume environment this quarter, didn’t help that of course, so we’re not leveraging the fixed cost base in that business unit the way that we want to either, so it’s a little bit about where the SG&A opportunities and other fixed cost opportunities on the margin side, but a lot of it is we were expecting more volume here and that more volume would have levered the fixed cost base, as well it would have provided a higher margin as well. I don’t think we’ll get to the 4% this year. I think we have a decent chance of getting close to the 4%, but those goals that we had established when we did these acquisitions and created this segment are intact and continue to be the same. On the water side, as we’ve mentioned you’ve seen a prolonged mix shift going on in water. We saw it again in this quarter away from groundwater pumping to greater surface pumping. Some of the international units are under-levered, meaning that there’s a fixed cost base there that is not generating the kind of revenue and profit that we need. I would not give up on that mid-teens operating income margin. I think the range is probably more like 15% to 17%. We’ve said for a long time 16% to 18%, but I think 15% operating income margins in water are doable for the longer term. Then in fueling, we will have swings that will be product and geographic mix driven, but generally we feel pretty good about that low 20s to mid 20s type range on a full year basis, and we don’t really see anything right now that would meaningfully deteriorate that for the long term.

That’s super helpful. Last one on the cost action side that you guys referenced, just some help on what exactly--what kind of actions you’re actually taking, as well as timing and potential benefit. Thanks, guys.

Yes, so the way we approach the first quarter in our business unit reviews, Mike, was to really look at it by business unit and then focus on recovery plans. The idea was if you miss your operating income target by X-dollars, then what are you going to do between April and December to try to recover that. Those actions are very different by business unit. Some business units, it’s just smooth sailing - they’re on their plan and they’re moving forward. I hesitate to give you an exact number because there are a variety of different actions - people reduction, not filling open positions, cutbacks in common SG&A categories. There’s a whole litany of actions, Mike, that are on the sourcing side that will be more impactful in gross profit than they will necessarily on SG&A, including tariff offset ideas, all kinds of things like that, so part of our confidence in maintaining our full year guidance is not only the volume recovery that Gregg mentioned - that’s a critical, critical part of it, but knowing that we’ve got some of these cost actions and other sourcing actions through the balance of the year that we think will contribute to both a better variable contribution margin and a lower SG&A run rate.

Appreciate it, thank you.

Thanks Mike.

Thank you. Our next question comes from the line of Edward Marshall with Sidoti & Company. Your line is now open.

Hi Gregg, John, how are you? Good morning.

Good morning.

I just want to follow up on that last question. You talked about some of the actions that you were doing. You know, you’re maintaining your sales guidance and you’re seeing additional cuts to costs. I’m curious, are you--with simply just maintaining the guidance for the year, and you’ve talked about picking up all the shortfall in Q1, I’m curious why you’re maintaining just the guidance and why it’s not actually going up from an EPS perspective.

Well I guess, Ed, maybe the way I’ll take a crack at answering that, as I pointed out in my prepared comments, our expectation for the first quarter was always below what the street consensus was, just because we know in part that the first quarter can be highly volatile. So generally from our perspective, we missed the first quarter by, call it $0.10 to $0.12 versus what our operating plan expectation was. To your question, we think that the $0.10 to $0.12 combining the two actions, the primary actions of recovery of volume and some of the cost takeouts, we think that we can claw back a decent portion of that in the last three quarters of the year. I don’t think we’re ready yet to say that we think we can go beyond that. Now, I think the thing that might drive us beyond that, Ed, would be better volume recovery than what we’re assuming, which is of course possible when you look at our first quarter results, but I would say we’re not really confident in committing to that right now. Our commitment is the $2.37 to $2.47, and even though we had a really bad first quarter, our general thinking is that we can get back to that.

Got it. Since you opened the door and you commented on the internal expectations versus consensus for Q1, can you talk about--I mean, the consensus is sitting at about $0.74 for Q2. Can you comment on Q2 and maybe your internal expectations so we’re not sitting in this situation again in Q2?

Yes, I will just say, Ed, it’s hard for us to give quarterly guidance, and I think the first quarter was a poster child for why we don’t want to give quarterly guidance. But relative to the street expectation right now, we would say that that’s a reasonable expectation and we expect to do slightly better than that for the second quarter.

Got it, okay. On weather, when you talk about weather impact on the sales for water, I think you mentioned a $2 million push out but I can’t imagine that was all of it. Can you talk about or maybe quantify the weather impact that would have affected the groundwater pumping systems in Q1?

Sure Ed, okay. Two different pieces of information. The $2 million push out related to large de-watering pumps, which is really unrelated to weather, more related to the capital cycles of the rental companies that we sell to. We’ve seen those get a little less lumpy and a little bit more smooth to the year, which is helpful for them, helpful for us certainly from a production point of view, so that was the push out I was referring to there. The early data that we have on the market is that unit sales in the groundwater channel were down somewhere between 12% and 15% in Q1 - that would be shipments from manufacturing. That’s the best data we have, so you can figure the dollar sales would be--because there’s some price increases, would maybe be down 10 and probably double that in March. I mean that’s why--you know, what we saw was really a great start in January, we felt things were going well, and then it just deteriorated very quickly in the back half of the quarter. That again gets back to the guidance thing, because last year, you may recall first quarter we were up 23% in operating income and we raised our guidance, full year is going to be up, and we ended up taking it back basically to the midpoint of where we started the year. So we’re always--lessons learned on Q1 is it’s a tough--because there’s a lot of volatility in Q1 and middle of the year we’ll have more information and greater clarity. We just don’t want to get too far ahead of ourselves, or behind, on Q1 results.

Got it. You referenced some competitive pressures in water. I want to look at it in context of two things: one, you talked about price, it looks like you’re getting that 2% to 5% that you would normally get, based on some of the comments you just made, but secondly I think--you know, I wanted to talk about the third party distributors up. I know I’m kind of cross-referencing between distribution and water, but maybe if we could talk about that for a second. Are you--because of your acquisition in distribution, are you able to manage your own supply chain a little bit better, which I guess is the right--the answer is yes, but third party distributors up, does that give you some pause, because it doesn’t seem like that’s what you did with your internal distribution. So just kind of clear that up for me, if you could. Thanks.

Sure. Let me take you through what I think are three parts to the question. The reason we want to give indication that third party, exactly to your point, is that one of the opportunities we have by having this distribution segment is the supply chain assets of it. That’s really a very interesting part of the value-add of this equation, and one that now, Ed, water is on one ERP system nationally, we’re on a different ERP system because Headwater’s is designed for distribution and ours is designed for manufacturing, but at least now we have one system in both and they can communicate with each other, and we see real opportunity there for supply chain. You are correct, that’s why there is--you know, there’s really no incentive for Headwater to, quote, buy ahead; matter of fact, there’s more incentive for them to reduce their capital structure to improve returns on capital. We use third party--our distribution sales to third party distributors is more of a barometer for how Franklin’s business is in channel, and as we commented, our sales to third party distributors in the channel were up in the Q1. Given the backdrop I just gave you for that channel, we feel pretty good about that. That said, these distributors buy and they’re not maybe in regions that were as impacted by weather as the Headwater, which is more of an upper midwest and west, which really got clobbered by heavy rains and snowpack and snow in California. California got a lot of water, which is good news for the long term, but for the short term it’s tough. We looked at our sales to third party distributors and they’re up, so we feel good. We feel like that means we’re managing the channels well, we’re managing the relationship, our relationship with Headwater and our relationship to the rest of our Franklin distributors, the people who distribute Franklin product, in a good way, so that’s why we give that data point. Now, in reference to the competitive nature, certainly in distribution margins--pricing was tough and there wasn’t a lot of pump sales in the first quarter, which impacted margins. But more broadly what I expect is that because manufacturers had a slow start in Q1 and they’ve got inventory, in Q2 we’re going to probably see some more promotional activity from manufacturers to distributors. As I said, we’ve seen some evidence of that already principally in small pump systems, not so much in large pumps yet but that remains to be seen. So I just want to caution people that if we get one of those situations where you get some price cutting and people trying to go for share, then they find out they’re not going to get share and things go back to normal, but everyone has numbers to hit and so that’s why we’re expecting it may be a little tougher for our manufacturing segment in Q2 in that channel.

Got it. Thanks for your comments, I appreciate it.

You’re welcome, Ed. Thank you for following us.

Thank you. Our last question comes from the line of Matt Summerville with D.A. Davidson. Your line is now open.

Thank you. Several questions. First, can you just provide a little bit of end market color for your water station businesses in North America in the first quarter and what you’re seeing in April thus far between the residential versus ag irrigation, and to the extent it makes sense, Gregg, of course if you want to work in some regional comments specific to the U.S., that would be helpful a well.

Sure, Matt. As a follow-on to Ed’s question there is that what we’re seeing is residential was down, ag was down more in Q1. We’re seeing outdoor sales through our distribution segment moving ahead of our plan in the first three weeks of April. The first three weeks, as we know, doesn’t make the quarter, but that’s encouraging. I think to your question about regional, I mentioned earlier that California, which has a large pump market, it’s also a pump market that has a large line shaft - the motors are on the surface and they’re driving a long shaft down to a pump down in the aquifer. Franklin Electric does not manufacture line shaft turbine equipment but our Headwater business sources line shaft turbine equipment from other pump manufacturers, so we expect the California market, given reservoirs are above normal, 150% of snow pack, basically no drought on the map, we’ll have a very slow start for the pumping business because there’s so much surface water available. For surface pumps, it will be available but for submersibles, not so much. Outside of California, if you looked at the U.S. drought map, if you looked at the beginning of the year, there was still significant drought in the southwest that’s basically all gone, so as we’re going into the growing season--or planting season, excuse me, it looks like surface moisture is in pretty good shape. I would think that would speak well for farmers, assuming things dry out enough that they can get into the fields. Is that what you were looking for, Matt?

Yes. I guess just more specifically on ag, it’s been pretty well documented the magnitude of flooding that we’ve had in the midwest, upper midwest, which I would think statistically speaking are pretty important overall ag markets. To your comments on, I guess, the pacing of April, are you actually seeing that piece of the business start to recover or is too early to tell, just given that things have been relatively wet, relatively cold? I guess I’m trying to handicap, back to John’s comment, around being in the neighborhood of $0.74 in the fourth quarter. I’m looking at it maybe in the other direction in terms of how much risk there is potentially to that outlook.

Sure, Matt. You’ve covered Franklin for a number of years, I think you’ve captured uncertainty pretty well. Keeping in the broader perspective of Franklin as a global business, half of our manufacturing revenues outside the United States are sales from our manufacturing product, but within this pro channel, which is important and it’s where we’re most vertically integrated and have profitable business, there’s a continued push out because people just can’t get in and repair systems anytime soon, and there’s some level of, quote, missing the season in the upper midwest. That would be a negative impact, no question about it. If you juxtapose that with is it going to be drier in the south or the southwest, it’s just too early to tell.

Then I guess, Gregg, if you already said this, I apologize, but what is your overall assessment of channel or inventories in the channel, both as it pertains to res and ag, if there’s any sort of read on that. Are you able to talk about the type of price competition you’re already maybe beginning to see? I would sort of think it’s a little maybe early on in the quarter to already be starting to see some of that.

I’d say that, Matt, earlier I mentioned that we expect that in units volume, from the data we have which is somewhat limited, as you know, we’d say that residential type product units down maybe 12% range, ag maybe down around the 15% range in units, so a little less down in dollars because of the price increases year over year, so call it 10 to 12. That’s what we saw in Q1, and I’d say it was down much more in March. As to competition, we’ve just seen some flyers come out on some promotions for the smaller pumps. Don’t know how far that’s going to go or how broad it’s going to be. To your point, it’s a little early in the quarter, but we saw some of that, and so--we saw evidence of that. Having been through this before, what happens is you’ll see if there’s a slow start for the manufacturers, then you see some pretty heavy promo--you can see some pretty heavy promotion in Q2, maybe not, but I’d just caution people that we’ve seen it in the past so we may see it again this year.

Maybe just one other quick one on Brazil and then one on fueling. With respect to Brazil, this is the first time that I can remember in a number of quarters you guys actually speaking positively about that business, albeit perhaps coming off of a lower depressed base. Are you convinced at this juncture, Gregg, that that business has turned the quarter? Then with respect to fueling, can you maybe review your revenue performance in China, particularly related to the environmental standard, and whether or not that standard is expected to drive incremental growth in China or is China sort of flattening out for Franklin for the time being?

Sure, I’ll take your first question first, Matt. Brazil, we were powering along for years, as you know, in Brazil with the double digit local currency organic growth, and then I guess it was about two and a half years ago, John, we started--I mean, Brazil really kind of just deteriorated. Yes, we have a good start to the year. Am I confident? I’m certainly more confident than I was three months ago, but we’ll see how the year unfolds. We’re seeing--we’re just seeing a good base in Brazil and it’s off of, as you point, a lower base, so we’re encouraged by that. With respect to China, this is a--John will share the numbers to the degree that we share them on what we think is going to be base versus incremental on the mandate. John?

Yes Matt, in China we had kind of said $50 million to $60 million opportunity for Franklin in 2019. We had thought that that opportunity would be in the same range in 2020 as well. The team is re-looking at some of the longer term forecast for China, but the 2019 estimate is slightly incremental to 2018 - it’s not gigantically larger than 2018, but we think we can be more in the mid to upper 50s there and perhaps beyond that. Unfortunately, as Gregg pointed out, it didn’t start real well in China. There was a bigger pause on the new year than what we have seen in the past, or kind of recovery from the new year, if you will. But we still think that 50 to 60 is the right number and we think it will be slightly incremental to what 2018 levels were.

Got it, thank you guys.

Thank you, Matt.

Thank you. We do have an additional question from the line of Walter Liptak with Seaport Global. Your line is now open.

Hi, thanks. Good morning guys. Just a follow-on to Matt’s question, talking about China. If you could just talk about the quarter and how things progressed during the quarter, and then the timing of the recovery in China fueling systems.

Yes, so the quarter started fairly well in China for us, Walt. As you know, in China when the new year begins, the whole country pretty much goes offline, and the question is then how quickly will it come back, if you will. What surprised us a little bit in the quarter was that comeback post--you know, we’re all back from holiday now, time to go back to business, and that didn’t materialize between the end of the holiday and the end of the quarter the way we thought it would. So you know, we’re prepared. We don’t believe we’re losing any market share. We have very strong customer relationships there, so we believe--and the work is still there, so there is nothing that saying that we’re missing the count of station conversions or anything like that. We believe it’s all still there and available for us to win in the last three quarters of the year, so that’s our view right now. The only thing that’s really changed in our view other than the less than expected first quarter is we have been talking this $50 million to $60 million range for this year, next year, and then maybe even beyond, and I think we’re a bit more cautious about the beyond at this point in time. We need to see how many stations actually get converted, what the competitive environment looks like, what the commitment’s going to be from some of the major oils. The conversions will start moving west in the country, which means they’re going to start moving more rural - that’s going to create a whole bunch of different issues for us and other manufacturers, not least of which is the whole compliance and our other--as you move more rural and west, are you committed to the same spec, quality spec for this equipment as you would be in the major cities. We have experience in China with other conversions where we have seen, well, the further from Beijing and Shanghai you move, the less adhered to all the technical specs and requirements. Those are all factors that are in our thinking for fueling in China.

Okay, and just to be clear, the China part of the business, we’re starting to see that recover in the second quarter, or are we still waiting?

Yes, we are starting to see that recover. Yes, seasonally a better time. Yes.

Okay, all right, great. In the Turkey and Argentina markets, I know these are meaningful. I wonder if you could size those for us in maybe percentage or millions of dollars [indiscernible].

Yes, at today’s exchange rates, the business in Turkey is about a $30 million top line business, and the business in Argentina will be in the $18 million to $20 million top line business. The Argentinean economy is kind of struggling through their currency devaluation. There’s an election coming up, so there’s political uncertainty now that’s crept into Argentina, so all those things generally are a bit of a pause for the business and economic climate.

Okay, got it. All right, thank you guys.

Thank you.

Thank you, and we do have a follow-up with the line of Edward Marshall with Sidoti & Company. Your line is now open.

I wanted to ask this earlier, but on fueling, you had some comments about the conversions moving west and so forth. As I look at your 3% sales growth, I look at another U.S. major competitor or peer up 20%. I’m trying to get a sense as to--on their fueling business, I’m trying to get a sense of what the difference is there. I know they make additional equipment that you don’t make. Has that conversion started to move west and that’s kind of displacing you, or are you seeing additional issues with tariffs that you’re working around? I’m just trying to get a sense of the disparity between the two results.

I can’t really comment. I haven’t seen the releases from, or if they’re out yet, for Dover or [indiscernible] - I guess one of them’s out. Their businesses are substantially larger than ours. They’re above-ground with the dispensing piece of their businesses. They may be seeing some benefit from the [indiscernible] deadline - I really can’t comment too much there. But in our business, we feel very comfortable with our plan and we feel very comfortable with the success of our team in gaining wins in the marketplace.

So this is less about competition and more about just timing, like you said? Okay.

Again, it’s difficult for me to respond. I haven’t seen the context of their comments. I would just say that if it’s specific to China, again I don’t know if they’re comparing apples and oranges here because they’re looking at above ground equipment as well as below ground. We’re strictly in the below ground equipment in that upgrade but for the fuel management system, so it’s difficult for me to draw comparisons.

And just--yes?

We don’t want to imply that it’s not competitive. It’s clearly very competitive, but to date we don’t have any information that would say, wow, we’re losing share to this competitor or that competitor, or as we go into some of the western provinces, we’re losing share there. We feel good about our customer relationships both at the big oil and distributor level, and really there’s not a lot that’s changed in that, so we would expect to compete fiercely and win our fair share.

One other thought is that we had a really strong start last year, and others may not have had as strong a start as ours, so they may have a better comp. That could be another. But again--

That makes sense.

[Indiscernible].

Yes, that makes sense. And by the way, that number was a global number, so it didn’t really give the context maybe in China that maybe we were alluding to here on this call. Just to be fair, I wanted to clear that up. All right, I appreciate it, guys. Thanks very much. Thank you.

Thank you, Ed.

Thank you. That does conclude today’s question and answer session. I would now like to turn the call back to Gregg Sengstack for any further remarks.

Thank you for listening to our first quarter earnings call. We look forward to speaking to you in July after our second quarter results are announced.

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