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Franklin Electric Co Inc (FELE 1.06%)
Q3Â 2019 Earnings Call
Oct 29, 2019, 9:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the Franklin Electric Third Quarter 2019 Earnings Call. [Operator Instructions]
I would now like to hand the conference over to your speaker today, John Haines, Chief Financial Officer. Thank you. Please go ahead sir.
John J. Haines -- Vice President, Chief Financial Officer
Thank you, Ashley, and welcome, everyone, to Franklin Electric's third quarter 2019 earnings conference call. With me today is Gregg Sengstack, our Chairman and CEO. On today's call, Gregg will review our third quarter business results, and I will review our third quarter financial results. When I'm through, we'll have some time for questions and answers.
Before we begin, let me remind you that as we conduct this call, we will be making forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to various risks and uncertainties, many of which could cause actual results to differ materially from such forward-looking statements. A discussion of these factors may be found in the company's Annual Report on Form 10-K and in today's earnings release. All forward-looking statements made during this call are based on information currently available. And except as required by law, the company assumes no obligation to update any forward-looking statements.
With that, I'll now turn the call over to our Chairman and CEO, Gregg Sengstack.
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Thank you, John.
Our third quarter earnings were a record for any third quarter in the company's history. Our earnings per share grew 14% from the third quarter 2018. Our improvement in earnings was led by our Distribution segment, which grew operating income by over 70% as a result of more favorable weather conditions in much of the United States and acquisitions.
Our free cash flow after capital expenditures is about 65% higher through the first three quarters this year versus the same period of 2018. Despite these earnings and cash generation improvements, organic sales growth was below expectations in our Water and Fueling Systems businesses.
In the US and Canada Water Systems business, groundwater pump sales were up about 1%. Sales of groundwater equipment through the professional distribution channel were up 7% overall, due to increases in transfers to the Headwater segment and down 3% to third-party distributors.
Large dewatering pump sales were up 2% due to continued strength in rental equipment and markets. Backlog in this product line is down from the second quarter, primarily due to expanding manufacturing capacity. Sales of other categories of surface pumps were down mid-single digits, coming off a strong second quarter.
Moving outside the US, our Water Systems business grew organically mid-single digits in Latin America and EMEA. In Latin America, sales were flat in Mexico and up in Brazil, and increased more significantly in the Southern Cone. While Europe continues to be slow, our business in EMEA and Middle East as well as Africa improved meaningfully. You may recall that last year the Turkish lira devalued significantly, impacting our business there.
Our Fueling Systems business delivered another record quarter. Sales were up again, up double-digits in the US and Canada. This is offset by an approximate 20% year-over-year decline in business in China. In the rest of the world, we saw declines in EMEA, Latin America and Australia, offset by growth in India and Southeast Asia.
Turning to Distribution. With a more normalized weather pattern in the US and stronger execution from our new branch structure in the west, the Headwater team delivered organic growth of 2% and with earnings from the acquisitions early this year, record results for the quarter.
That brings me to our outlook for the fourth quarter. I will start with Distribution. As expected, the business improved in Q3, and we expect the fourth quarter to see a similar improvement over last year as well. We expect modest growth in our US groundwater and surface pumping lines, being offset by a tough comparison to last year for a large dewatering pump line.
Outside the US, we expect modest organic growth, somewhat offset by currency translation. Our US fueling business should continue to deliver strong growth and while we expect our business in China to recover some from Q3, we do not expect it to reach a level of last year's Q4, so we expect overall fueling organic growth to be modestly positive.
Based on our third quarter results and our current view of our end markets, we expect our fourth quarter to be similar to last year in both revenue and earnings. This would result in full-year 2019 earnings per share before restructuring at the low end of our current guidance.
I will now turn the call over to John to discuss the numbers in more detail. John?
John J. Haines -- Vice President, Chief Financial Officer
Thank you, Greg.
Our fully diluted earnings per share were $0.72 for the third quarter of 2019 versus $0.63 for the third quarter of 2018. Third quarter EPS before the impact of restructuring expenses was $0.73, compared to 2018 third quarter EPS before restructuring of $0.64. Restructuring expenses in the third quarter of 2019 were $0.4 million and were related to various manufacturing and distribution realignment activities, and resulted in a $0.01 impact on earnings per share in the third quarter of 2019.
Restructuring expenses in the third quarter of 2018 were $0.3 million related to branch consolidations and other asset rationalizations in the Distribution segment, and resulted in a $0.01 impact on earnings per share in the third quarter of 2018.
Third quarter 2019 sales were $348.4 million, compared to 2018 third quarter sales of $341.9 million, an increase of 2%. Sales revenue decreased by $5.8 million or about 2% in the third quarter of 2019 due to foreign currency translation. And we estimate this revenue decline lowered our earnings per share in the third quarter by about $0.02 versus the third quarter of 2018.
Water Systems sales were $199.8 million in the third quarter 2019, versus the third quarter 2018 sales of $199.3 million. In the third quarter of 2019, sales from businesses acquired since the third quarter of 2018 were $2.3 million. Water Systems sales decreased about 2% in the quarter due to foreign currency translation. Water Systems organic sales increased by about 2% compared to the third quarter of 2018. Water Systems operating income was $28.4 million in the third quarter of 2019 and in the third quarter of 2018.
During the third quarter, the company acquired First Sales, LLC, a manufacturer of water treatment and filtration equipment for the residential and commercial markets. First Sales, which has about $14 million in annual revenues, creates an operating platform in the highly fragmented water treatment space and provides synergies for our core groundwater customers and channels in North America.
Fueling System sales were $78.1 million in the third quarter 2019 compared to third quarter 2018 sales of $77.8 million and were a record for any third quarter. Fueling System sales decreased about 1% in the quarter due to foreign currency translation. Fueling Systems organic sales increased about 2% compared to the third quarter of 2018. Fueling Systems operating income was a record for any third quarter at $21.6 million compared to $20.9 million in the third quarter of 2018. Fueling Systems operating income was higher in the quarter due to favorable product sales mix.
Distribution sales were $87 million in the third quarter 2019 versus third quarter 2018 sales of $78 million. In the third quarter of 2019, sales from businesses acquired since the third quarter of 2018 were $7.3 million. The Distribution segment sales grew about 2% organically compared to the third quarter of 2018.
The Distribution segment operating income was $5.9 million in the third quarter of 2019, compared to $3.1 million in the third quarter of 2018. Distribution's operating income was higher in the third quarter due to higher sales volumes and acquisitions.
The company's consolidated gross profit was $117.6 million for the third quarter of 2019, an increase from the third quarter of 2018 gross profit of $113 million. The gross profit increase was primarily due to higher Fueling Systems and Distribution sales. The gross profit as a percent of net sales was 33.8% in the third quarter of 2019 versus 33% in the third quarter of 2018.
Selling, general and administrative expenses were $74.5 million in the third quarter of 2019, compared to $72.5 million in the third quarter of 2018. SG&A expenses from acquired businesses were $1.5 million. The company's SG&A expenses in the third quarter of 2019 declined by about $1.7 million due to the effect of foreign currency translation.
During the first quarter of 2019, the company changed the management reporting for certain transfers of manufactured products between Water and Fueling segments. This change was made to better align the production of certain products by reportable segment and sales to third-party customers. To consistently compare 2019 results to the prior year, certain 2018 net sales and operating income reclassifications were made.
These reclassifications resulted in lowering third quarter 2018 results of Fueling Systems and increasing third quarter 2018 results of Water Systems net sales by about $1 million and operating income was unchanged versus what was reported in this period last year. There is no impact on the company's previously reported consolidated financial statements.
During the third quarter of 2019, the company recognized about $2.1 million of foreign exchange transaction gains below the operating income line. Virtually, all of this gain was driven by the 36% weakening of the Argentinean peso during the quarter. The company has some hedge protection against the significant strengthening of the Argentinian peso.
In the third quarter of 2019, our effective tax rate, net of discrete events, was about 20% higher than the third quarter 2018 effective tax rate of about 16%. The higher tax rate resulted in about $1.6 million of incremental income tax expense, had the third quarter 2018 rate been in effect. The higher tax rate negatively impacts earnings per share by about $0.04. 20% is a reasonable estimate for the full-year 2019 effective tax rate.
The company ended the third quarter of 2019 with a cash balance of $47.8 million, which was $11.4 million lower than at the end of 2018. Cash decreased primarily due to acquisitions and debt repayments. The company had $79.1 million in borrowings on its revolving debt facilities at the end of the third quarter of 2019 and $89.1 million in borrowings at the end of the third quarter of 2018.
As of January 1, 2019, the company adopted the new lease standard and has recognized additional operating liabilities of about $25 million for its outstanding operating leases with corresponding right-of-use assets of the same amount. The impact of this new accounting standard is non-cash in nature and does not affect the company's cash position. The company does not consider the impact of this standard to be material to the consolidated results of operation or to the cash flows.
Cash from operations through the first three quarters of 2019 was about $90 million, or 119% of net income compared to $60 million, or 74% of net income for the same period of 2018. Our free cash flow, cash from operations less capital expenditures is about $75 million, and about 65% higher through the first three quarters of this year compared to the same period of 2018.
This improvement in cash flow was primarily due to a reduction in working capital requirements as the company focuses on improvements in customer and vendor terms. The company did not purchase any shares of its common stock in the open market during the third quarter of 2019.
At the end of the third quarter 2019, the total remaining authorized shares that may be repurchased is about 1.3 million. On October 22nd, the company announced a quarterly cash dividend of $0.145 per share. The dividend will be paid November 15th to shareholders of record on November 1st.
This concludes our prepared remarks. And we would now like to turn the call over for questions.
Questions and Answers:
Operator
[Operator Instructions] And your first question comes from Edward Marshall with Sidoti & Company.
Edward Marshall -- Sidoti & Company -- Analyst
Hey, guys. Good morning. How are you?
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Good morning, Ed.
John J. Haines -- Vice President, Chief Financial Officer
Good morning.
Edward Marshall -- Sidoti & Company -- Analyst
So, I'm looking at Headwater on a sequential basis. So from 2Q '19, revenue is about the same. Was there something in the mix, or was there something structurally that changed within your Headwater division that had a much better drop through relative to Q2 of this year?
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Yeah, Ed. Couple of things on Headwater. We were hurt in the first half of the year on the top line by the weather as we've talked about. It was a much more moderate weather environment really across the country in the third quarter. Our business in the Southeast part of the United States, especially the Driller Services, Inc., business had a really nice quarter. The drop-through, though, the benefit that we saw in operating income was really in the businesses that are all in the western part of the United States, the Western Hydro and 2M acquisitions.
Remember that last year, those were the businesses that were going through a lot of the branch restructuring and rationalizations. We closed some branches. We combined some branches. We, otherwise, rationalized some assets there. And despite the fact that, that business had a decline in revenue, they had a really meaningful improvement in their operating income.
So, those two businesses combined had almost a 60% increase year-over-year in third quarter operating income. So, it wasn't due really to a lot of top line benefit there, but it was due to a lot of these costs and restructuring efforts. And then that combined with the strength that DSI in the Southeast and combined with the acquisition we did this year, a company called Milan in Michigan, those were all the main drivers for the improved operating results at the Distribution segment.
Edward Marshall -- Sidoti & Company -- Analyst
Got it. And if you took the costs last year, why did we see the impact in Q3 and not Q2? I'm just trying to understand that.
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Ed, you've got to, again, look at this -- yeah, we were going through some changes and so there is some stabilization. There is some margin pick up. Q2 was -- people were still recovering from a very weak Q1, I think pricing was just a little bit more aggressive out there. So, we saw some stability in margins. We again saw some better execution, and we saw some lower fixed cost as well.
Edward Marshall -- Sidoti & Company -- Analyst
So the structural changes is now, I won't call it permanent, but are more normalizing as we move forward and this is kind of a margin that we should anticipate on a go-forward?
Gregg C. Sengstack -- Chairman and Chief Executive Officer
These are the kinds of margins we would expect in the season, which would be Q2, Q3, and then keep in mind Q4, Q1, which is a low season as when we get delevered. And why we think we are going to have an improvement year-over-year to last year's Q4 -- Q4, Q1, of course, we are even marginally profitable or marginally lose money.
Edward Marshall -- Sidoti & Company -- Analyst
Got it. Okay. So looking after the fueling business, I think, John, you cautioned us last quarter or two, not get comfortable in the high 20s, the mid 20s is more of the range but the run rate continued. What's going on? Is it continuing to be the positive mix in North America, and how does that -- how does that look for the balance of the year and into 2020?
John J. Haines -- Vice President, Chief Financial Officer
Yeah. The OI margin, really two things. It is positive sales mix set. So, our sales in the US and Canada, our fuel management systems continues to be very strong and we have a very nice margin profile on those products. The second thing that I've mentioned in the past, as you know, the business does a really good job of leveraging its fixed costs. So, there is not a ton of SG&A at or other fixed cost add as the business continues to grow its top line, so that leverage is helpful there as well.
The caution remains around a mix shift, away from maybe some of the more favorable profitability products. Geography mix also matters. So in quarters where we might see big spikes in revenue in some of the developing world markets, that can impact our margin profile as well. So, it was a good, it was not a great growth quarter, organic growth quarter for fueling mainly because of China. But from our -- from an earnings perspective, it continues to be very strong.
Edward Marshall -- Sidoti & Company -- Analyst
Okay. Good, And then the foreign exchange gain below operating income, looks like there was a change on the balance sheet. Did you sell something or what's going on there, the $2.1 million?
Gregg C. Sengstack -- Chairman and Chief Executive Officer
No, the $2.1 million is a gain that is primarily driven by the hyperinflation accounting in Argentina. So the reason we benefit from that add is that the hyperinflation accounting rules require us to separate our assets into monetary versus non-monetary assets and liabilities. Our net position in Argentina is a net monetary liability. So, that's unusual and the big portion of that is driven by deferred tax liability. It's unusual in the sense that many other companies have net asset position, not net liability position. So when the Argentinean peso weakens to the US dollar, which it did significantly in this quarter and has year-to-date, we will recognize gains. So, that's the rationale for why we have that significant gain in the third quarter. It had a -- there was a big movement in advance of this past weekend's election in the third quarter in the peso to the US dollar.
Edward Marshall -- Sidoti & Company -- Analyst
Got it. Thanks very much.
Operator
[Operator Instructions] And your next question comes from Walter Liptak with Seaport Global.
Walter Liptak -- Seaport Global Securities -- Analyst
Thanks. Good morning, guys.
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Good morning, Walt.
John J. Haines -- Vice President, Chief Financial Officer
Good morning, Walt.
Walter Liptak -- Seaport Global Securities -- Analyst
Wanted to ask about the trends that you've seen in Fueling Systems in North America. It sounds like the market is pretty robust and it should continue. I wonder what kind of project funnel you've got looking into 2020 and you think this kind of growth rates can continue?
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Yeah. Walt, we haven't gone out with 2020 guidance, just to say [Phonetic] broadly with capital is relatively inexpensive. And you're seeing, I think a secular move by major marketers to acquire and upgrade large networks of stations. And I think that's driving some of the underlying growth. You're seeing that through us. I think Dover and Ford have both reported and they had, I think, something north of 10% growth as well. And I think theirs was driven by North America. So the market is robust. We're all seeing this investment. These major markets are seeing the returns by making these upgrades to the stores. A lot of these stores were upgraded or the forecourts were upgraded over 20 years ago when the last major tank regs came out.
So it's kind of a, maybe a natural secular time in the marketplace. And then Franklin is doing well with getting wins and getting market share gains on some of our fuel management system technology, which we mentioned earlier, is what's resulting in some of the margin improvement in North America as well. So, as long as we continue to see, I think, a relatively favorable capital environment, there is some upgrade for the EMV initiative for dispensers that -- you could argue that helps us. You can also argue that hurts us because of where the dollars go, but we've all seen some pretty nice lift here in the North American market.
Walter Liptak -- Seaport Global Securities -- Analyst
Okay. Great. And the China market, that seems to be slowing a little bit sooner than we thought. And maybe a little bit more dramatically. Was it the same issue that was -- that you talked about last quarter for underground? Or was there something else that was going on this quarter to slow sales in China?
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Again, two factors seem to be affecting our business in China. One is, it's your comment, I think things are getting done a little faster and with a little bit more for the independent marketers, not the state-owned enterprises, a little bit more with local products than we anticipated. The second factor is, I mentioned I believe last quarter, is that the scale of the capital that the major -- the state-owned enterprises are allocating to station upgrades has been shrunk or shrunken I guess. And so what we're seeing is that the station owners or the state-owned enterprise stations are only investing in the underground piping systems and not so much in fuel and fuel management or fuel pumping and some of the other products we're capturing as well. So, a couple of factors there have slowed it down.
The third factor is that we are recognizing their 70th year at the end of the month and the end of the quarter. So, there is some slowdown. We know that impact several initiatives. There was a slowdown for several weeks in construction. We think that's what's going to come back a little bit in Q4. The thing we're looking for in China now is that, as the piping initiatives kind of winds its way down is we're looking at in-station diagnostics as being the next wave for the Chinese state-owned enterprises and other stations to be upgraded, so that there can be a continuous monitoring of the vapor recovery systems. And we see that as being the next kind of multi-year initiative, and we expect to see some traction there. We just don't know if it's going to be early 2020 or later in the year. So, we're having one kind of declining revenue source. We should have a lift in other revenue source. How they cross over is not yet clear for us.
Walter Liptak -- Seaport Global Securities -- Analyst
Okay. Got it. Sounds good. And if I could switch over to water, the groundwater business and I wonder if you could just review with this end market and how that tends to trend in the fourth quarter? I think it's still relatively slow. And thinking about 2020, could there be a pickup, kind of a reversion back, I mean, after the tough year this year?
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Sure. So, Walt, two things. One is, is that, to your point, it's been pretty slow, I'd say generally kind of flattish. Our sales to third-party distribution because we don't have visibility on their inventories other than anecdotally for the year of 1% or 2%, but for the quarter were down 2%. Our best visibility is on our own distribution out-the-door sales, which are down year-to-date, but were up in the quarter 2%.
And I'd say that Headwater's footprint is more western based. And so that's where we had the toughest situation with California and just in kind of the worse -- as some of the Midwest. The Southeast been relatively dry. We've done relatively well there. Looking at 2020, if we have another 125-year events or year, once a year on record, I would expect the results to be similar. But if we have a more normalized weather year, that will be, of course a -- it should be a positive driver for us.
Walter Liptak -- Seaport Global Securities -- Analyst
Okay. Sounds good. Thank you.
Operator
I am showing no further questions at this time. I will now turn the call back to Greg Sengstack.
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Again, we thank you all for joining us for our third quarter conference call. We look forward to speaking to you in the New Year for the fourth quarter and annual results. You all have a good week.
Operator
[Operator Closing Remarks]
Duration: 29 minutes
Call participants:
John J. Haines -- Vice President, Chief Financial Officer
Gregg C. Sengstack -- Chairman and Chief Executive Officer
Edward Marshall -- Sidoti & Company -- Analyst
Walter Liptak -- Seaport Global Securities -- Analyst
