Franklin Electric Co., Inc. (FELE) Q1 2022 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to the Franklin Electric Reports First Quarter 2022 Sales and Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Jeff Taylor, Chief Financial Officer. Please go ahead.

Thank you, Kim and welcome everyone to Franklin Electric’s first quarter 2022 earnings conference call. With me today is Gregg Sengstack, our Chairperson and CEO. On today’s call, Gregg will review our first quarter business highlights and I will review our first quarter financial results in more detail. When we are through, we will have 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 maybe 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. And 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. Picking up right where we left off in 2021, we again delivered record results, which included the highest consolidated net sales, operating income and EPS for our first quarter and by segment in Franklin Electric’s history. I would like to take this moment to thank our teams across the globe for their relentless commitment to our customers clustering in another great quarter. Demand remains high for our products across the business with considerable strength in all end markets resulting in our manufacturing open order balance, increasing materially from year end. Our open order balance grew from $175 million at year end to approximately $290 million at the end of the first quarter, which included an approximate $50 million increase from large dewatering pumps and Water Systems in addition to increases in other Water Systems and Fueling Systems products. This strong demand signal and open order balance give us confidence in our outlook for 2022 and our expectations for robust demand throughout the remainder of the year. Furthermore, we expect to increase the throughput in our facilities to meet the normal seasonal demand increase during the second and third quarters and work down our open order balance. With healthy demand at our backs, we are executing on our strategy to grow Franklin as a global provider of water and fuel systems. That being said, throughout the first quarter, supply chain constraints continue to impact our results, which our team has navigated very well despite the difficulty in predicting where and when the next issue will arise. Although we anticipate these challenges to persist throughout the year and will likely impact different materials and geographies, our team has adapted to the situation and demonstrated their ability to remain nimble to ensure we are meeting the needs of our customers. As we discussed on our last call, we have intentionally elevated our inventory levels in the short-term to mitigate supply and logistics challenges. It is important that in this environment, we are supporting the resiliency of the supply chain. We feel we are well positioned to meet the strong demand from our customers. At the same time, inflationary pressures have also persisted, resulting in increased material, labor, freight and transportation costs. As a result, we continue to execute our pricing strategy to offset these higher costs and implemented additional pricing actions across all our businesses throughout the quarter with a focus towards maintaining the integrity of our margin profile. However, the effect of inflation compressed our margins in Water Systems and Fueling Systems during the first quarter as higher costs were realized before our pricing actions were fully affected. Turning to our segments, in Water Systems, we experienced overall revenue growth of 38% for the first quarter, reflecting strong demand, record backlog and a contribution from strong acquisition growth. This segment also reported operating income growth of 6% and operating margins of 12.2%. Water Systems end markets demonstrated continued strength during the quarter, driven by strong commodities and crop prices, dry weather in the U.S. and other regions of the globe, and increased demand for housing in the rural U.S. In the U.S., groundwater pumping system revenue increased 45% during the quarter, supported by strong growth in a core market. Overall, organic growth in the U.S. for Water Systems was 29%. Outside the U.S., Water Systems organic growth was 25%, with solid demand recovery and growth in EMEA and Latin America regions. Our Fueling Systems business also had a solid quarter, producing overall revenue growth of 28%, operating income growth of 19% and operating margins of 24.4%. These results reflect inflation and higher costs offsetting by pricing, robust volume growth and strong pent-up capital demand for infrastructure build-out, which we see extending throughout the year. In addition, we continue to expect a greater focus on wafer recovery management and monitoring countries outside the U.S., driving additional growth for our fueling business as the pandemic subsides. We are also seeing accelerated investment in additional fueling infrastructure in India, which we expect to foster growth as projects in that region were initiated in the first quarter and are expecting to gain momentum throughout this year. Our U.S. Distribution business again delivered a strong quarter with overall revenue growth of 41%, alongside operating income growth of 370% and operating margins of 7%, continuing to highlight the segment’s role as a growth engine for the company. This outstanding growth remains supported by sustained demand across the country over recent quarters. Switching gears let me provide a quick update on the strategic acquisitions we announced at the end of 2021. During the first quarter, the integration of these acquisitions progressed as planned and the bolt-on acquisition of B&R Industries has been fully integrated. As a reminder, that acquisition expands our presence in the Southwestern U.S. water treatment market. And our acquisition of Blake Group, a professional groundwater distributor in Northeast United States, further extends our geographical footprint into New York and New England regions within the Distribution segment, a key catalyst for long-term growth. Overall, our recent acquisitions have performed well. We are pleased with our performance and we will continually assess new opportunities as they arise. Our capital allocation strategy remains unchanged. We will continue to invest in our company both organically and inorganically, while at the same time returning cash to our shareholders is evident in our share repurchases and dividends distributed during the quarter. We have been prudent and efficient with our approach to capital allocation and remain focused on driving returns for our shareholders. Touching on our outlook, although we have maintained a strong momentum built throughout 2021, we are mindful that the challenges we are facing are likely to persist at some level for the remainder of 2022. As a result, we are currently not raising the guidance ranges we established last quarter. Before turning the call back over to Jeff, I want to take a moment to recognize Franklin and our employees for being named to Newsweek’s list of America’s most responsible companies for 2022. The work we do at Franklin advances our goal to expand the availability of clean water across the globe and to address the safety and lowest total cost of ownership around fueling stations. We continue to make significant investments in research and development to increase the efficiency and sustainability of our products and launched a number of initiatives to eliminate waste and reduce consumption across a number of our global facilities. I would like to thank the Franklin team for their efforts in building a sustainable future and I am proud of all that you do. I will now turn the call back over to Jeff.

Thanks, Gregg. Overall, it was a record first quarter performance for the company and our operating segments. We established new first quarter company records for consolidated revenue, operating income and earnings per share. Our fully diluted earnings per share were a record for any first quarter in the company’s history at $0.63 for the first quarter of 2022 versus $0.59 for the first quarter of 2021. First quarter EPS before the impact of restructuring expenses was $0.64 compared to 2021 first quarter EPS before restructuring of $0.59. Restructuring expenses in the first quarter of 2022 were $700,000 and resulted in a $0.01 impact on earnings per share from the first quarter of 2022. First quarter 2022 consolidated sales were a record $451.5 million compared to 2021 first quarter sales of $333 million, an increase of 36%. The increase from acquisition-related sales was $48.2 million, while organic growth contributed 25%. Sales revenue decreased by $13.1 million or about 4% in the first quarter of 2022 due to foreign currency translation. Water Systems sales in the U.S. and Canada were up about 38% compared to the first quarter of 2021 due to acquisition-related sales, price and volume. In the first quarter of 2022, sales from businesses acquired since the first quarter of 2021 were $32.1 million. Water Systems sales in the U.S. and Canada grew 29% organically in the first quarter. Sales of groundwater pumping equipment increased by about 45%, and sales of all surface pumping equipment increased by now 21%, all due to strong end market demand. Water Systems sales in markets outside the U.S. and Canada increased by about 14% overall. Sales revenue decreased by $12.4 million or approximately 13% in the first quarter of 2022 due to foreign currency translation. Outside the U.S. and Canada, Water Systems organic sales increased by about 25%, driven primarily by higher sales in Latin America, Europe, the Middle East and Africa markets, partially offset by lower sales in the Asia Pacific market. Water Systems record operating income was $33.2 million in the first quarter of 2022 compared to $31.3 million in the first quarter of 2021, while operating margin decreased by 360 basis points compared to the prior year quarter. The decline in operating margin was due to inflationary pressures and supply chain challenges, which the company continues to work to offset with pricing and to some degree and unfavorable product mix in the quarter. Distribution achieved record first quarter sales at $134.9 million this year versus first quarter 2021 sales of $95.7 million. In the first quarter of 2022, sales from businesses acquired since the first quarter of 2021 were $14.3 million. The Distribution segment organic sales increased 26% compared to the first quarter of 2021. Revenue growth was primarily price-driven on continued strong demand in all regions and product categories. The Distribution segment operating income was a record for the first quarter at $9.4 million compared to the first quarter of 2021 operating income of $2 million. Operating income margin was 7% of sales in Distribution, primarily because of revenue growth and improved operating leverage. Fueling Systems sales were a record of $72.5 million in the first quarter of 2022 and increased 28% versus the first quarter 2021. Sales revenue decreased by $700,000 or approximately 1% in the first quarter of 2022 due to foreign currency translation. Fueling Systems sales in the U.S. and Canada increased by about 33% compared to the first quarter of 2021. The increase was broad-based across virtually all product lines. Outside the U.S. and Canada, Fueling Systems revenues increased by about 2% and sales increases of 4% and the rest of the world outside of China were offset by lower sales in China. Fueling Systems operating income in the first quarter was $17.7 million, a new first quarter record compared to $14.9 million in the first quarter of 2021, driven by higher sales. The first quarter 2022 operating income margin was 24.4% compared to 26.2% of net sales in the prior year. Operating income margin in the first quarter decreased in Fueling Systems, primarily due to inflationary pressures and supply chain challenges, which the company continues to work to offset with pricing and to some degree, an unfavorable product mix. The company’s consolidated gross profit was $145.3 million for the first quarter of 2022, an increase from the first quarter of 2021 gross profit, the $115.5 million. The gross profit as a percentage of net sales was 32.2% in the first quarter of 2022 versus 34.7% in the first quarter 2021. We experienced significant cost inflation in materials, components, labor, freight and tariffs, which we are all recovering with pricing, but not fully maintaining our historical margins. We expect further price improvement versus costs going forward as we work down in open order balance and fast price actions become fully effective. Selling, general and administrative, or SG&A, expenses were $104.7 million in the first quarter of 2022 compared to $81.6 million in the first quarter of 2021. SG&A expenses from acquired businesses were about $12.4 million. Excluding acquisitions, SG&A expenses were higher by $10.7 million or about 10% due to higher variable performance-based compensation expenses and increased spending to support sales growth. Although SG&A expense in dollars is higher, SG&A as a percent of sales is lower by 130 basis points for the company overall and all business segments are lowered as well. The effective tax rate for the first quarter 2022 was about 20% before the impact of discrete events was about 21%. The effective tax rate for the first quarter of 2021 was about 14% and before the impact of discrete events was about 20%. The increase in the effective tax rate was primarily a result of higher net favorable discrete events reported in the first quarter of 2021. The effective tax rate for the full year 2022 is projected to be about 21% before the impact of discrete events. Yesterday, the company announced a quarterly cash dividend of $0.195 that will be paid to shareholders on May 19 of record on May 5. The company purchased approximately 187,000 shares of its common stock in the open market for about $15.6 million during the first quarter of 2022. At the end of the first quarter of 2022, the total remaining authorized shares that may be repurchased is roughly 544,000. This concludes our prepared remarks, and we will now turn the call back over to Kim for questions.

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

Hi, good morning, gentlemen.

Hi, Mike.

Maybe first just on the demand side of things. Gregg, could you just give us a little bit more detail on how you’re thinking about the end markets as we move forward, probably most interested in the residential U.S. landscape and then the ag cumulative landscape?

Sure, Mike. Yes, in the U.S., we continue to see strong demand and pent-up or contractors having a lot of work in front of them. Anecdotally, I was at a couple of contractor trips in February and where you think about contractors maybe having work out 2 to 4 weeks, maybe a little bit longer 6 to 8 weeks or maybe some bigger contractors I talked to one and obviously, I’m talking to some of the larger contractors that is already booked throughout the entire 2022, that was back in February. And recent update from our distribution, our headwater leaders, we’re seeing, again, strong backlogs of demand for contractors throughout the country. And that’s, again, being promoted by, I think, some of the housing moves, both just increase in housing construction as well as more rural housing construction and favorable weather conditions. And then to your point about ag side, again, with higher ag prices, it allows farmers to cash flow pivots, they will invest in that, they will be using their pumps more frequently and that also drives replacement demand because we have this large replacement market. And so that’s just – and again, the U.S. market is our largest one, but we are seeing that demand lift more broadly across the globe. And again, because of the strong drop drive of commodity prices and then that gets into mining. So that’s also lifting some of the demand for our larger products.

Thanks. And then the Water margins, obviously spent enough time in the prepared remarks talking about the timing pressure from inflation there. So as you think about the guidance and on a forward basis in those Water margins, obviously, you have elevated dewatering orders, which probably roll out this year, which may be hurt the mix a little bit going forward. But how do you look at the capture of pricing and the timing of that rolling through and kind of the margin range we should be thinking about on the Water Systems side?

Yes. Good morning, Mike, this is Jeff. Yes, I think you hit on some of the key points there. As we think about the guidance on a go-forward basis, the first quarter was generally in line there. As we see on a go-forward basis, I would say our pricing is generally a couple of months behind due to the backlog is that backlog flows through, then it will pick up the price actions that we took in either late Q4 or early Q1. So we do expect to recover some margin over the next two quarters, I would say, one to two quarters. And then along the line, we are seeing some pressure on the mix in the Water Systems business obviously having strong demand in dewatering is a big piece of that, as you’ve commented. We expect that it will continue as we fulfill that backlog that we have in that product line. Also on the Fueling side, we’re seeing some mix flow through, and it’s generally on the electronic components where we’re continuing to see inflationary pressure and supply chain challenges. So in the area of controls and drives and some fuel management system, we’re seeing some mix effect from that product line being down year-over-year. And as that recovers, then we will benefit from that on a go-forward basis. But it’s probably going to be later in the year before we see a significant recovery there.

Appreciate it. Thank you.

You are welcome.

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

Thanks. I was wondering if you guys could comment on how much price you realized in Q1? And how much price you expect to realize for the full year 2022?

Yes. Thanks, Matt. Good morning. So in terms of Q1, I think that’s probably the easier part of your question in terms of how much price we’re realizing. I would say across the company, we’re in the double-digit range in the 18% to 25% range overall on a year-over-year basis. We have pricing actions that we’ve taken in the first quarter that haven’t become fully effective at this point in time. Across the company, in the first quarter, we’ve announced generally between, I would say, 5% and about 20% increases depending on the region, the location, the product line between Water and Fueling in some areas are – need to catch up a little more than other areas. So that’s the general range. But generally, first quarter increases are in the low double-digit range. We will continue to monitor additional price actions that we need to take as we evaluate inflation going forward. We do expect to take additional price actions in the second quarter. Some of those have already taken place. As for our forecast on the full year, I think it’s just going to be dependent upon where prices go for materials, components, freight, supplies and such. And so – but it should be strong double-digit range by the end of the year.

Yes, those are big numbers. When you think about that open order balance, how quickly are you fully turning that balance? Because I would imagine there are some things that come in that ship immediately. So I’m curious as to how quick you’re turning it in the context of how much unabsorbed inflation is sitting in that unfilled backlog at any given point in time?

Well, I would say in terms of turning the inventory, our goal is to turn that inventory as quickly as possible. But from the fourth quarter to the first quarter, our open order balance increased sequentially. So we have a lot of work to do there. The $290 million open order balance, as Gregg commented, $50 millionish of that is for large dewatering pumps. And so you have about $240 million of the remainder. It’s hard to say exactly how quickly we’re going to term that. It’s going to be dependent upon how quickly supply chains can recover in the key components that are constraining us at this point in time become available. But I think, generally, we’re a couple of months behind on the pricing lag versus when we’re seeing costs come through and the driver of that is the open order balance.

When you think about what you’ve observed since the end of the year in supply chain, is your sense that things are getting worse, sort of the same? And I guess, I want a little bit of context around these lockdowns that have been happening across parts of China, if you have seen a discernible change in your supply chain environment as a result of that?

Yes. So what we are seeing is that what I would say is that I think things bottomed in, let’s call it, August of ‘21. We’ve seen modest improvements as part of why we’re able to pay a substantial increase in inventory as we’ve been able to get a hold of product we’ve been bringing it in. Unfortunately, when you have a – when you are building a product and you have 100 components, you only have 99 of them in the stock, then that’s the one that’s missing is the challenges. So, that’s the one that everyone is chasing. So again, I would say that we are seeing modest improvement in supply chain from the bottom of last summer. In the quarter, I would say that we had more challenge – we had some challenges around labor availability as Omicron went through the facilities, including U.S., Mexico and other parts of the globe. Restrictions got tighter in Europe during the first quarter, particularly in the first half of the first quarter. That seems to be behind us now. Now as you pointed out, China is going through their challenges. It’s been focused on Shanghai. You may recall our facility in the Suzhou is a couple of hours out of Shanghai and currently hasn’t been affected in a material way, and our supplies continue to come out of China on a regular basis, supporting our factories here. So, the Shanghai incident has not impacted our production or our supply chain in a material way. But we will have to see if this rolls through other parts of China, then that may change that answer.

Got it. Thank you, Gregg. Thanks Jeff.

Our next question comes from the line of Walter Liptak from Seaport Global. Your line is now open.

Hi. Thanks. Good morning guys.

Hi Walter. Good morning.

I wanted to ask about the dewatering business. And the applications that, that’s going into? And if you think this was sort of a one-time increase, or are we at the beginning of seeing more dewatering orders?

Walter, again, most of that increase is for rental So, they are going to – it’s going to go into the fleets of various equipment rental companies, and we are seeing that in the U.S. and Canada, and we are also beginning to see some interest – growing interest in the European market as well. Oftentimes, those rental pumps are going into oil and gas applications, particularly bringing water to the well site for fracking. We don’t make pumps for fracking, but getting water through the well sites. So, to the degree that natural gas pricing is up, that’s generally good for us. The degree that well and – is up is generally good for that business, but they are also used in a number of other applications as the pioneer brand is getting a stronger recognition in municipal bypass, construction dewatering, and then also in mining. So, we just see that, again, with the buoyant economy, the investment infrastructure, higher commodity prices, that’s generally good for that business. But it is a business that does ebb and flow more with the – again, it’s a capital – more capital intensive business, so it does have more ebbs and flows than say the residential replacement market for water pumps, which is much more predictable in its end use in the sales.

Okay. Great. Thank you. That helps. The – in the Distribution segment, I wonder if – with the recent rise in U.S. mortgage rates or for whatever reason, if you saw any sensitivity to that just like in the most recent weeks for residential products. And I guess going forward – kind of slowing them happening. Okay.

No, I didn’t mean to cut you off there. So, the distribution business is probably – it is not probably, it is our best leading indicator for the U.S. groundwater business because it’s interfacing directly with the contractors are installing the product. That said, when you look at rising rates, again, for new construction also for replacement business, that’s not going to impact the near-term because a large amount of a contractor work is, is replacement product. But – and for drilling of new wells, I pointed out earlier, many of these contractors are out weeks and months in commitments. So, we expect – those are committed for homes that have already been or permits have already been hold or homes that have already been financed. And so to the degree that there is a slowdown in rural housing, mindful that there may be a slowdown in housing in urban areas, but there is a slow out in rural housing. We might see that – we will see that effect out months from now. But again, because it’s such a large replacement component and the contractor mix is also towards, we have a large portion of our sales are ag and other applications besides resi, we are not expecting a significant impact to that stream. But at least we will have a forward indication with our distribution business.

Okay. Great. And then the last one, just a follow-on on the pricing. As you indicated, some of the pricing measures that you have taken to offset inflation have been pretty significant. So, I wonder how your customers are doing with the pricing, is everybody kind of in the same boat and accepting the price increases pretty rapidly, or are they – is there any kind of pushback to it yet?

Right now – and keep in mind, some of these higher numbers that Jeff put out, we sell some commodities straight through like distribution will sell steel pipe, plastic pipe, it’s bought on a spot basis, sold on a spot basis as cable, wire cable and so on. So, there are some things there – you are straight passing through the increase. And right now, everyone is focused on availability. And so we are seeing a little pushback on pricing because it’s well documented that the inflation is out there. You can pick up the paper and read about it and contractors and customers across the globe are looking for availability of product. So, that’s the paramount issue over price today.

Okay, great. Alright. Thank you.

Our next question comes from the line of Chris McGinnis from Sidoti. Your line is now open.

Hi. Good morning. Thanks for taking my questions. Nice quarter. I was just wondering if you can comment on expectation for cash flow for the year given the investment in inventory in Q1? Thanks.

Yes. Good morning Chris, glad you are able to get through this quarter. Sorry, we had an issue last quarter, but it’s good to connect today. In terms of cash flow for the full year, we do have a significant investment that we have made in inventory currently. So, we are carrying a higher level of inventory there than we normally would. The good news is our turns are still remaining generally in check there. So, we are not totally out of line with the inventory that we have. We do expect by the end of the year that we will be able to turn over some of that inventory and recover that working capital, which will be a favorable impact on our free cash flow for the year. I would say at this point in time, our goal for free cash flow, free cash flow conversion would still be at 100% free cash flow conversion. And that is obviously highly dependent on the ability to turn over a portion of that inventory and recover by the end of the year. But that’s still the target that we are shooting for and our expectation going forward.

I appreciate that. And then just maybe just a comment maybe on the outlook for M&A, just kind of given the – I guess the talk earlier around how well the integration has gone on the recent ones? Thanks.

Sure, Chris. We continue to look at opportunities. There is a number of deals that we get to look at. And when they make sense, we will move forward the pricing and the strategy, the strategic fit makes sense. So, we are going to continue to look at M&A, but we don’t typically chase deals. And many of the deals we do are with private companies held by families. And where and when they decide to sell is really up to them, but we just maintain close contact and they will pick up the phone and give us a call.

Great. I appreciate it. Thanks again for taking my questions. Good luck in Q2.

Thank you.

Thank you.

There are no further questions at this time. I am now turning the call back to Gregg Sengstack.

We thank you for joining us this morning for our conference call and look forward to speaking to you after the next quarter end. Have a great week.

This concludes today’s conference call. Thank you for participating. You may now disconnect.