Q2 2023 Franklin Electric Co Inc Earnings Call
The second fiscal quarter is the start of the busy season for our core northern hemisphere markets.
When we typically build inventories to meet demand.
However, its performance.
Supply base continues to improve.
During the quarter, we focused on reducing inventories to more normalized levels.
This operational focus and agility allowed us to accelerate shipments to convert backlog sequentially decreasing inventory by $26 million.
Reducing our backlog to $186 million.
As a result, our year to date, the cash flow improved by $105 million over the prior year.
We still have some work ahead of us, but we continue to make progress on our commitment to improve our cash flow generation.
Turning to our segments water systems delivered record sales and operating income for any quarter in its history with revenues and operating income each increasing approximately 4% drip.
Driven by robust sales of our large dewatering pumps and year over year growth other surface pump products.
Groundwater business was solid despite being negatively impacted by winter weather in the U S and other regions in previous few years and our intentional reduction of inter segment sales.
As our lead times are improving we are reducing transfers to the headwater distribution segment to rightsize their inventory of our products.
We expect that other customers are right sizing their inventories as well.
We believe these weather and Destocking I wanted to be transitory and we continue to see healthy end market demand across our business.
For example, in our water treatment business, our direct sales to consumers this quarter, we're up about 10% sequentially.
We're lapping the housing market slowdown that started last summer.
Overall, our system reported an operating margin of 16% flat year over year as leverage from sales growth was offset by the mix impact from large dewatering pump volumes.
Fueling systems reported revenue decrease of 7% compared to the prior year period, while delivering strong operating margins and record second quarter operating income.
After the sales decrease was due to us exiting our tank manufacturing business located in the 19th.
Julie systems record second quarter operating margin of 33, 2% an increase of 290 basis points compared to the prior year period was driven by robust demand for our higher margin critical asset monitoring fuel management systems and grid solution products.
During the quarter, we experienced further supply chain improvements.
Chip and certain component availability continues to be a challenge.
We understand that a major convenience store marketer customers are not reducing your plan build programs solid programs has slowed such that it appears that several plan 2023, new to industry builds are now likely to be completed in early 2024.
We expect that higher interest rates, whether in the availability of construction labor have all had an impact on the timing of these new builds.
We believe we are gaining market share and fuel management systems are continuing to build momentum with convenience store markets further the well documented stressing the electrical grid is driving investment in our grid solution critical asset monitoring products. This investment appears to be accelerating.
Distribution revenue increased 1% from the prior year period, despite unfavorable weather impacting to start with contractor installations commodity pricing continued to decline and customer inventories trending to more normalized levels.
Operating income decreased about 24%, primarily driven by lower commodity prices.
Segment delivered an operating margin of nine 2% historically strong margins 300 basis points below last year's record operating margin, which was aided by last year's strong inflationary environment.
More importantly, the operating margin increased sequentially by 590 basis points, reflecting a normal seasonal pick up in the second quarter.
Team remains focused on executing our strategy to grow and leverage the foundation, we built in our distribution business for the last several years.
Our balanced capital allocation strategy remains unchanged, we evaluate each opportunity on its economic and strategic merits and continue to return capital to shareholders through dividends and share repurchases.
First in our business and explore M&A opportunities.
While we are mindful of the macroeconomic pressures that continue to persist and the transitory issues of whether an impact of channel inventory right sizes across all three of our reporting segments Youre optimistic about the underlying demand in our core markets. Our second quarter results keeps us on track with our full year 2023 guidance, which was raised last quarter.
As a result, we are reaffirming our 2023 full year sales and EPS guidance range to one 5 billion to $2 to $5 billion in revenue and $4 25 to $4, 45% and earnings per share.
Before turning the call over to Jeff I'd like to mention our 2023 sustainability report, which was just published in June .
Expanded from previous year's this year's sustainability report provides an update on the progress we have made on several ESG initiatives as well as key areas of focus for the next few years I'm proud of the progress we have made in our ESG performance as reflected in this year's sustainability report, but as I said earlier, we have more work to deal.
With that I'll now turn the call over to Jeff for the financial highlights.
Thanks, Greg and good morning, everyone overall.
Overall, it was a record second quarter for Franklin Electric we established new quarterly records for consolidated sales and earnings per share.
Second quarter 2023, consolidated sales were a record $569 1 million a year over year increase of 3%. Despite the 2% headwind due to foreign currency translation.
Our fully diluted earnings per share were $1 27 for the second quarter 2023 versus $1 26 for the second quarter 2022.
Water systems sales in the U S and Canada were up 4% compared to the second quarter 2022.
Due to price and volume.
Foreign currency translation decreased Canadian sales by 1%.
The sales growth in the U S and Canada was led by sales of large dewatering equipment, which increased approximately a 100%.
Wet weather across most of the U S. In the first half of the year and some destocking in the U S Pro channel led to lower sales of groundwater pumping equipment.
Water systems sales in markets outside the U S and Canada were up 3% foreign currency translation decreased sales outside the U S and Canada by 10%.
Sales increases in EMEA, and Latin America, more than offset slightly lower sales in the Asia Pacific markets.
Water systems operating income was $50 8 million in the second quarter 2023.
$1 8 million or 4% versus the second quarter of 2022.
Operating income margin was 15, 8% flat compared to last year the.
The increase in operating income was primarily due to higher sales.
Distribution second quarter sales were a record $193 1 million versus second quarter 2022 sales of $191 1 million a 1% increase.
The distribution segment's operating income was $17 8 million for the second quarter year over year decrease of $5 5 million.
Operating income margin was nine 2% of sales in the second quarter 2023 versus 12, 2% in the prior year.
The distribution segment was negatively impacted by winter weather consistent with our prior comments relating to water systems.
Income was also negatively impacted by margin compression from lower pricing on commodity based products sold through the business.
Fueling systems sales were $80 4 million in 2023 versus second quarter 2022 sales of 86.0 million a 7% decrease.
<unk> system sales in the U S and Canada decreased 6% compared to the second quarter 2022, due to lower demand from Destocking in general inventory and supply availability and lead times improve.
We experienced growth in our fuel management systems in pumping systems as well as our grid solutions business.
Outside the U S and Canada fueling systems revenues decreased 8%, primarily due to the divestiture of the tank business in 2022, and lower sales in the Asia Pacific region.
Fueling systems operating income was $26 7 million, a second quarter record compared to $26 1 million in the second quarter 2022.
The second quarter 2023, operating income margin was 33, 2% compared to 33% of net sales in the prior year.
Operating income and margin increased primarily due to price realization and favorable product and geographic sales mix shift and disciplined expense management.
Franklin Electric's consolidated gross profit was $188 5 million for the second quarter 2023.
Down slightly from last year's second quarter gross profit of $189 3 million.
The gross profit as a percentage of net sales was 33, 1% in the second quarter 2023 versus 34, 3% in the prior year.
Gross profit margin was negatively impacted by weather and margin compression from unfavorable pricing commodity based products sold through the business.
Selling general and administrative or SG&A expense was $107 4 million in the second quarter 2023, compared to $108 3 million in the second quarter of 2020 to the.
The decrease in SG&A expense was largely due to disciplined expense management, including lower spending in marketing and advertising in the quarter.
G&A cost as a percent of net sales decreased to 18, 9% in the second quarter 2023.
From 19, 7% in the second quarter 2022.
Consolidated operating income was $80 9 million in the second quarter, 2023 down zero point $1 million or less than 1% from 81.01 million in.
In the second quarter 2022, despite an unfavorable foreign exchange translation headwind of approximately $1 million.
Second quarter 2023, operating income margin was 14, 2% versus 14, 7% of net sales in the second quarter 2022.
The decrease in operating income and operating margin was primarily due to the decrease in operating income from the distribution segment.
Other non operating expenses were higher in the second quarter 2023 compared to the prior year.
Interest expense was higher due to higher interest rates.
Next foreign exchange losses were higher primarily due to the stronger U S dollar and our operations outside the U S, particularly in Turkey and Argentina.
The effective tax rate was 19% for the quarter compared to 22% in the prior year quarter.
We generated approximately $43 million of operating cash flow in the first half of 2023 compared to using or negative $62 million in operating cash flow in the first half.
22, an improvement of $105 million.
In 2021, and 2022, we invested in higher levels of working capital to support our growth.
In 2023, we expect working capital to continue to return to more normal levels, leading to improved cash flows.
The company purchased approximately 9000 shares of common stock in the open market for about <unk> 9 million during the second quarter 2023.
At the end of the second quarter 2023, the remaining.
Chip authorization is approximately $1 1 million shares.
Yesterday, the company announced a quarterly cash dividend of <unk> 22 that will be paid August 17.
Shareholders of record as of August <unk>.
This concludes our prepared remarks, we'll now turn the call back over to Andrew for your questions.
Thank you.
As a reminder, if you have a question at this time. Please press star one one on your telephone. If your question has been answered or you wish to remove yourself from the queue. Please.
Please press star one one again.
One moment please for our first question.
And our first question comes from the line of Matt Summerville with D. A Davidson.
Yes.
Thanks, a couple of questions can you maybe just put a finer point on what you saw from a destocking standpoint, when in the quarter. It started if youre still seeing a lingering impact into the third quarter and maybe is there a way to quantify how much of an impact it had on Q2, so maybe just start there.
And then I have a follow up.
Yes, Matt This is Greg Adam sure, Jeff will have a follow on to this.
A little tough for us to parse it out because of the.
Look we had a couple of years of really dry weather.
C&I the housing slowdown from last.
Summer.
So yes.
Sales in the quarter and RAMAR reprise the most visibility United States you can see that.
Water sales are out the door or up 1% at actual units are up a little bit more than that because the value of the commodity piece was lower.
<unk> per for commodity that we sold like Piper wire.
So that's kind of the best indicators that the.
That business.
It was actually up off the door and yet we reduced our transfers by about $10 million into the business intentionally reduce their inventory.
So.
That's a bogey I must say that thats.
40% of kind of our sales from that channel.
So you can maybe extrapolate from that.
So it was kind of throughout the quarter.
Maybe you could put a finer point, Jeff may have a better a different point of view better. Please.
No I don't have a hard number.
To quantify the amount of Destocking as Greg said, it's really hard to kind of separate how much was weather related versus how much was destocking. What I can tell you is that we are seeing in supply chain improved.
Sure.
Delivery times to our customers have improved in the second quarter, our delivery times from our suppliers improved in the quarter we.
Others are seeing that as well, which is allowing them to thoroughly normalize or rightsize their inventory levels and so that certainly had an impact I also think that higher interest rates are playing a role here. So people are realizing that the cost of carry in inventory is higher today than it was a year ago.
And because of that but we're also looking to pull down those inventory levels.
Obviously.
We think it's a little more prevalent in fueling and we've seen on the water side.
Ask.
<unk>.
Some delays.
And starts on those new to industry installations, but.
Hard to hard to separate the effect between.
Whether in Destocking, we do believe its transitory I do think that we will see some impact carryover into Q3.
Once again hard to quantify what that is at this time.
Got it.
Follow up can you talk about.
What price realizations look like on a year over year basis for Franklin Electric and if there's a material difference in the businesses one of the things I'm trying to get out is how much.
Much did lower commodity pass through way on the distributions segment and then maybe Jeff. If you can comment on what you expect free cash conversion to look like for Franklin in 23. Thank you guys.
Yes, certainly.
Matt.
So I would say that.
Pricing realization that we're seeing on a year over year basis.
Thanks to the commodity piece out of headwater for this comment and I think we're seeing mid single digits generally pricing across the board and Thats water is kind of mid to high single digits at this point in time.
We've talked about that we expected as we progress through the year with price increases being less frequent this year.
And being more stable more of a return to normal pricing environment that we've seen in the past that those.
We will continue to.
The contract as we move through the year and we lap those price increases from last year.
The headwater side on the on the non commodity products on the pumps, the motors and controls and drives those types of products.
Theyre seeing good price realizations, and they'll see something consistent with water systems.
Mid single digit pricing.
But on the commodity.
Product side, we're seeing price decreases and thats.
Really what's driving a big part of the margin compression and water is seeing in their business.
In the first half of this year and then the.
The fueling business is seeing kind of low to mid single digit pricing. So everybody is positive on pricing at this point in time.
Free cash flow conversion, our target is and continues to be 100%.
Based on our.
Our current view for the rest of the year, we expect that we'll be able to.
To exceed that.
Bye.
A reasonable amount.
We go through the back half of the year and we typically generate very strong cash flow.
In the back half of the year and so we turned the corner in Q2 as you know we have very strong free cash flow in the quarter and certainly compared to the prior year and sequentially as well and so we expect to see pretty normal recovery of cash strong free cash flow generation in the back half of the year.
Understood. Thank you thanks, guys.
Yes.
One moment please for our next question.
And our next question comes from the line of Mike Halloran with Baird.
Yes.
Hey, good morning, everyone.
So.
Couple of questions here.
First.
I think probably goes with part of Matts first question a little bit.
We think.
When I hear what you're saying, which is lead times are normalizing.
But you had a destock in the quarter goes to kind of make sense, but at the same time, you're talking about a pretty healthy backlog level as you look in the environment. So.
Maybe you can just find.
Find a way to rectify those to me they seem contradictory on the surface, but obviously, it's what you are seeing below the surface. So love to understand how those all fit together.
Well I guess a couple of things are going on to your point is again.
Again, the second quarter.
I think as people are coming into the season in both the.
Compared to prior year, a little bit tougher comp from the standpoint of weather and then also I think people are just kind of burning through what they have on hand.
Our customers.
So we're seeing that at the same time R. R.
Large pump business that's.
A different business.
We work off the backlog so.
A meaningful portion of our of our backlog, which relates to large pumps, which are to be delivered over a series of months.
We are even seeing now some some appeals going into 2024 so.
So we have good visibility of that which is different than our short cycle business.
Short cycle businesses more.
We go into Q.
Q3, which used to be Q2 was our largest revenue quarter as a manufacturer now with a more meaningful distribution business Q3 tends to be maybe a little bit bigger than Q2. So we just we're in that part of the season, Yes, California has been you've got a lot of range theyre using a lot of surface water.
Micro market and we had.
Decent results in Northern Latin America, Europe did well.
Southern Africa, do well Asia, it looks like it's coming back. So we have a sense, that's where we have yes.
First cycle business, but our people are confident right now in the back half of the year.
Yes.
Helpful. I'll go ahead, sorry, sorry, Jeff I was going to say.
The comment I would add areas.
Greg talked about our large pumps in there more.
Longer order cycle versus our short cycle business.
A big part of the decrease we saw in our backlog was in our past news and so we've made great progress.
In the quarter in catching up on past dues.
And some of the decrease was on the large pumps, but a big chunk is also.
And the short cycle business. So we're very pleased with.
We're seeing the backlog.
In this environment and we're making.
Great progress in terms of reducing past dues and past dues are getting almost getting back to what we would say is a norm.
A normal level for us.
Once again pleased with that.
Well that makes sense, Jeff thanks for that add on and the second question relates to something I think Greg you touched on that briefly.
How to think about what seasonality now it looks like your business I understand the headwater piece, probably a little bit more sequential improvement.
But obviously you pointed out a bunch of things.
And going on into Q from a destock perspective, whether perspective that maybe changes how that cadence it looks from <unk> to <unk>. So.
More on the wetter the waterside water side cumulatively, but any help you can give to how you think that should play out and as we look through the back half of the year, how it compares to normal seasonality in kind of context would be great.
Yeah.
<unk>.
So.
Obviously, the middle part of the year is generally the strong sees as far as in the northern hemisphere, it's the drilling season and the groundwater business in <unk>.
Those are going to be our strongest periods of time every year is a little different.
So.
You can then take it year by year I would say, Greg can confirm our <unk>.
Correct me, if I'm wrong, but I think typically.
Historically, maybe Q2 has been a little bit of a stronger quarter for us, but in the last couple of years.
We've certainly seen that strength continue into Q3 and I think this year in particular with.
The wet weather that we saw in the first half of the year.
U S was really much wider this year than prior.
Prior couple of years that we've seen in the first half of the year and I think that's gonna.
Hopefully, we see things dry out there and I think we've started to see that already.
And that will lead to some pick up in activity in the back half of the year and then I would say the other thing that can impact that seasonality.
Only to be talking about our quarter and the end of the year, but certainly.
How long the season goes into into the fourth quarter and so if winter weather kind of holds off and we have a long season that will obviously will play into the full year seasonality.
Yeah.
Thanks, gentlemen, appreciate it.
Thank you. Thank you Mike Thank you.
Please for our next question.
And our next question comes from the line of Walter Liptak with Seaport Research.
Hey, good morning, guys.
Yes.
When youre answering the question, but I wanted to ask in a different way with the with the guidance for maintain four.
For 2023, and the weaker second quarter.
What are your key assumptions.
We're maintaining that guidance.
Yes.
I would say that.
Our outlook really hasn't changed materially for the full year, obviously, we're maintaining our full year guidance.
So from that perspective really little to no change from the last quarter ill Echo a couple of points that I made last quarter, we are expecting to see more of a return to normal in 2023 versus what we saw in 'twenty, one and 'twenty two.
We see inflation continuing to moderate.
We see <unk>.
And really organic growth.
Kind of mid single digits, certainly depending on our business in a region.
And then.
Obviously, if we get that kind of growth, we get good leverage on it and flow through.
For our bottom line results as well.
We expect supply chain is going to continue to improve.
Our base demand has been very solid and very very healthy we have a high.
Component of replacement demand in our in our core business and that's generally very stable.
That plays into our outlook and our view for the rest of the year. We continue to see FX translation continuing to be a headwind and there is about 2% in the second quarter, we generally view it to be about 1% to 2% we have started to see.
Some areas, where the dollar is stabilizing in Saudi.
Maybe even a weakened versus a couple of our currencies.
On the macro level, we're not economists.
I would say predicting.
The economy is going but I don't think we see a recession built into our outlook I think we see.
Economy, continuing to move along.
Current level through the end of the year and into 2024.
Okay, great and with the.
The Destocking issue and maybe the timing issue that you just spoke about in the previous question.
Is some of that related to the <unk>.
Agricultural irrigation markets and I wonder.
No.
What kind of visibility you have into things firming up in the third quarter.
Yes for our business.
We saw the AG side kind of hold up it was it was positive on a year over year basis, but kind of low single digits.
So we didn't see as much on.
The AG side.
I would say that.
More we've seen a little more on the residential the resi side.
And both our base water business, but also in water treatment and we've talked about.
Out of the water treatment has a little more exposure sensitivity on the resi side.
<unk> water business to us.
Okay, great. Okay. Thank you.
Thank you Paul.
Thank you I would now like to hand, the call back over to CEO , Greg <unk> for any closing remarks.
Thank you for joining us this morning.
Conference call, we look forward to speaking to you. After the end of Q3 with our results have a good week.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating and you may now disconnect.
Okay.
[music].
Okay.
[music].
Okay.
[music].
Okay.