Ladies and gentlemen, thank you for standing by, and welcome to the Franklin Electric Reports First Quarter 2020 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. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mr. John Haines, Chief Financial Officer, Franklin Electric. Please go ahead, sir.

Thank you, Olivia. And welcome everyone to Franklin Electric’s first quarter 2020 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 the impacts our company is experiencing from the global pandemic, and I will review our first quarter financial results. When I’m through, we’ll have some time for questions and answers. Before we begin, let me remind you that as we conduct this call, we will be making forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to various risks and uncertainties, many of which could cause actual results to differ materially from such forward-looking statements. A discussion of these factors may be found in the company’s Annual Report on Form 10-K and in today’s earnings release. All forward-looking statements made during this call are based on information currently available and except as required by law, the company assumes no obligation to update any forward-looking statements. With that, I will now turn the call over to our Chairman and CEO, Gregg Sengstack.

Thank you, John. Thank you all for joining us. This morning, I’m going to cover four topics in my prepared remarks. First, I would like to address the health status of our employees; second, I will review the results of our first quarter; third, I will review the current state of affairs in our business; and fourth, give you our current thinking about how we see our business for the balance of the year. So first, the status of our employees’ health. We continue to monitor each of our facilities, and I’m pleased to say that we’ve experienced few COVID-related employee health issues to date. Our global product supply leadership and facilities teams have done a great job implementing social distancing and improved industrial hygiene processes, all to keep our people safe. We are following the evolving guidelines in the U.S. Center for Disease Control, the CDC, and other global health authorities and are continuing to provide additional personal protective equipment, or PPE, for our people who were recommended. In accordance with the U.S. Cybersecurity and Infrastructure Security Agency guidelines as well as similar guidelines published by other governments around the world, the products that Franklin Electric manufactures and distributes are considered critical and our workers essential to support our world’s infrastructure. Therefore, where possible, Franklin Electric remains open for business. I will now review the first quarter 2020 results. Our first quarter results were better than our expectations. While manufacturing revenues were down double digits, improved mix, margins and reduced operating expenses produced an improvement in our operating income that was higher than our expectations. With more normal weather, our distribution revenue was ahead of expectations, and results were better than last year. Overall, operating income before restructuring expenses was up 11% on 8% lower sales. And our earnings…

Thank you, Gregg. Our fully diluted earnings per share were $0.23 for the first quarter of 2020 versus $0.19 for the first quarter of 2019. First quarter earnings per share before the impact of restructuring expenses was $0.24 compared to 2019 first quarter EPS before restructuring of $0.21. Restructuring expenses in the first quarter of 2020 were $1.9 million and were related to various manufacturing branch realignment activities in all three segments and resulted in a $0.01 impact on earnings per share in the first quarter of 2020. Restructuring expenses in the first quarter of 2019 were $1.1 million, and resulted in $0.02 impact on earnings per share in the first quarter of 2019. First quarter 2020 sales were $266.8 million compared to 2019 first quarter sales of $290.7 million, a decrease of 8%. Sales revenue decreased by $8.1 million or about 3% in the first quarter of 2020 due to foreign currency translation. Water Systems sales in the U.S. and Canada decreased by 14% overall compared to the first quarter of 2019, primarily due to lower sales of dewatering equipment. Sales of dewatering equipment decreased by nearly 54% due to lower sales of rental channels and substantial uncertainty in oil production end markets. Sales of groundwater pumping equipment increased by 2% versus the first quarter 2019. Sales of surface pumping equipment decreased by 14% on lower sales of both wastewater and water transfer systems as customers in this channel began to feel the impact of the global pandemic and start to lower their own inventory levels. Water Systems sales in markets outside the U.S. and Canada decreased by 11% overall, foreign currency translation decreased sales by 9%. Strong organic growth in Latin America and EMEA was not enough to offset declines in Asia Pacific, most notably in Korea, Japan…

[Operator Instructions]

Yes, Olivia, we’re ready to begin the question-and-answer session. Thank you.

Our first question coming from the line of Mike Halloran from Baird. Your line is now open.

Hey, good morning, gentlemen.

Good morning, Mike.

Good morning, Mike.

So maybe just talk a little bit about the difference in trends you’re seeing between Headwater and call it, your core water assets, the down 4% that you’ve see in Headwater and positive ex the effect – the more heavily affected regions. That’s quite the difference between if we’re assuming that the core water business is plus or minus that 20% you referenced. Is that spread just you think the inventory correction? Or do you think there’s something else going on there?

Well, we’ll answer that in two parts. First, Mike, I’ll talk a little bit about just the global groundwater business. And I think John will talk on data on the incoming orders. So there’s, again, a high replacement factor in groundwater. The weather conditions are better this year. And certainly, we’re seeing that through the Headwater data. We’re also seeing, I mean, Europe has hold up reasonably well and EMEA generally, South America is holding up okay. I think it’s going to slow down a little bit here. And we’re seeing a recovery in the Asia Pacific region around the water space. That’s – I think to your point, the destocking or the negative order rates that we’re seeing, particularly now year – early in the second quarter, late in the first quarter, really kind of centers more around, again, the Pioneer numbers are large dewatering as well as the – as we call the plumbing wholesale channel, where you can see more variation in inventory balances. We’re selling to some buy and merge larger customers, not so much in the dewater channel. John can give you more specifics.

Yes. Mike, I guess the only thing I would add to that is that, as you saw, Headwater had a really nice growth in the first quarter and that business unit has a lot of momentum. And what we’re encouraged by is that sales growth and some of the inroads they have made in certain markets, prepandemic, 2M in the western part of the United States was strong. DSI was strong in the southeastern part of the United States. The caution right now, of course, is that with the government-mandated shutdowns, it’s hard to see what that may do to their top line. And as we pointed out, when you take away the three states that are affecting us most from a government-mandated shutdown, California, Michigan and Washington, all important states for the Headwater business, the growth trajectory from mid-March to now is very different than what it is for the total Headwater. So that we – they were off to a good start. We thought and still think that Headwater is going to have a good 2020.

So are the like-for-like products between your Water Systems business and then what would sell-through the Headwater channel? What are those like-for-like products tracking at right now? Are those towards that 20%? Or are those tracking a little bit better from a pure equipment sale perspective, within Water Systems?

Mike, so as I understand the question is that, are we seeing the groundwater products that would go through the Headwater business, are we seeing similar flow through to our other distributor customers in the groundwater channel? The answer is yes. The falloff that we’re seeing beyond the large dewatering pumps, which has been – is kind of – you go back to the 2014, 2015 time is mostly in the plumbing wholesale channel, which are surface pumps, you think some pumps, think effluent pumps, that type of product, which goes through really – principally through a separate channel through the plumbing channel.

And then how are you thinking about decremental margins here? Really nice margin performance in the quarter relative to revenue levels, sustainability of that and any delineation by segment would be helpful?

Yes. We aren’t ready to comment on decremental margins, Mike. As you point out, we had a nice margin period in the first quarter. We think a lot of that is going to carry forward into the second quarter and the balance of the year, namely price achievement and lower raw material input costs. The things we’re looking at, of course, are the operational inefficiencies that may arise from lower inputs into the plants, the loss leverage on fixed manufacturing costs, those are the price achievement and the momentum we had on the raw material input side in the first quarter, we expect will continue.

Hey, appreciate it. Thanks for the time John and Gregg.

Thank you, Mike.

Our next question coming from the line of Edward Marshall from Sidoti & Company. Your line is now open.

Hey Gregg, John, how are you? Hope, you are doing well, your families, successors are safe.

Thank you, Edward. Same to you.

Good morning.

If I should get a glass of water, John.

Yes, I’ve been up a whole bottle down, so I’m in good shape. Thank you.

Congrats, all right. So you touched on decremental margins briefly, I guess, on water. I wanted to look at fueling, and I wanted to kind of go back to 2009, and I think we had some discussion about this already. But as you look at that, there was a pretty happy decremental margin in 2009. Is that something that we should be thinking about this time around as your fueling business kind of starts to slow? Just any color you could provide there?

Yes. I think there’s – there are several things that are different from that last downturn. One is how global this business is, more global than it was and the reliance in that period on the California vapor recovery so again, Ed, the comment on fueling margins really aren’t that different than water, really nice price achievement in the first quarter. Confident we can hang on to that lower raw material input costs. We think that trend generally will continue. We are, of course, concerned about what we are hearing in the U.S. market. The U.S. has been a pretty consistent source of growth for our fueling business. So the same kind of concerns, loss operational efficiencies, if that volume goes down, loss manufacturing, leverage on our fixed cost base. But generally, we would say that there’s still more margin momentum and positive on the fueling side than there is negative right now.

Got it. And if I can look at the dewatering portion of the business on water, and maybe you can break out for me what the North America energy sales was as a percent of revenue for 2019? And what I’m specifically looking at is maybe the cadence through the quarter, specifically, how did March look versus January and February? And then maybe if you could talk about the trends that you’re seeing so far in April in that dewatering business.

Yes. The – just to put some historic numbers out there, our total Pioneer business in 2019 was about $108 million top line in the first quarter, and that business declined by about $13 million as we expected it to. So Pioneer was largely on our first quarter expectations. And that is primarily the result of large customers who are in the rental channels, notifying us that they were deferring delivery of equipment that had been on order and had been produced for them. Now we think as you go through the quarter, that things got a little bit worse in terms of that outlook, especially for the end through fourth quarters because of what was going on in the oil space, as you’ll recall. We think a lot of this equipment that goes through rental companies ultimately ends up in some type of an oil and gas exploration type of application. So as we were talking about – as we were talking in January and February about what was happening to the dewater equipment, we were basically saying, yes, this is kind of what we expected to happen. As we get to March, then it started to incrementally get worse, and that uncertainty is one of the – kind of the big four that Gregg talked about as creating uncertainty in our financial outlook for the balance of the year.

Got it. And did you say that should be – of that decline in water? How much do you anticipate Pioneer could potentially be down year-to-year as we move into 2Q?

Well, we’re – it will be down in 2Q as well. But we’re not putting boundaries on those estimates right now, Ed, just because there’s too much uncertainty. What I can tell you in our original plan was is that there would be this pretty significant drop in the first quarter, a more narrow drop in the second quarter and then growth starting in the third and fourth quarter. So that was our original thinking. And now we – now that original thinking is, of course, disrupted. So I think the best we can say is that it was kind of on our original AOP and our operating plan in the first quarter. It was about $108 million in total last year. Of the – the other thing I’ll add is that of the 20% that Gregg talked about water revenues being down, if you pull Pioneer out of that for that same period, it’d be about 15%. So it’s a meaningful driver of what’s going on, what we currently see going on.

Got it. Got it. Okay. You mentioned the dividend. Thanks for the support there. I’m curious, you mentioned also buybacks in that conversation. I mean when you think about cash, do you think that the buyback is something that you’ll continue to do throughout this year? Have you kind of thought about delaying that to maybe conserve cash for the dividend, et cetera? I mean how do you think about your capital deployment? Thanks.

Yes. The capital deployment view hasn’t changed dramatically. And as I mentioned, we’re going to dial back the CapEx a little bit from $30 million to $20 million. The thinking on repurchases is kind of two parts, as you’ve heard in the past. The first part is to try to offset the dilution of equity awards that we make. That number is probably in the 300,000 to 350,000 share range annually, which is where we were in the first quarter. So we’ve kind of done that. The second part is related to opportunistic buying that we will do based on our view of a forward multiple. Now of course, that view got disrupted very significantly here. But the short answer is that, yes, we’ll remain opportunistic around share repurchases. And if we see that, that makes sense through the course of the year, we’ll continue to do that. But like I said, we’ve bought the dilution impact already in the first quarter. So that need is – it’s gone. Our primary use of cash will continue to be accretive acquisitions. We continue to look and manage our pipeline the way we always have look at and manage our pipelines the way we’ve always had. As I mentioned, we don’t think the dividend will change. We have quite a bit of liquidity, quite a bit of debt capacity should we need that. And then the final thing I would say is that we made tremendous progress on working capital in the first quarter. Now that’s going to change. We get that. Inventory levels, AR levels, what happens to our customers, stress on our customer, all of those things are, of course, on our mind. But there’s a lot of momentum and there’s a lot of initiatives inside our company right now to continue to improve working capital. So we think that, that should continue to be a source of cash from operations. Long-winded answer, but that’s kind of the totality of how we’re thinking about it.

And I’ll just follow-up with what John’s commented, that is, we have a balance sheet that we can use strategically certainly, buybacks is one strategy, but accretive acquisitions is the first one. And as you think about companies going through the situation pandemic, and it’s going to create opportunities. And so we want to be prepared for those opportunities and use our balance sheet thoughtfully as we move through this pandemic issue and challenge.

Just to be clear with what you’re saying, you’re trying to save your dry powder for the opportunity that you may see. Is there any particular market in water, fueling, dewatering, and even Headwater? Where do you think you’d invest first?

Yes. And as we’ve discussed in the past, we don’t formally allocate capital to any individual segment or business or geography. We have a pipeline of deals. We continue to cultivate opportunities. And because we often buy companies from family businesses or family businesses from individuals, timing is more on their end than our end. So we will continue to work that way.

Okay. Appreciate it, guys. Thank you.

Thank you.

Our next question coming from the line of Ryan Connors from Boenning and Scattergood. Your line is open.

Great. Thanks for taking the question. Hope, you guys are well.

Thanks, Ryan. Good morning.

I wanted to go back to kind of the first question you got there and appreciate the comments on Headwaters and the relative resiliency there being a good forward indicator. But just to take a big picture view of that. I think what’s interesting about this downturn, it hit so fast that we kind of have a bit of suspended animation in some of those later cycle project-driven markets where stuff that was funded, approved and underway has continued, but the concern is what about the next round of projects that are trying to get funded and approved now? And what does that mean for demand – not this year, but 2021? So you do serve a lot of those later cycle project-driven markets. You’re cutting CapEx, a lot of other people are cutting CapEx. What’s your big picture view, obviously, more qualitative, but what’s your big picture view of those later cycle markets into as we go beyond quarters and start talking into 12 months out?

Yes. Ryan, there are a number of letters in the alpha that people have been using to describe the current situation. And you can pick your own letter for each market as you so choose. I would make the observation in our water space is that we often talk about our groundwater business, which is about half of our water revenue is a very high replacement market. And Franklin, with, call it, half of our business there is residential, all 30% Ag, which has been kind of bumping on the bottom for several years now. And then you have the more industrial or commercial project type business, you would say, is maybe the balance of that. So I think as you think through qualitatively, the business, the demand for water doesn’t really go away. We have been looking to grow the business in the commercial and industrial segments but more with the large dewatering pump lines leading. And of course, the submersible lines are – were complementary to that in the case of mining and in the case of some industrial applications, but mostly in the mining space and then the recovery of raw materials. So yes, I’m sure that, that project delays will have some impact on our business top line going out, as you pointed out. But we’re seeing more of that impact, I think, in the large dewatering surface pumps that we are – we necessarily see it in the submersible pumps.

Okay. And then my other question was on the issue of inventory destocking and distributors. Is that increasing your own working capital needs in terms of you being forced to carry more inventory? I mean – or sort of – I mean there’s been some discussion on other calls about manufacturers trying to not become the bank that’s got to become the inventory holder of default. I mean what – how is that responsibility shifting up and down the supply chain?

Yes. So we – being the bank on one level is something, I guess, you want to avoid. On other hand, being the bank when you have critical supply chain relationships, both up and down the supply chain is where you have competitive advantage. So we’re going to work hard in the latter and try to avoid some of the former. And that said, kind of – we think more of the inventory swings tend to be, again, more of the plumbing HVAC channel there. We also have consignment relationships with our suppliers. So we’ll be taking some risk. They’ll be taking some risk as we navigate through that. As it is a submersible business, given that we’re really the world leader in that product line, we are effectively are in the banks, and that’s okay. It’s a high-margin product. It’s a critical replacement product. You need to have it on a shelf when people need it. So there, we’re willing to invest.

Okay. And then in terms of – just a follow-on for that as it relates to Headwaters. I mean is Headwaters able to – if that’s a broader trend that liquid, well financially positioned manufacturers like yourself are able to play that role. Is that something Headwaters will benefit from that maybe inventory needs within the channel will dissipate a little bit?

Interesting. If you look at it a couple of ways. One is that Headwater having access to Franklin’s capital base has the ability to finance their inventory in a good way. The flip side of that is that now that we have Headwater up on one ERP system and Franklin’s essentially on one ERP system. Our ability to see through and end is getting greater. So our ability to optimize supply chain with our relationship with Headwater is going to only improve with time. So that would be an opportunity to actually take inventory out of the relationship. So we’ve seen actually a modest reduction in Headwaters inventory on hand in the first quarter as compared to last year, even though their sales have been up. So it’s an indication that inventory management is growing and it’s – in our ability to do it more effectively between Franklin and Headwater.

Got it. Very helpful. Thanks for your time, guys.

Thank you, Ryan.

Our next question coming from the line of Walter Liptak with Seaport. Your line is open.

Hi, thanks. Good morning, guys.

Good morning, Walt.

I got onto the call a little bit late. And so I just wanted to ask the April question. Have you quantified how much the revenue is going down in April?

Yes. What we said, Walt, was that when you look at our Water Systems and our Fueling Systems segment, and you look at revenue compared to the same period last year, it’s down about 20%...

For the last six weeks.

For the last six weeks, right? So six weeks from mid-March to the end of last week, fueling and water are down about 20%. Headwater for the same analysis for the same period is down about 4%, but we also made a point that when you exclude from that analysis, the states that are most impacted by the government-mandated shutdown or stay-at-home orders, be it California, Michigan and Washington, it’s actually up 6%. So – for that same period of time. So we know that, that is impacting our Headwater business. It’s more difficult to assess how that’s impacting the other businesses, but it’s clearly a factor. So yes, last six weeks. Yes…

Okay. Yes. Thanks for repeating that for me. So the exposure that you have to China, to Italy, to some of these countries that have started to open up for business, again, have you seen demand trends improve there? Or are we just down at the bottom there?

Yes. Since you missed a couple of earlier remarks, in China or I’d say Asia Pacific more broadly in our water space, we’re seeing that returning to normal. Part of the decline we had in the first quarter, frankly, is our own supply chain interruption. That was about $3 million of product that we didn’t get to the right place at the right time. The balance was the decline we saw in – principally in Japan, Korea and China. And China’s reopened and back near normal. We are seeing our fueling business in China begin to tick up. That’s encouraging. How much it ticks up, and how big it becomes, that’s unknown at this point. China is still pretty opaque in that respect. Yes. Interesting thing in Europe. We had a very good quarter in the first quarter in EMEA generally. Some weakness in near East, where we’re going to feel some of that in Turkey right now as Turkey is kind of going through the growth in COVID-19 cases. And we’ve seen demand hold up in Europe in April. So EMEA seems to be doing okay. And we mentioned earlier that South America is maybe not quite as strong as Europe is doing okay as well, but maybe not – and that’s…

Okay. Great. Right. I’ll try and ask something that maybe, it hasn’t been talked about yet. The restructuring was less than the $1 million, you made comments about the cost structure, I think, in the press release. Are you making any changes to mitigate the 20% slowdown that you’re seeing? How are you looking at the cost going into the second quarter?

Yes. So we’ve – a couple of primary things. We’re cutting discretionary spending throughout the company, Walt, as you might expect. So this would be things like travel, of course, other types of spending categories outside consulting, whatever discretionary categories, we think make sense, we will go cut. The principal restructuring activities that are going on in the company right now are consolidations of facilities in North America, one from Little Rock to Oklahoma City and then one in the Portland area, Greater Portland area, where we’ve got a couple of facilities. So we are accelerating those restructuring initiatives, making them happen sooner. They were kind of second half or fourth quarter-type initiatives originally, we’re going to accelerate that. And then we’re looking at and considering a number of other cost out or cost reduction type of opportunities, but we’re not ready to comment on those right now until we are fully committed to them, and we’ve had an appropriate communication on what they are with our leadership and employee teams.

Okay. Okay. Thanks very much, guys.

Our next question coming from the line of Matt Summerville from D.A. Davidson. Your line is now open.

Thanks. Hey, guys.

Good morning, Matt.

Good morning, thank you. I wanted to ask about maybe a little bit of color in U.S. Canada water in the first quarter. What you saw in Ag versus residential? And if there’s any context you can provide around those two markets as it pertains to kind of the trailing 12-week number you mentioned?

Yes. The groundwater sales were up in the U.S., about 2%. And that was more residential driven and focus and Ag focused. Our view of Ag is – remains not very positive, Matt. Given all the things that were happening even before the pandemic. There’s not a lot of differentiation in the 20% that we mentioned between product lines. So we would say that, that’s – of course, that’s across the board, but I’m not sure there’s a lot of distinction in that between residential and Ag.

There is distinction between groundwater and what we call surface water.

Yes. Yes. More of the 20% is driven by the surface impacts that we’ve been discussing. But in terms of groundwater, not a lot of distinction.

Got it. And then, I guess, with respect to inventories coming down in the channel, you mentioned sort of the plumbing wholesale side of things as it pertains to the other surface category. How far do you think we are into that inventory takedown? And then similarly, in groundwater, are you seeing the same type of behavior? And then I’m going to ask the same question, how far into that process do you think we are at this point?

I’ll take the easier one, the groundwater one. I’ll let, John, do the other. In the groundwater space, we are coming into the season. And so I would say that we qualitatively a couple of our larger distributors were a little hesitant about taking down inventory towards the end of Q1. But ultimately, that’s going to pass-through. So I’d say that now that – we’re a few weeks away from kind of the market breaking in. It’s kind of – somewhere in May, things really start picking up. And as we see lifting of some of these stay-at-home orders in a couple of states we pointed out, I would expect that to be somewhat of a net positive as well. As to the surface business, kind of the water transfer products, the effluent products, sump pump products, it has not been quite large as large – we didn’t have the rain events we had last year, which impacted that end demand and it becomes a little less clear as to the replacement cycle, the ability for plumbers to get access to homes, although, a plumber can obviously work by themselves in social distance, but the ability for people to do that kind of product. Here again, in such a large replacement market, if your sump pump goes out, you need to replace it. Your effluent pump goes out, you need to replace it. So – but it’s hard for me and/or for John, I think to speculate kind of where we are in the cycle. I’ll let John, unless you got something else you want to share?

Yes. I think the only thing I would add there is the point that we have some large customers, Matt, that didn’t have the weather events that they expected to have in the first quarter. And that probably is causing them to carry a little more inventory. And then the second point is when you look at some history here, we do think that these type of destocking impacts are fairly quick, and we would expect the bulk of that to happen in the second quarter.

Kind of more of a V-shape.

Yes. But again, Gregg, we’re speculating here a bit. So but there was some coming into the second quarter, higher inventories to start with just because the weather wasn’t quite what some of these folks expected it to be.

Got it. And then just two other quick ones. How much of a hit do you expect based on where exchange rates are, John, to EPS in 2020? And then what was your average realized price in Q1 year-over-year. Thank you.

Yes. So on the realized price in Q1, Matt, in the Water Systems segment, it was just over 200 basis points. And in Fueling Systems, it was just over 350 basis points. So nice price realization, as I mentioned. In terms of FX, when we started the year, Matt, we were thinking that Water would be somewhere in the 1.5% range, maybe 150 basis points. And fueling is a lot less than that because we’re doing business in U.S. dollar more frequently in our fueling business. So call it, maybe 50 to 70 basis points in fueling. Right now, when we look at 2020, that water number might be between 400 and 500 basis points, just when you consider current spot rates. So that is a pretty meaningful difference than the 150 that we had been assuming. Feeling it will be less, maybe 1%, probably still less than 1%. So you can kind of work that through – that difference through on the variable margins and impacts. But that’s kind of what we’re expecting right now relative to FX.

Got it. Thank you, guys.

And I’m showing no further questions at this time. I would now like to turn the call back over to Mr. Gregg Sengstack for closing remarks.

Thank you, Olivia. We live in interesting times and wish everyone on the call to, again, stay safe, be safe. We look forward to reviewing our second quarter with you all probably in late July. Until then, take care.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may all disconnect.