Franklin Electric Co., Inc. (FELE) Q4 2021 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to the Franklin Electric Reports Fourth Quarter 2021 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, today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your host today, Jeff Taylor, Chief Financial Officer. Please go ahead.

Thank you, Michelle, and welcome everyone to Franklin Electric's fourth quarter and full year 2021 earnings conference call. With me today is Gregg Sengstack, our Chairperson and CEO. On today's call, Gregg will review our fourth quarter and full year business highlights, and I will review our fourth quarter and full year financial results in more detail. When we're finished, we'll have some time for questions and answers. Before we begin, let me remind you that as we conduct this call, we'll 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 the call are based on information currently available, and as 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 Chairperson and CEO, Gregg Sengstack.

Thank you, Jeff, and thank you all for joining us. While this call with shareholders is to review our company's performance, I would like to start by taking a moment to publicly congratulate and thank the entire team at Franklin Electric for a record year. It takes a team effort to deliver outstanding results, despite the many challenges we faced in 2021. For the fourth quarter, sales, operating income and EPS were records for any fourth quarter in our history. And the fourth quarter closed out the highest performing year in Franklin's history that we established new all-time full year record for sales, operating income and earnings per share. Demand across the business remains strong with continued strength in all end markets, fueling additional growth and a robust open order balance. Our results substantiate our strategy as we capture the healthy demand across our end markets and advance Franklin as a global provider of water and fuel systems. Supply chain constraints continue to affect our industry and we expect them to continue at least through the first half of 2022, most likely through the balance of 2022 in the case of some input materials and geographic regions. Our team navigated these ongoing challenges as well prepared to handle future volatility. Our current inventory levels are intentionally elevated when compared to the fourth quarter of last year, in preparation for future volatility and in response to strong demand. Inflationary pressures continued in the fourth quarter, increasing material, freight, transportation and labor costs. In response, we continue to implement our pricing strategy to offset these higher costs that are committed to maintaining margin discipline across the business. Turning to our segments. In water systems, we delivered overall revenue growth of 36% with organic revenue growth contributing 23%. As I've mentioned in prior quarters, demand has continued to be driven in large part by a robust housing market in the U.S., strong crop prices, dry weather in some regions of the U.S. and globally, in addition to ongoing strong demand in developing regions. In the U.S., groundwater pumping systems revenue increased 34% in the quarter, supported by strong residential and agricultural demand. And overall, organic growth in the U.S. for water systems was 26%. Outside the U.S., water systems organic growth was 20% with solid demand recovery and growth in all regions, led by Asia Pacific and EMEA. Our fueling systems business also delivered a strong quarter, producing overall revenue growth of 21%, operating income growth of 18% and operating margin of 28.1%. These results were supported by strong pent-up capital demand for infrastructure built out in the U.S., which we see continuing through 2022. As the pandemic subsides, we expect greater focus on vapor recovery, management and monitoring countries outside the U.S. as well, driving additional growth for fueling. Our U.S. distribution business again delivered outstanding results with overall revenue growth of 50%, alongside operating income growth of 1,000% and operating margins of 4.8%, continuing to highlight the segment's role as a growth engine for our company. This growth has been supported by sustained demand across the country over recent quarters. Looking ahead, we will integrate our recent acquisition and focus on growing our market share in the U.S. groundwater space. We are focused on developing and using proprietary technology to both improve availability and reduce working capital in this business. We also will continue to thoughtfully increase our geographic footprint. 2021 was a decisive year for strategic acquisitions, particularly in the water treatment space. During the fourth quarter, we completed a small but strategic bolt-on acquisition in our BNR industries, which was our third water treatment acquisition for the year. This latest acquisition is in the Western United States, which is a key water treatment market. At the end of the year, we also announced the acquisition of Blake Group, a professional groundwater distributor with 14 locations throughout the Northeast United States. As I mentioned, the distribution segment is a key catalyst for long-term growth. With the integration of Blake, we expand our geographical footprint into New York and the New England markets. I want to welcome our new employees from BNR and Blake to the Franklin team. During the year, we maintained our strong free cash flow generation that delivered less than 100% conversion as we battled through inflationary pressures and invested in working capital to support the strong growth we are experiencing. As we look to the future, we believe we are well positioned to drive strong cash flow consistent with our past performance. Our capital allocation strategy remains unchanged. We will continue to invest in organic and inorganic growth while at the same time returning cash to shareholders. To that end, last month, we announced an 11% increase in our quarterly dividend, which marked the 30th consecutive year that Franklin has increased its dividend. This increase is a testament to the efficacy of our capital allocation strategy, our confidence in the outlook of the business and our historical commitment to deliver increasing returns to our shareholders. Turning to our outlook. After experiencing significant growth in our business in 2021, we expect continued strong demand in our core markets and a preference for our products as we deliver value to our customers by leveraging our five key factors. At the same time, the challenges of global supply and labor constraints, logistics challenges remain. While we have entered 2022 with considerable momentum, we expect these challenges to persist at some level for most of the year. As a result, we are initiating our 2022 full year revenue guidance in a range of $1.9 billion to $2.05 billion with EPS in the range of $3.50 to $3.75. In summary, 2021 was a pivotal year for Franklin. We were well positioned to capture the pent-up demand, while at the same time building on our own strong foundation through strategic acquisitions to expand our core offerings and geographic reach, particularly a water treatment distribution in our grid solutions businesses. As we look to carry this momentum into 2022, our outlook is based on our five key factors for success; quality, availability, service, innovation and cost. Our goal is to become an indispensable partner to our customers, while ultimately expanding the availability of clean water on a global scale and addressing safety and lowest total cost of ownership in the maintenance and operation of fuel stations globally. I will now turn the call back over to Jeff.

Thank you, Gregg. Our fully diluted earnings per share were a record for any fourth quarter in the company's history at $0.85 for the fourth quarter of 2021 versus $0.57 for the fourth quarter of 2020. Fourth quarter earnings per share before the impact of restructuring expenses was $0.86 compared to the 2020 fourth quarter earnings per share before restructuring of $0.57. The company's fourth quarter results included an estimated $0.12 earnings per share gain related to a 6.5 million one-time income gain on a bargain purchase price transaction on the income statement in the other income and expense section. While it is not our practice to callout items as non-GAAP adjustments in our reported results, we are mentioning this gain due to its size and since we do not consider it to be operational in nature. Fourth quarter 2021 consolidated sales were a record 432.5 million compared to 2020 fourth quarter sales of 321.1 million, an increase of 35%. The increase from acquisition-related sales was $40 million, while organic growth contributed 24%. Sales revenue decreased by 6.6 million or about 2% in the fourth quarter of 2021 due to foreign currency translation. Water systems sales in the U.S. and Canada were up about 58% compared to the fourth quarter of 2020. In the fourth quarter of 2021, sales from businesses acquired since the fourth quarter of 2020 were 29.6 million. Water systems sales in the U.S. and Canada grew 26% organically in the fourth quarter. Sales of groundwater pumping equipment increased by about 34%, sales of dewatering equipment were up about 61% and sales of other surface pumping equipment increased by about 11%, all due to strong in-market demand. Water systems sales in markets outside the U.S. and Canada increased by about 15% overall. Sales revenue decreased by 6.9 million or about 7% in the fourth quarter of 2021 due to foreign currency translation. Outside the U.S. and Canada, water systems organic sales increased by about 20% driven primarily by higher sales in Europe, the Middle East and African markets, as well as sales growth in the Asia Pacific and Latin America markets. Water systems record operating income was 34.6 million in the fourth quarter of 2021 compared to 30.4 million in the fourth quarter of 2020, while operating margin decreased by 200 basis points compared to the margin in the prior year quarter. The decline in operating margin is due to the dilution from water treatment at lower margins, higher SG&A and variable compensation and higher inflation costs not entirely offset by price realization. Distribution achieved record fourth quarter sales at 116.9 million this year versus fourth quarter 2020 sales of 77.9 million. In the fourth quarter of 2021, sales from businesses acquired since the fourth quarter of 2020 were 8.5 million. The distribution segment organic sales increased 39% compared to the fourth quarter of 2020. Revenue growth was driven by broad-based demand in all regions and product categories. The distribution segment operating income was a record for the fourth quarter at 5.6 million compared to the fourth quarter of 2020 operating income of 0.5 million. Operating income margin was 4.8% of sales in distribution, primarily because of revenue growth and improved operating leverage. Fueling systems sales were a record 79 million in the fourth quarter 2021 and increased 21% versus the fourth quarter of 2020, which was entirely organic growth. Fueling systems sales in the U.S. and Canada increased by about 30% compared to the fourth quarter of 2020. The increase was due to higher demand for fuel management systems and pumping systems and piping. Outside of the U.S. and Canada, fueling systems revenue were flat and sales increases of 2% in the rest of the world outside of China were offset by lower sales in China. Fueling systems operating income in the fourth quarter was 22.2 million, a new record for any quarter compared to 18.8 million in the fourth quarter of 2020, driven by higher sales. The fourth quarter 2021 operating income margin was 28.1% compared to 28.7% of net sales in the prior year. Operating income margin in the fourth quarter decreased in fueling systems, primarily due to higher inflation, particularly higher freight costs. The company's consolidated gross profit was 145.2 million for the fourth quarter of 2021, an increase from the fourth quarter 2020 gross profit of 111.4 million. The gross profit as a percentage of net sales was 33.6% in the fourth quarter of 2021 versus 34.7% in the fourth quarter of 2020, and was lower due in part to higher inflation cost. We experienced significant cost inflation in materials, components, freight and tariffs, which were not completely offset with pricing contributed to the lower gross profit margin. Selling, general and administrative expenses were 97.7 million in the fourth quarter of 2021 compared to 76.7 million in the fourth quarter of 2020. SG&A expenses from acquired businesses were about 10 million. Excluding acquisitions, SG&A expenses were higher by $12 million due to higher variable performance-based compensation expenses and increased spending to support sales growth. Consolidated operating income was a record 47.2 million compared to the prior year quarter at 34.4 million, an increase of 37%. Effective tax rate for 2021 was approximately 18%, essentially flat with the prior year. The tax rate for the full year 2022 is projected to be about 21%. The company ended the fourth quarter of 2021 with a cash balance of about $40 million and generated 130 million of net cash flow from operations during 2021 versus 212 million in 2020. The decrease was primarily due to higher working capital requirements in support of higher revenues, including higher inventory to compensate for ongoing supply issues. Free cash flow conversion was 65% and was below our expectations. We plan on returning to a normal level of free cash flow generation in 2022, because we believe we are well positioned to drive strong cash flow consistent with our past performance. As Gregg mentioned earlier, on January 24, the company announced a quarterly cash dividend of $0.195 that will be paid on February 17 to shareholders of record on February 3. This represents an 11% increase from the prior quarterly dividend. This dividend increase will mark the 30th consecutive year that Franklin has increased its dividend demonstrating its commitment to returning cash to shareholders and our confidence in the outlook of the business. This concludes our prepared remarks. I will now turn the call back over to Michelle for questions.

Thank you. [Operator Instructions]. And our first question comes from the line of Mike Halloran with Baird. Your line is open. Please go ahead.

Good morning, everyone.

Hi, Mike.

Good morning.

So a couple of questions here on the guidance. First, obviously, really healthy guidance, strong growth year-over-year. Maybe help understand two components of it. One, volume versus price or at least qualitatively how you're thinking about those two pieces. And secondarily, when you think about trends through the year, pretty normal sequentials or is there some variance in how you're thinking about that pattern through the year?

Yes. Good morning, Mike. Thanks for the questions. In regard to our guidance, there's a couple of components there. First of all, we have the full year acquisitions that were completed in 2021 built into our guidance, so that's certainly going to contribute to the volume component of it. We expect strong demand and organic growth to continue in our base business. And Gregg mentioned the ongoing supply chain and inflation issues. Pricing versus volume, we're seeing inflation in the mid-single to high-single digit ranges. So we're certainly pricing to offset that level of inflation. So I think we're going to certainly put pricing in to cover that and maintain our margin to the greatest extent possible. So probably a little bit heavier on the price side, but there's strong volume growth in the guidance that we gave overall. In terms of the dynamic of the seasonality, we do expect first half to be under a little bit more pressure than the second half of the year. And so we see inflation probably impacting us greatest in, once again, first quarter, first half of the year.

And was that a profitability response there or was that more just on the revenue line, or kind of a combination of both?

On the seasonality?

Yes, the front half being a little bit more impacted than the back half comment.

Yes, it will impact our margins more in the first half than it will in the second half.

So that's a good bridge to the next question. A lot of moving pieces here with the acquisitions you've brought in with the price cost dynamics, inflation, timing, et cetera. Maybe a little directional help on how you're thinking about margins year-over-year by segment, or any kind of variances we should think about on that side?

Yes. So, Mike, I guess quantitatively, we don't give margin guidance by segment. But certainly, we do see -- if you look implied in the guidance range, I think if you look at the midpoint, you would see that generally we're planning to maintain our margins within their normal ranges that we expect for our three business segments. The lower end of the guidance, you would probably see stronger inflation than what we built into the midpoint. And then vice versa on the higher end of the margin guidance. But as you look at the segments, we would expect them to be in the normal ranges.

Okay. I appreciate it. Thank you.

Thank you. And our next question comes from the line of Matt Summerville with D.A. Davidson. Your line is open. Please go ahead.

Thanks. A couple of questions just, first, as a follow up. Price cost, where would you have been for the fourth quarter? And then with the price increases you're putting in the place for '22, is that more of a list price increase? Are there surcharges involved? I guess I'm trying to understand how permanent or not all of these increases might be for you guys.

Thanks, Matt. So as you look at the full year of 2021, inflation and pricing has been interesting. It's been dynamic as we started out the first half of the year. It was slower and it seemed to accelerate as we move through the year. As we kind of move through the quarters, we had -- the second quarter I believe we were slightly below in terms of pricing covering costs we called out on the third quarter. On the fourth quarter, we were just slightly below on that price cost dynamic. But for the full year, we were ahead. So we were able to at least maintain on the full year basis. As you look at moving into 2022, we're continuing to implement and evaluate additional pricing actions. And I would say that everything's on the table in terms of what those may be. So each business is a little bit different. We'll see less price increases on many of our businesses, or it will be the increase in the base price of the product. Other markets, there may be surcharges to offset specific materials, components and/or freight. And so I think it's -- everything's on the table.

In the past, you guys have talked about or at least in the recent past what, I can't remember if you called it open orders or backlog, but what did that number look like coming out of the fourth quarter? Did it increase sequentially relative to Q3? And I guess maybe one for Gregg around -- relative to your guide for the full year '21, what surprised so much internally versus your plan for the upside in the fourth quarter? Thank you.

So, I'll take the latter part first, Matt, is that just continued strong demand. We do have some seasonality with the Northern Hemisphere being more Northern Hemisphere weighted, but just a continued strong demand across all three segments and beyond really kind of where we were forecasting. We don't have a lot of visibility in this business. We are a short-cycle business generally with the exception of some of our large pumping systems. And fueling, we do talk to some major marketers about their station build plans. But this is a short-cycle business. So we look at current demand, we talk to the people in the marketplace, but we're just getting a lift in all segments and across the globe. So we outperformed on the top line and have been all year relative to internal planning, which has been, of course, a struggle for us to keep up. But we see that continuing into 2022. And again, we're short cycle, but in talking with contractors the last couple of weeks and looking at our dynamics of our backlog of some of our larger pumping systems, looking at our fueling business is that at this point, we don't see it slowing down for us in '22, given just kind of where the inventory levels are in the marketplace. And Jeff can give you some more dynamics around our backlog. Again, it's not something that we typically talked about in the past, because we typically don't have one or a very large one, but it's gotten to be sizable and it continues to grow a little bit. So Jeff can give you some information on that.

The open order balance or backlog at the end of the year was approximately 175 million for the total company. That's an increase of about 30 million from the prior quarter. So we did see it grow in the fourth quarter and year end. So we continue to see strong demand across certainly our water systems business, our fueling business and then distribution is performing exceptionally well.

Got it. Thank you, guys.

Thank you, Matt.

Thank you, Matt.

Thank you. And our next question comes from the line of Ryan Connors with Boenning & Scattergood. Your line is open. Please go ahead.

Great, thanks. Thanks for taking my question. I wanted to come at the distribution business more just from a big picture standpoint on the margins. It's been tough to sort of pin down where those margins shake out any given quarter. The results have certainly been improved on a run rate over time, but still a lot of volatility quarter-to-quarter. So how do we think about -- are we closer to where that business gets to a run rate where it's a little easier to think about a model and where might that be?

Sure. Ryan, because I have a history with this, I'll give Jeff a break in this one. So if you go back to when we stood up distribution and we said it's going to be -- we said publicly we were looking at 4% to 6% OI range, the business is seasonal. So you may recall the first couple of years, we actually lost money in Q1 and Q4 and made much more in Q2 and Q3 to make up for it. And this year, we made money in all quarters. And that's somewhat level in the maturity of the business. I've looked at some other distribution businesses where there's public information and how they've matured over time and saw a similar pattern where there's a seasonality aspect to it, that as the business grows and matures, that you begin to, while you still have the seasonality and you still have the margin change quarter-to-quarter, is that you begin to make money in Q1 and Q4. And that's what we expect going forward. So we feel great about a 7% margin overall for the year, with the strength in Q2 and Q3. And we want to declare victory as the first year of being above the 4% to 6% range, but we feel pretty confident that this business is going to continue into '22 with similar kind of dynamic and kind of a similar seasonality that you saw in 2021.

Got it. Okay. So you have the seasonality. That's helpful. The other one just on fueling, it does seem like we've had a few quarters now where China has been somewhat of a pretty material drag there. So can you just give us your updated thoughts strategically? Is that something you see getting better? Is there a thought to monetize that piece of it at some point? What are your strategic thoughts about fueling in China?

Yes, definitely not to monetize it. It is a piece of the business and we have a presence there, we have good brand recognition. The business is probably at a nadir [ph]. Now it's in a run rate and would expect a whole lot of acceleration from where it is today. It's in the low-teens sales wise. What we are all kind of waiting for, us and Gilbarco and Dover and others, is for China to start moving towards in-station diagnostics in a meaningful way. They have approved more local systems. But that said, we haven't seen really any initiative of any substance from the government to initiate that program. And it's important in a country like China, and look there are burning a lot of coal, there's a lot of challenges around pollution. But one of the easiest ways to recover VOCs is through vapor recovery systems at the gas station. And we have a system, others have systems but our systems have proven it works in China. And so it's just a question of when the government decides to get more serious about that aspect of their pollution control. And it's a pretty opaque area to do business in China. We don't get a lot of forward visibility. When they decide to spend the money, they spend it. And that's when we have to react. So right now, I see it being a good business. It's stable and again the low teens unfortunately. And we still see some upside -- some big upside if they get initiative behind in-station diagnostics.

Got it. Okay. Thanks for your time.

Sure. Thank you, Ryan.

Thank you, Ryan.

Thank you. And I'm showing no further questions at this time. And I'd like to turn the conference back over to Gregg Sengstack for any further remarks.

We appreciate you all joining us today and we look forward to speaking to you after the end of the first quarter. Have a good week.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.