Earnings Call Transcript - FELE Q4 2021

Operator, Operator

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. Please be advised, today's conference is being recorded. I would now like to hand the conference over to your host today, Jeff Taylor, Chief Financial Officer. Please go ahead.

Jeff Taylor, Chief Financial Officer

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 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.

Gregg Sengstack, Chairperson and CEO

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, where we established new all-time full year records 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, and most likely through the balance of 2022 in the case of some input materials and geographic regions. Our team navigated these ongoing challenges well and is 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 and 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, and 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 an 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 delivering 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, and 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 in water treatment distribution in our grid solutions businesses.

Jeff Taylor, Chief Financial Officer

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 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 call out 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 of 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 was 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 and 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.

Operator, Operator

Thank you. Our first question comes from Mike Halloran with Baird. Your line is open. Please go ahead.

Michael Halloran, Analyst

Good morning, everyone.

Gregg Sengstack, Chairperson and CEO

Hi, Mike.

Jeff Taylor, Chief Financial Officer

Good morning.

Michael Halloran, Analyst

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?

Jeff Taylor, Chief Financial Officer

Yes. Good morning, Mike. Thanks for the questions. In regard to our guidance, there are 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 the 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, the first quarter, first half of the year.

Michael Halloran, Analyst

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

Jeff Taylor, Chief Financial Officer

On the seasonality?

Michael Halloran, Analyst

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

Jeff Taylor, Chief Financial Officer

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

Michael Halloran, Analyst

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?

Jeff Taylor, Chief Financial Officer

Yes. So, Mike, while we don't provide margin guidance by segment, we do observe that if you analyze the midpoint of our guidance range, it indicates we plan to keep our margins within the usual ranges expected for our three business segments. The lower end of the guidance may reflect higher inflation than what is accounted for in the midpoint, and the higher end would suggest the opposite. Overall, we anticipate the segments to remain within their normal ranges.

Michael Halloran, Analyst

Okay. I appreciate it. Thank you.

Operator, Operator

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

Matt Summerville, Analyst

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 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.

Gregg Sengstack, Chairperson and CEO

Thanks, Matt. Looking at the full year of 2021, inflation and pricing have been quite interesting and dynamic. In the first half of the year, it started off slowly but then accelerated as we progressed. During the second quarter, we were slightly below in terms of pricing covering costs, which we noted in the third quarter. In the fourth quarter, we were also just slightly below in that pricing-cost aspect. However, for the entire year, we managed to stay ahead, maintaining our position on a full year basis. As we approach 2022, we are continuing to implement and assess additional pricing actions, considering all options available. Each business varies slightly; some may see reduced price increases while others might experience an increase in the base price of the product. In other markets, there could be surcharges to cover specific materials, components, or freight. So, we are treating everything as a possibility.

Matt Summerville, Analyst

In the recent past, what did the number for open orders or backlog look like coming out of the fourth quarter? Did it increase sequentially compared to Q3? Additionally, for Gregg, regarding your guidance for the full year '21, what were the internal surprises that contributed to the upside in the fourth quarter? Thank you.

Gregg Sengstack, Chairperson and CEO

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 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.

Jeff Taylor, Chief Financial Officer

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.

Matt Summerville, Analyst

Got it. Thank you, guys.

Gregg Sengstack, Chairperson and CEO

Thank you, Matt.

Jeff Taylor, Chief Financial Officer

Thank you, Matt.

Operator, Operator

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

Ryan Connors, Analyst

Thank you for taking my question. I'd like to discuss the distribution business from a broader perspective regarding margins. It's been challenging to determine the margins for each quarter. While we've seen improvements over time, there remains significant volatility from one quarter to another. How do we assess whether we're nearing a stable run rate for that business, making it easier to develop a model?

Gregg Sengstack, Chairperson and CEO

Sure. Ryan, since I have some background on this, I'll take this one. If you recall, when we established distribution, we mentioned that we were aiming for an operating income range of 4% to 6%. The business has a seasonal pattern. In the initial years, we actually incurred losses in the first and fourth quarters but gained significantly in the second and third quarters to compensate. This year, we turned a profit in all quarters, which reflects the business maturing. I've observed other distribution companies with publicly available data that show a similar trend, where seasonality is present but as the business grows, it starts to earn profits in the first and fourth quarters as well. That's our expectation moving forward. We're optimistic about reaching a 7% margin overall for the year, bolstered by strong performances in the second and third quarters. We're pleased to report that this is the first year we've exceeded the 4% to 6% range, and we are confident that this business will continue along the same lines into 2022, showing similar dynamics and seasonality as in 2021.

Ryan Connors, Analyst

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?

Gregg Sengstack, Chairperson and CEO

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 low point now, but we expect a 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 are 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 to work 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 as a good business. It's stable and again in the low teens unfortunately. And we still see some big upside if they get initiatives behind in-station diagnostics.

Ryan Connors, Analyst

Got it. Okay. Thanks for your time.

Gregg Sengstack, Chairperson and CEO

Sure. Thank you, Ryan.

Jeff Taylor, Chief Financial Officer

Thank you, Ryan.

Operator, Operator

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.

Gregg Sengstack, Chairperson and CEO

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.

Operator, Operator

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